Sanity Check - Mortgage vs Cash

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Topic Author
frisbee
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Joined: Tue Jan 06, 2015 8:02 am

Sanity Check - Mortgage vs Cash

Post by frisbee »

I'm looking for a Cash vs. Mortgage sanity check on a new home. Let me know what I'm failing to consider.

Age 50 in Pennsylvania, net worth is good, we both have 6-figure incomes, no kids and no liabilities.

SO &I are getting ready to make an offer on our first house. Selling price is $400k. We easily qualify for a 15-yr conventional mortgage at 5.6%. We would expect to pay off the loan in 7-years (peace of mind).

If we paid cash, the $400k is half our liquid (stocks & money market) assets. We expect to immediately spend another $80k on home improvements/fixes.

With the recent market downturn, liquidating $480k would enable us to show L/T capital losses of (-$6000).

Holistically (because I'm not sharing all my personal data and no one can predict future market movements and mortgage rates) my question is whether we'd be better off paying cash (and realizing $6k in capital losses)? We'd avoid some closing costs but give up some liquidity (essentially moving stocks into home equity).

Thoughts? Thanks in advance - Frisbee
lakpr
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Re: Sanity Check - Mortgage vs Cash

Post by lakpr »

Not attempting to answer your question at all. But, trying to buy a home with a person who you are not married to, is a disaster waiting to happen on a zillion different levels. DO NOT DO IT.

(Response assumes that the use of "SO and I" implies no marriage; else you would have explicitly stated "DW and I" or "DH and I" etc )
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Wiggums
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Re: Sanity Check - Mortgage vs Cash

Post by Wiggums »

Is there a reason you want a house now that the mortgage rates are higher and price of the house is likely elevated too? Not really an ideal time for real estate.

I agree with Lakpr that purchasing a house and then putting more than 80k in renovations when unmarried can go bad very quickly. Especially if you cannot buy them out. My friend bought a nice home with his partner who change their mind on homeownership. Yge partner insisted on selling the house and generating a big tax bill since the house was not held 2 years. Another friend paid to finish the basement. At breakup time, his partner wanted to sell the home and split 50/50. It’s a big purchase and if one of you dies, you have a big mess.
"I started with nothing and I still have most of it left."
Topic Author
frisbee
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Re: Sanity Check - Mortgage vs Cash

Post by frisbee »

Sorry to confuse the thread from the onset, we are married (15 years). I use SO on other bulletin boards to describe us. That's not a risk for us.

A friend pointed out that paying 6% mortgage while earning less after-tax in the stock market is dumb.
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Metsfan91
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Re: Sanity Check - Mortgage vs Cash

Post by Metsfan91 »

frisbee wrote: Sun Oct 02, 2022 6:21 pm I'm looking for a Cash vs. Mortgage sanity check on a new home. Let me know what I'm failing to consider.

Age 50 in Pennsylvania, net worth is good, we both have 6-figure incomes, no kids and no liabilities.

SO &I are getting ready to make an offer on our first house. Selling price is $400k. We easily qualify for a 15-yr conventional mortgage at 5.6%. We would expect to pay off the loan in 7-years (peace of mind).

If we paid cash, the $400k is half our liquid (stocks & money market) assets. We expect to immediately spend another $80k on home improvements/fixes.

With the recent market downturn, liquidating $480k would enable us to show L/T capital losses of (-$6000).

Holistically (because I'm not sharing all my personal data and no one can predict future market movements and mortgage rates) my question is whether we'd be better off paying cash (and realizing $6k in capital losses)? We'd avoid some closing costs but give up some liquidity (essentially moving stocks into home equity).

Thoughts? Thanks in advance - Frisbee
I'd do mortgage. I'll keep the money invested. I know market is down right now. But, I do not expect the market to stay down for a long period. Market goes up in the long run. Also, if the dire need arise, I can liquidate investment and get cash. But, I won't be able to sell the house right away. Selling house isn't that convenient. Yes, I'll be paying high interest rate on mortgage. But, interest is tax deductible. This should help lower income tax.
"Know what you own, and know why you own it." — Peter Lynch
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9-5 Suited
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Re: Sanity Check - Mortgage vs Cash

Post by 9-5 Suited »

Well, no one knows your personal risk tolerance, so what you'll often find is people answering what they would do (according to their own risk tolerance). In that way, this question is a bit like asking what your asset allocation should be, and having people respond with their own preferred allocation. Kind of helpful as a survey, but not great personal advice.

Here's one thing I feel pretty confident about across all of these mortgage threads - if you hold a sizable amount of fixed income assets in your portfolio, I would just sell them and use the proceeds to further reduce the required mortgage. The median expectation would be that you'll come out ahead this way, with the caveat that you have to be comfortable losing the liquidity. Some people will object on the grounds of "not being able to rebalance" but you never know if you'll ever even encounter that opportunity in the next 10 years or so. The standard assumption IMO should be mortage payoff is preferred to owning bonds at lower rates than the mortgage.

If you are very stock heavy or 100% stocks in your AA, then it's just the risk tolerance thing again. You may win, you may lose. For what it's worth, I think a plan to pay it off in 7 years will work out very well, as will a plan to just pay it off. It's not a decision I would agonize a lot over since either way sounds like you'll be fine.
Topic Author
frisbee
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Re: Sanity Check - Mortgage vs Cash

Post by frisbee »

9-5 Suited wrote: Sun Oct 02, 2022 9:08 pm Well, no one knows your personal risk tolerance, so what you'll often find is people answering what they would do (according to their own risk tolerance). In that way, this question is a bit like asking what your asset allocation should be, and having people respond with their own preferred allocation. Kind of helpful as a survey, but not great personal advice.

Here's one thing I feel pretty confident about across all of these mortgage threads - if you hold a sizable amount of fixed income assets in your portfolio, I would just sell them and use the proceeds to further reduce the required mortgage. The median expectation would be that you'll come out ahead this way, with the caveat that you have to be comfortable losing the liquidity. Some people will object on the grounds of "not being able to rebalance" but you never know if you'll ever even encounter that opportunity in the next 10 years or so. The standard assumption IMO should be mortage payoff is preferred to owning bonds at lower rates than the mortgage.

If you are very stock heavy or 100% stocks in your AA, then it's just the risk tolerance thing again. You may win, you may lose. For what it's worth, I think a plan to pay it off in 7 years will work out very well, as will a plan to just pay it off. It's not a decision I would agonize a lot over since either way sounds like you'll be fine.
This makes a lot of sense to me. We are getting to the age where our overall portfolio is trending towards fixed investments and while Bonds have a different liquidity than a Home, they are roughly IMO in the same asset class from a risk profile. I appreciate everyone's comments.
RVohioken
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Re: Sanity Check - Mortgage vs Cash

Post by RVohioken »

I am a Dave Ramsey fan. He might say, you are essentially borrowing money to invest in the market. Is that what you want to do? If that makes sense for you, ok, if not pay cash.
thedaybeforetoday
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Re: Sanity Check - Mortgage vs Cash

Post by thedaybeforetoday »

frisbee wrote: Sun Oct 02, 2022 6:21 pm I'm looking for a Cash vs. Mortgage sanity check on a new home. Let me know what I'm failing to consider.

Age 50 in Pennsylvania, net worth is good, we both have 6-figure incomes, no kids and no liabilities.

SO &I are getting ready to make an offer on our first house. Selling price is $400k. We easily qualify for a 15-yr conventional mortgage at 5.6%. We would expect to pay off the loan in 7-years (peace of mind).

If we paid cash, the $400k is half our liquid (stocks & money market) assets. We expect to immediately spend another $80k on home improvements/fixes.

With the recent market downturn, liquidating $480k would enable us to show L/T capital losses of (-$6000).

Holistically (because I'm not sharing all my personal data and no one can predict future market movements and mortgage rates) my question is whether we'd be better off paying cash (and realizing $6k in capital losses)? We'd avoid some closing costs but give up some liquidity (essentially moving stocks into home equity).

Thoughts? Thanks in advance - Frisbee
I appreciate you don't want to share to many details, so please skip by if you don't want to answer the following that could yield more accurate guidance.
1) Sounds like you have $800k liquid and therefore $320k liquid after home purchase and improvements. Based on your income, comfort and spending levels, how much liquid are you comfortable with?

2) Are your "non - liquid" funds in retirement accounts that could be accessed if necessary? IE: Do you have retirement funds or even substantial retirement funds in a Roth such that contributions to that/those Roth(s) could be pulled without penalty if needed? Do you have retirement funds in a 457 from a previous position that you have been separated from for 1+years so that those funds could be pulled without penalty if needed?

Interested to hear your response as I'm not sure what you are considering "liquid".
"When I was a kid my parents moved a lot, but I always found them." R. Dangerfield
Topic Author
frisbee
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Re: Sanity Check - Mortgage vs Cash

Post by frisbee »

"liquid" in our definition is a Vanguard brokerage account that can be sold without penalty within a few days (other than capital gains). We have Roth & 401Ks that we won't touch unless there's an emergency (and even then, this would likely be the final option just prior to a loan shark). We went with the cash offer - Both because it made financial sense and also to try to thin the competition.
lakpr
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Re: Sanity Check - Mortgage vs Cash

Post by lakpr »

$400k at 5.6% interest rate equals a mortgage interest expense of $22,400 per year.
Coupled with the maximum SALT deduction of $10,000, your itemized deductions will be $32,400.
Standard deduction for a couple in 2023 is going to be $27,700 { Link: https://news.bloombergtax.com/payroll/y ... nd-credits }
Your net benefit by going with the mortgage = $4,700.

With both spouses earning 6 figure incomes, I think the Federal tax bracket for you is 24%, plus 3% Pennsylvania state tax bracket, implies a combined marginal tax rate of 27%. So you will save $4,700 * 0.27 = $1,270 per year on taxes.

OR, you are going to be spending $22,400 - $1,270 = $21,130 per year in mortgage interest per year. Effective mortgage interest rate = $21,130 / $400,000 = 5.29%. Note that this is an *after-tax* interest rate.

In your tax bracket of 27%, you need to earn in any investment that you make, a return rate of 5.29% / (1 - 27%) = 7.23% prior to taxes, just to break even.

The question boils down to: Do you think you can earn more than 7.23% in your investments, year-in and year-out until the mortgage is paid off?

*PERSONALLY* I think that's a high bar to achieve. We are talking stock-market like returns, but which you can achieve simply by paying all-cash and liquidating your existing investments.
KlangFool
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Re: Sanity Check - Mortgage vs Cash

Post by KlangFool »

frisbee wrote: Sun Oct 02, 2022 6:21 pm
Age 50 in Pennsylvania, net worth is good, we both have 6-figure incomes, no kids and no liabilities.

SO &I are getting ready to make an offer on our first house. Selling price is $400k. We easily qualify for a 15-yr conventional mortgage at 5.6%. We would expect to pay off the loan in 7-years (peace of mind).

If we paid cash, the $400k is half our liquid (stocks & money market) assets. We expect to immediately spend another $80k on home improvements/fixes.

With the recent market downturn, liquidating $480k would enable us to show L/T capital losses of (-$6000).

Holistically (because I'm not sharing all my personal data and no one can predict future market movements and mortgage rates) my question is whether we'd be better off paying cash (and realizing $6k in capital losses)? We'd avoid some closing costs but give up some liquidity (essentially moving stocks into home equity).

Thoughts? Thanks in advance - Frisbee
frisbee,

"Age 50 in Pennsylvania, net worth is good, we both have 6-figure incomes, no kids and no liabilities."

That means you are not financially independent.

"SO &I are getting ready to make an offer on our first house. Selling price is $400k. We easily qualify for a 15-yr conventional mortgage at 5.6%. We would expect to pay off the loan in 7-years (peace of mind)."

Why would you have a peace of mind if you are not financially independent with a paid-off house? You should go for a 30 years mortgage if the interest rate difference is not that much. Invest the extra and pay off the whole mortgage when you are financially independent.

"If we paid cash, the $400k is half our liquid (stocks & money market) assets. We expect to immediately spend another $80k on home improvements/fixes.

With the recent market downturn, liquidating $480k would enable us to show L/T capital losses of (-$6000)."

If you are unemployed in the coming recession, how long can you lasts if the stock and housing market drops 50% at the same time? How much financial loss would you suffer if the recovery takes 3 years and you were unemployed during that period?

KlangFool
30% VWENX | 16% VFWAX/VTIAX | 14.5% VTSAX | 19.5% VBTLX | 10% VSIAX/VTMSX/VSMAX | 10% VSIGX| 30% Wellington 50% 3-funds 20% Mini-Larry
lakpr
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Re: Sanity Check - Mortgage vs Cash

Post by lakpr »

KlangFool wrote: Mon Oct 03, 2022 12:08 pm "If we paid cash, the $400k is half our liquid (stocks & money market) assets. We expect to immediately spend another $80k on home improvements/fixes.

With the recent market downturn, liquidating $480k would enable us to show L/T capital losses of (-$6000)."

If you are unemployed in the coming recession, how long can you lasts if the stock and housing market drops 50% at the same time? How much financial loss would you suffer if the recovery takes 3 years and you were unemployed during that period?
With no mortgage payment, and $320k remaining liquid { $400k is half, so $800k is total taxable portfolio, less $480k is $320k left }, with no kids, $320k ought to last at least 8 years with just 2 mouths to feed.

At the end of 8 years, they would so close to age 59.5 that they can withdraw from any 401(k) / IRA type retirement investments penalty free.
KlangFool
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Re: Sanity Check - Mortgage vs Cash

Post by KlangFool »

lakpr wrote: Mon Oct 03, 2022 12:11 pm
KlangFool wrote: Mon Oct 03, 2022 12:08 pm "If we paid cash, the $400k is half our liquid (stocks & money market) assets. We expect to immediately spend another $80k on home improvements/fixes.

With the recent market downturn, liquidating $480k would enable us to show L/T capital losses of (-$6000)."

If you are unemployed in the coming recession, how long can you lasts if the stock and housing market drops 50% at the same time? How much financial loss would you suffer if the recovery takes 3 years and you were unemployed during that period?
With no mortgage payment, and $320k remaining liquid { $400k is half, so $800k is total taxable portfolio, less $480k is $320k left }, with no kids, $320k ought to last at least 8 years with just 2 mouths to feed.

At the end of 8 years, they would so close to age 59.5 that they can withdraw from any 401(k) / IRA type retirement investments penalty free.
lakpr,

A) We do not know OP's current annual expense. But, I seriously doubt that it is 40K per year.

B) With 100% stock and 50% stock market drop, the 320K would drop to 160K.

KlangFool
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lakpr
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Re: Sanity Check - Mortgage vs Cash

Post by lakpr »

KlangFool wrote: Mon Oct 03, 2022 12:14 pm lakpr,

A) We do not know OP's current annual expense. But, I seriously doubt that it is 40K per year.

B) With 100% stock and 50% stock market drop, the 320K would drop to 160K.

KlangFool
A) If and when both spouses are unemployed simultaneously, I would expect that a significant belt-tightening would take place. A $400k house in PA suggests that the house is in an MCOL area. $40k is a finger-in-the-air guess, but plenty of couples can live reasonably well on $40k per year; especially with no mortgage expense. Property taxes, I would guess, would be around $8k per year on this $400k house ... that still leaves $32k or $2600 per month for food and utilities.

My family of 4 spends no more than $1000 per month on food, and I live in NJ, a relatively HCOL area for comparison. Even utilities average only $300 per month including winter months. Together, that's still only half the budget.

B) This assumes that this couple would continue to stay in a 100% stock allocation. Firstly, I didn't see anywhere in the original post or elsewhere that they are 100% stocks in their allocation; on the contrary there was mention of MMF (Money Market Funds), implying that this couple is definitely not 100% stocks in their AA. If and when the financial armageddon of simultaneous unemployment occurs, I'd think a prudent course of action would be to trim stocks further ...

I'd think still they can coast until age 59.5 relatively safely
Tavistock1
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Re: Sanity Check - Mortgage vs Cash

Post by Tavistock1 »

KlangFool wrote: Mon Oct 03, 2022 12:08 pm
frisbee wrote: Sun Oct 02, 2022 6:21 pm
Age 50 in Pennsylvania, net worth is good, we both have 6-figure incomes, no kids and no liabilities.

SO &I are getting ready to make an offer on our first house. Selling price is $400k. We easily qualify for a 15-yr conventional mortgage at 5.6%. We would expect to pay off the loan in 7-years (peace of mind).

If we paid cash, the $400k is half our liquid (stocks & money market) assets. We expect to immediately spend another $80k on home improvements/fixes.

With the recent market downturn, liquidating $480k would enable us to show L/T capital losses of (-$6000).

Holistically (because I'm not sharing all my personal data and no one can predict future market movements and mortgage rates) my question is whether we'd be better off paying cash (and realizing $6k in capital losses)? We'd avoid some closing costs but give up some liquidity (essentially moving stocks into home equity).

Thoughts? Thanks in advance - Frisbee
frisbee,

"Age 50 in Pennsylvania, net worth is good, we both have 6-figure incomes, no kids and no liabilities."

That means you are not financially independent.

"SO &I are getting ready to make an offer on our first house. Selling price is $400k. We easily qualify for a 15-yr conventional mortgage at 5.6%. We would expect to pay off the loan in 7-years (peace of mind)."

Why would you have a peace of mind if you are not financially independent with a paid-off house? You should go for a 30 years mortgage if the interest rate difference is not that much. Invest the extra and pay off the whole mortgage when you are financially independent.

"If we paid cash, the $400k is half our liquid (stocks & money market) assets. We expect to immediately spend another $80k on home improvements/fixes.

With the recent market downturn, liquidating $480k would enable us to show L/T capital losses of (-$6000)."

If you are unemployed in the coming recession, how long can you lasts if the stock and housing market drops 50% at the same time? How much financial loss would you suffer if the recovery takes 3 years and you were unemployed during that period?

KlangFool
Klangfool is tough but often strikes a chord. I have clients in similar circumstances ( decades long realtor ) . If you are intent on buying, vs cash/ mortgage and having liquid funds to purchase, unless you’re in a competitive situation w this home, do a mortgage - best you can get, consider an ARM, get the house, re look in a year or 2, refinance at a lower rate, or pay off- not that hard
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