Cash purchase of primary residence

[TheAbacus]

My wife and I are both "middle income" physicians, who currently have jobs in a place where we want to work for an intermediate term (3-5 years to fulfill visa requirements). We work in a small town, and the housing market here has been in what seems to be a perpetual lull. Therefore, I am quite skeptical in buying a house - I am concerned that a property which interests us, may not sell off easily when the time comes. We're renting at the moment.

1. What are the pros and cons of planning a future primary residence purchase with cash?

2. What vehicle would you consider to save money for such a purpose? I have noted that Johanna has suggested high quality corporate bonds, but with the rising Fed rate anticipated (3 times in 2017, per reports), I am concerned if this would be a bad time to enter the bond market.

[The White Coat Investor]

1. Main benefit is the home is paid off from day one. Main downside is you can't leverage up the rest of your life with relatively attractive debt. Same arguments you see with paying off a mortgage early.

2. Depends on how firm the date when you need the money is and the consequences of not having it. If you need the money in "3-5 years" and you're perfectly fine with waiting until 5 if markets are down at 3, then you can afford to take more risk. I would argue you could just get a mortgage for a few years until recovery if the market is down, so I'd probably take some significant risk with it. But reasonable people could range anywhere from 100% CDs to 100% equity.

[DMFA]

Leverage, basically, and a big chunk of your assets all at once.

The argument is that mortgage interest is tax-deductible and you can get a very low rate on mortgages anyway; e.g. if you get a 15-year fixed at 3%, and you're in the 33% bracket, your effective interest is 2%, which can be right around inflation (though it recently has been < 1% in some years).  That money would most likely be earning greater than that in the market over those 15 years.

If you're hitting AMT, though, then I don't think you can deduct mortgage interest from that.  I admit I know very little about AMT.

You'll probably want a lower-risk, tax-efficient holding which still has some likelihood for growth.  Corp bonds are decent for that, but they can be tax-inefficient since they earn on dividends.  Munis are tax-efficient, but don't earn as much.  If you want to be a bit more aggressive, you could add some stocks for growth at the cost of risk.

You may want to *consider* a balanced, tax-managed fund like VTMFX, which is a 50/50 passive fund with low-dividend (2.1% div yield) stocks and intermediate-term, mid-rate (7-15 yr, 4-6%) municipal bonds, *if* that's the sort of risk/reward and allocation you'd be interested in.

[TheAbacus]

Thank you both for your insights. Do you think my rationale makes sense? Is there a certain mortgage rate (numerically) where you would willingly take on a mortgage, for the sake of leverage?

I was trying to mentally justify a cash purchase of a home as:

1. Mortgage interest rates will rise by the time we're ready to purchase - that might translate into a 100% guaranteed ROI of 4% or higher.

2. All cash offer may allow us to negotiate a lower rate (I hope I am correct, though I am uncertain how an all cash offer benefits the seller).

3. The dreaded AMT does allow deductions for mortgage interest on the primary residence. However, there appears to be a growing sentiment in Congress to restrict itemized deductions - speculative, but if mortgage interest rates cannot be wholly deducted, then that makes mortgages rather unattractive.

[TheAbacus]

DMFA wrote:

 

You may want to *consider* a balanced, tax-managed fund like VTMFX, which is a 50/50 passive fund with low-dividend (2.1% div yield) stocks and intermediate-term, mid-rate (7-15 yr, 4-6%) municipal bonds, *if* that’s the sort of risk/reward and allocation you’d be interested in.

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Thank you for this recommendation. I get a feeling that balanced funds are often frowned upon by seasoned investors, but admittedly these are reasonable for a novice like myself. Having said that, a significant portion of the fund that you mentioned are in bonds. This brings me back to my concerns in the original post - is it a bad time to enter the bond market at the moment, for reasons mentioned above?

[PhysicianOnFIRE]

I bought our current home with cash, and I've been happy with that decision. Closing was simple, and we are debt free, which is a wonderful thing. We sold some taxable investments to cover a majority of the costs, and had started saving some cash in a 1% interest savings account when we decided to go the cash route.

Another benefit of paying with cash is that you'll probably be less inclined to go over your prescribed housing budget. If we had gone with a mortgage, we could have easily decided to spend another $100,000 or $200,000 when we had set out to look only in a lower price range.

 

[TheAbacus]

PhysicianOnFIRE wrote:

I bought our current home with cash, and I’ve been happy with that decision. Closing was simple, and we are debt free, which is a wonderful thing. We sold some taxable investments to cover a majority of the costs, and had started saving some cash in a 1% interest savings account when we decided to go the cash route.

 

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Good article, hot off the press! Thank you. Does a cash purchase impact closing costs as well?

 

PhysicianOnFIRE wrote:

Another benefit of paying with cash is that you’ll probably be less inclined to go over your prescribed housing budget. If we had gone with a mortgage, we could have easily decided to spend another $100,000 or $200,000 when we had set out to look only in a lower price range.

 

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That's the scary truth about credit, in any form. Credit cards, mortgages, even educational loans, change consumer behavior and spending patterns.

[DMFA]

If we're getting into the guesswork of what Congress might or might not do, then you've got to wonder if the Trump tax plan well even have AMT or something like it.

[PhysicianOnFIRE]

TheAbacus wrote:

Does a cash purchase impact closing costs as well?

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Definitely. I don't recall the details, but some of the closing costs are related to the mortgage itself, so those are eliminated.

We also bought a For Sale By Owner home (and sold our previous home the same way). In both cases, neither party was represented by a realtor, so we saved tens of thousands in fees there (main benefit is to the seller).

 

[TheAbacus]

I really appreciate all the wisdom and personal experiences everyone is sharing!

Going back to my original question #2 - it feels like a really bad time to enter the bond market, based on what I've read (rising Fed rate). Does anyone have any thoughts on this aspect?

[jfoxcpacfp]

TheAbacus wrote:

Going back to my original question #2 – it feels like a really bad time to enter the bond market, based on what I’ve read (rising Fed rate). Does anyone have any thoughts on this aspect?

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The original recommendation to buy high quality corporate bonds timed to mature at date of need has nothing to do with "getting into the bond market" as in "speculating" that prices will rise or fall. The amount of the loan is repaid at maturity.

As for a bond fund...well, you probably know my distaste for bond speculation and it's even greater with interest rates rising. Please do not speculate on short-term goals. Liquidity and safety are far more important.

Now on to the residence:

• Buying a residence that you may sell in 3 years is not a good idea. It is a little different from investing in a single class of stock for the short term (which is speculative) in that you at least get to occupy the home so you get personal use out of it. But no certainty on growth. Growth is for the long term.


• Buying a house with cash in the current interest rate environment is an emotional, not practical, decision. As others have mentioned, future tax deductions and brackets are particularly uncertain, at least for the next few months. I believe you can do better.

[TheAbacus]

Per your article: "The chance that you may make a killing is far outweighed by the risk that you will need to move the reception to Cracker Barrel when that bond fund takes a nosedive."
:lol: But bonds can default too, right? Can bond funds reduce that risk with diversification? The fact that I am asking such basic questions suggests that I have a lot to learn.

jfoxcpacfp wrote:

• Buying a residence that you may sell in 3 years is not a good idea. It is a little different from investing in a single class of stock for the short term (which is speculative) in that you at least get to occupy the home so you get personal use out of it. But no certainty on growth. Growth is for the long term.

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Good. That is the reason we're not buying at the moment - we do not anticipate staying here beyond 3-5 years. Furthermore, selling property in this market has been remarkably difficult, based on how long some of these homes have remained on the market.

jfoxcpacfp wrote:

• Buying a house with cash in the current interest rate environment is an emotional, not practical, decision. As others have mentioned, future tax deductions and brackets are particularly uncertain, at least for the next few months. I believe you can do better.

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The plan is to buy a house when the need arises, in 3-5 years. Market situations / interest rates may be different at that time. Having said that, since you mention that buying with cash would be an impractical decision, are you that heavily in favor of a low interest mortgage? Is there a mortgage interest rate at which you would feel you'd rather just purchase with cash, assuming both options are feasible?

[jfoxcpacfp]

TheAbacus wrote:

Per your article: “The chance that you may make a killing is far outweighed by the risk that you will need to move the reception to Cracker Barrel when that bond fund takes a nosedive.” But bonds can default too, right? Can bond funds reduce that risk with diversification? The fact that I am asking such basic questions suggests that I have a lot to learn.

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I stipulate high quality corporate bonds exactly because of the extremely low risk of default and to explain why the concern you expressed in your 2nd question is not valid. Even money under the mattress can be stolen. To reiterate, I am not talking about using bonds as an investment, merely as a way to earn more on your money without the risk of investment. There is no "interest rate risk". A bond fund is not a diversification, in my opinion, unless you intend to use bonds as an investment, which I never recommend.

The learning never stops, but over-education can sometimes ruin a perfect solution.

[TheAbacus]

Thank you for your opinion.

[Ed_CLU]

One additional note: as a cash buyer you will be much more valuable to the seller (no mortgage contingency in the offer).  And upon closing you would be able to pay ALL (both buyer and seller) closing costs out of your pocket and reduce the sale price accordingly.  This would put a lower price on the deed which would reduce your transfer tax and future property taxes.  Depending on where you live and how long you own the house this could lead to significant savings.  These strategies are typically not possible when a bank is involved.