Pros and Cons of Taking out a Home Mortgage: To finance or pay cash for your home?
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Pros and Cons of a Mortgage
How to decide if you should pay cash for a house or use a mortgage
There are pros and cons for taking on debt to buy property.
It depends on several different factors, such as... what is your risk tolerance? What are the opportunity costs if I do buy a home with cash? Do I have the cash available to buy a house I would want to live in? How long am I planning to live in the house?
These are all important questions that will determine if you are better off buying a house for cash or if you will end up financing the purchase with a mortgage.
Pros of buying a house with a mortgage
Pro #1: Achieving the American Dream without having to save for it
One of the biggest reasons mortgage debt is so popular in the United States is simply because most people cannot afford to pay cash for a home. The mortgage loan gives them the opportunity to own their own piece of property when, in all likelihood, it would not be possible for a very long time, if ever.
Pro #2: Leverage is good (the financial principle of leverage, not the show on TBS… although it does have its moments)
Leverage refers to borrowing money in order to have a chance to substantially increase your gains (or losses… if you are not careful). When used to purchase a mortgage, leverage is automatically attained when you borrow that money from a bank or credit union. If you put down $10,000 on a $100,000 house, you have leverage $90,000 through your bank loan. So, even though you only bought it for $10,000, you are really able to play with the full $100,00 value of the house. As the value of the house changes, this leverage will adjust and your potential return will change with it. If the house is in a really nice area and appreciates in value to $120,000 after 2 years, you will have made a gain of $20,000. Even if you had bought the house for cash the gain would be the same, but you would have only made a 20% gain (or 10% annually). Since you financed $90,000 of the home you essentially turned $10,000 in $30,000, which is still just a gain of $20,000, but the return on the money you invested is 200%!!! Choosing a mortgage over paying cash allows you to use this leverage to your advantage, and while it may not be 100% safe, historically the real estate market has beaten inflation.
Pro #3: Rates can only stay this low for a certain amount of time (dirt cheap right now!!!)
All things considered, mortgage rates look pretty attractive right now. If you consider that historical average for inflation is around 3% and the historical average stock return is around 11%, mortgage rates are dirt cheap. Even if rates pop back up to 5%, 6%, 8%, or higher… it is likely that the stock market and housing market will adjust with those rates, giving you higher equity in your home and better return on investment in your stock portfolio. If you are able to purchase a home with a fixed rate under 5% consider yourself lucky. I would recommend locking in a fixed rate before they start to rise again, but I play it pretty safe.
When purchasing a home mortgage you need to take extra special care to compare the different rates and terms available. Not all mortgages are created equal and you want to make sure you are getting the best deal for yourself. For most people, this is the largest purchase and biggest debt they will ever take on, so don’t be sold something that doesn’t work for you and your family. Take the time to research all the different options and don’t be afraid to ask hard questions. The down payment needed for a home really depends on the mortgage company, but traditionally they will want 10% to 20% down in order to feel comfortable paying the remaining balance of the loan. A short time ago, it seemed like you could get a mortgage with 0% down. After the crash, most mortgage lenders that were still in business realized that the owners that had little to no equity in their homes were often the ones walking away from their mortgage. So, along with the collateral of the home itself, most mortgage lenders now ask for more money upfront. There are still some low down payment programs available, such as FHA loans through the government
Cons of buying a house with a mortgage
Cons of Buying a House with a Mortgage
Con #1: Not all mortgages are created equal
It is way too easy to see the low mortgage rates available and find yourself signing up for an adjustable rate mortgage. You know in the back of your head that the rates will eventually reset (and likely the payments will be higher), but it is easy to justify in your own head. “Oh, I will be making more money by then”, or “I will take out the ARM loan and the difference between that and the fixed rate I was considering will go right into savings, so I will be ready when the balloon payment comes”. However, life often gets in the way, and the raise or promotion you thought you had locked down never came to fruition, or the money you were saving for the balloon payment in 5 or 7 years ended up being allocated to Junior’s college fund, or remodeling the kitchen. All of a sudden you are up the creek with no paddle.
Con #2: You could lose your home.
During the housing boom, in the early 2000’s, people were seeing houses gain 10-20% in just a year or two and figured that things would keep booming and they could refinance with the equity they were destined to build, and payoff their home or set new terms for the loan right before the ARM adjusts or before the balloon payment was due. We all know how this ended up… with the crash in 2007, many people found themselves underwater and eventually lost their homes
Con #3: Additional Fees
When you apply for a mortgage there is an origination charge. When you have the property assessed to make sure the bank is comfortably loaning you money (since the property will fall to them if you are delinquent with payments), there is a fee. Money held in Escrow, points, good faith deposit, etc… Here a fee, there a fee, everywhere a fee fee? If you were to buy a house for cash you don’t have to worry about many of these fees, and various charges that the bank happily charges you during the process.
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