Cash Stash: Navigating Investments Before Buying A Home

There are several factors to consider when deciding whether to invest cash before buying a house. On the one hand, paying in cash can speed up the buying process, lower long-term costs, and provide instant 100% home equity. It can also be more attractive to sellers, who won't have to worry about financing falling through at the last minute. Additionally, skipping out on interest payments can save a lot of money in the long run.

On the other hand, investing cash before buying a house can provide better financial flexibility and allow you to use the money for other purposes, such as investing or saving for retirement. It's also important to consider the opportunity cost and how much liquidity is required in your financial portfolio.

Ultimately, the decision depends on individual financial situations, goals, and preferences. Consulting a financial advisor or tax professional can help weigh the pros and cons of each option.

Weigh up the pros and cons of paying cash vs. getting a mortgage

Weighing up the pros and cons of paying cash vs. getting a mortgage is an important step in the home-buying process. Here are some key points to consider:

Paying Cash for a Home:

Pros:

• No interest on loans: Paying cash eliminates the cost of interest on loans, which can save tens of thousands of dollars over time.
• Faster buying process: Cash purchases often have a faster buying process as there are no loan approvals or lender requirements, making it more attractive to sellers.
• No lender-related closing costs: Paying cash helps you avoid lender-related closing costs such as origination fees, resulting in significant savings.
• Instant home equity: Paying cash gives you instant 100% home equity.
• No loan approval worries: Cash offers are more likely to be accepted by sellers as they don't have to worry about financing being denied.

Cons:

• Reduced financial flexibility: Paying cash for a home can reduce your financial flexibility for other goals, such as retirement or unexpected expenses.
• Opportunity cost of investing: Investing the cash instead of using it for a home purchase may provide higher returns over time.
• Potential impact on other expenses: Paying cash for a home may impact your ability to cover other expenses like homeowners insurance, utility bills, and home maintenance.
• No mortgage interest deduction: When paying cash, you don't get the tax benefit of deducting mortgage interest payments.

Getting a Mortgage:

Pros:

• Financial flexibility: A mortgage allows you to preserve your cash for other financial goals and investments.
• Tax benefits: Mortgage interest payments are tax-deductible, which can reduce your tax bill if you itemize deductions.
• Credit score improvement: Regular and timely mortgage payments can help improve your credit score over time.
• Easier qualification: Getting a mortgage may be an option if you have a thin credit file or difficulty qualifying for a cash purchase.

Cons:

• Higher overall cost: Mortgages come with interest payments that add up over time, resulting in a higher overall cost compared to paying cash.
• Longer buying process: The mortgage process involves loan applications, approvals, and underwriting, which can take several weeks and increase the risk of the deal falling through.
• Additional closing costs: Getting a mortgage incurs lender-related closing costs, such as origination fees, which can be significant.
• Appraisal requirements: Mortgages often require appraisals, and if the home appraises for less than the offered price, it may require a larger down payment.

Assess your current financial situation

When assessing your current financial situation, there are a few key areas to consider:

Debt and Credit Score

Start by evaluating your debt and credit score. Aim to reduce overall debt and improve your credit score, as these factors will impact the interest rate on your loan. A higher credit score will typically result in a lower interest rate. You can request a free copy of your credit report annually to check your score. Additionally, calculate your debt-to-income (DTI) ratio, which lenders use to determine your ability to take on additional debt.

Monthly Budget and Spending

Review your current and future spending to determine how much home you can afford. As a general guideline, total debt payments, including your future mortgage, should not exceed 36% of your pre-tax income. Similarly, your total monthly housing costs should not exceed 28% of your pre-tax income. It is recommended to live with a future house payment for a few months to test your budget. This can be done by depositing the difference between your current rent or mortgage and your expected housing and maintenance costs into a savings account.

Down Payment and Emergency Fund

Determine whether you have sufficient funds for a down payment. While a 20% down payment is ideal to avoid paying private mortgage insurance (PMI), it is not always necessary. There are loan options available that require as little as 3% down. However, a larger down payment can provide significant savings in insurance costs over time. In addition to the down payment, ensure you have an emergency fund to cover unexpected expenses, ideally covering at least three months' worth of living expenses.

Income and Employment Stability

A reliable source of income is crucial for making monthly mortgage payments. Lenders will consider your regular income when deciding on the loan amount. While there is no specific minimum income requirement, maintaining a DTI below 50% is generally recommended for approval. Additionally, consider your employment stability, as a consistent income will help you anticipate your monthly budget and afford a home.

Additional Homeownership Costs

Remember that the costs of homeownership go beyond the monthly mortgage payment. These include insurance, property taxes, closing costs, utilities, and maintenance. Be sure to factor in these expenses when assessing your financial readiness for buying a house.

Consider your financial goals

Before buying a house with cash, it's important to consider your financial goals and ensure that this decision aligns with them. Ask yourself if you're willing to sink all your money into an all-cash home purchase, or if you would rather invest in retirement accounts or other financial instruments.

Paying all cash for a property means you won't have a mortgage loan and the accompanying interest payments. However, this also means you won't be able to claim the mortgage interest deduction to lower your tax bill. Additionally, if you plan on applying for a mortgage or loan in the future, buying a house with cash will leave you with less money for a down payment or repayments.

It's crucial to weigh the opportunity cost of investing your cash in a home against the potential returns of alternative investments. Consult a financial advisor or wealth manager to make an informed decision.

Compare to alternative investments

When considering investing cash before buying a house, it's important to weigh the benefits of using cash to buy a home versus taking out a mortgage, and to compare these options to alternative forms of investment.

Liquidity

If you invest your cash in a home, you may find yourself with a lot of money tied up in a highly illiquid asset. This means that you can't quickly turn it back into cash in the event of an unforeseen financial emergency.

Returns

Over time, investing has the potential to earn more profits than you would save on interest and closing costs by buying a house with cash. The average annualised return of the S&P 500 is about 10%. In the long run, an investment in a low-fee index fund following the S&P 500 would likely have given you a much higher net worth than you would have paid in interest on a mortgage of the same amount.

Risk

Alternative investments often carry more risk than conventional investments. This is because they don't have the same historical track record as other investment opportunities, they may not be as regulated, and they might offer less transparency.

Tax benefits

There are also tax benefits to investing in stocks and shares. If you use your extra cash to invest in the stock market directly or to live on while investing in a tax-advantaged account, you will potentially save more in taxes than you would have by itemising your mortgage interest.

Other options

There are other alternative investments to consider, such as commodities, derivatives contracts, intellectual property, cryptocurrencies, non-fungible tokens (NFTs), art, collectibles and antiques.

In conclusion, there are several factors to consider when deciding whether to invest cash before buying a house. While buying a house can be a good investment, there are also alternative investment options that may offer higher returns, lower risk, and better liquidity. It's important to carefully weigh the pros and cons of each option before making a decision.

Consult a financial advisor

When deciding whether to invest cash before buying a house, consulting a financial advisor can be a wise move. They can provide personalised advice and guide you through the complexities of this significant financial decision. Here are some reasons why seeking professional advice is beneficial:

• Expertise and Objectivity: Financial advisors are qualified professionals who can offer an objective perspective on your financial situation. They will assess your financial health, including your income, expenses, savings, investments, and goals. By analysing these factors, they can provide tailored advice on whether investing cash before buying a house aligns with your financial objectives.
• Investment Strategies: Financial advisors are well-versed in investment strategies and can help you explore alternatives to investing cash in a home. They can educate you on the potential risks and rewards of different investment options, such as stocks, bonds, or other assets. By understanding these options, you can make a more informed decision about whether to invest cash in a home or pursue other investment opportunities.
• Tax Implications: Consulting a financial advisor can help you understand the tax implications of your decisions. For example, they can explain the tax benefits of mortgage interest deductions if you choose to get a mortgage instead of paying cash for a home. They can also advise on capital gains taxes if you need to liquidate other investments to purchase a home with cash.
• Retirement Planning: Buying a house with cash can have a significant impact on your retirement planning. A financial advisor can help you evaluate whether investing cash in a home aligns with your retirement goals. They can discuss the opportunity cost of tying up a large sum of money in a illiquid asset, such as a house, versus investing it for potential long-term growth in a retirement account.
• Risk Management: Financial advisors are adept at risk management and can help you assess the risks associated with different options. For instance, they can explain the risks of tying up a substantial amount of cash in a home, including reduced liquidity and the potential impact on your overall financial portfolio. They can also advise on the risks and benefits of taking out a mortgage, including the financial leverage it provides and the associated interest rates and fees.
• Comprehensive Financial Planning: Financial advisors take a holistic approach to your finances. They can help you create a comprehensive financial plan that incorporates your short-term and long-term goals, including buying a house. By understanding your priorities, they can provide advice on timing, budgeting, and strategies to achieve your goals while managing your cash flow effectively.

Remember, when consulting a financial advisor, be transparent about your financial situation and goals. Provide them with detailed information about your income, expenses, savings, debts, and any other relevant factors. This will enable them to offer the most accurate and tailored advice for your specific circumstances.

Frequently asked questions