For many Americans, the idea of paying cash for a piece of residential real estate — whether their primary home or a vacation house — is a dream come true. After all, it means your financial planning has paid off and you're financially secure.
But even if you can use that cash for your house, should you? Here are a few important questions to answer to decide if cash or financing would be a better financial step for you.
1. Will Your Liquid Cash Be Low?
First, assess your liquid cash reserves. In the event of an emergency, a natural disaster, big home repairs, or another unexpected expense, could you pay what's needed without resorting to expensive alternatives? If not, you may want to save your cash as saving it can help you stay financially stable.
2. Could You Get a Better Return?
If you finance a home, you will pay interest on the loan. But could you invest the money in some way that results in a net positive? For instance, if you finance at 3% but can get 7% in a low-risk market portfolio, this actually earns 4% on the money overall. However, this investment option should be conservative so you don't end up accidentally losing money on a bad bet.
3. Should You Trade Bad Debt for Good?
Debts come in two main varieties: good and bad. House debt is generally considered good debt because it's at a low interest rate and usually appreciates in value. Credit cards and high-interest debts are considered bad debt because they bring a net negative to your finances. If you carry bad debt, would it do your finances more good to pay it off and instead carry the good debt of a mortgage?
4. What Is Your Emotional Reaction?
While much of the discussion about finances is all about the numbers, don't overlook the emotional component. If you sink a huge amount of cash into your illiquid home, would you sleep better at night because you owe less? Or would you sleep better if you have higher cash reserves? The answer is individual, but it can be just as important as the monetary elements.
Where to Start
Clearly, the decision about how much cash to use for a home purchase and how much to finance has a lot of moving parts. Start by consulting with a financial planner. They will work with you to price out various scenarios, analyze weak spots in your financial plan, and identify the best use of funds earmarked for your home. Call a financial advisor today to make an appointment.