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Pay in Cash - Why not?
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RandomWalker



Joined: 23 May 2009
Posts: 4

PostPosted: Sat May 23, 2009 6:29 pm GMT    Post subject: Pay in Cash - Why not? Reply with quote

Hey All,
I recently came into the fortunate position of being able to buy a house without taking out a mortgage (sufficient cash). I'm still employed and expect to stay that way. Please critique my thinking.

I want to pay <500, and fully expect real estate to lose another 10-20%. I'm OK with losing $ on this "investment".

What I'm not OK with is paying interest, or taking on debt. The average American family pays 14% of household income in debt service... no thanks. I want the peace of mind of low overhead.

Peace of mind: This is *huge*. This is a respite from the state of the world/economy/country. I don't want to give that up. Listening to radio today, a woman called in to say she had to stay in her house and could not follow her transferred military husband. Reason: they were underwater 20K.

Negotiations: Paying in 100% cash should give us a edge. Risk Reduction to the seller should be worth.... mmm, maybe as much as 5%?

Opportunity Cost: Interest Rates are ~4.5%. To get the same return would require 6% pretax. Nothing qualifies that I can see; best return is to avoid debt.

Inflation: a wash. When inflation hits, those with cash will be eroded.. and our place will be worth less. C'est la vie.

Wife: not happy, wants to up the budget and take on 100-150 mortgage. Despite many people we know losing jobs or being right on the edge financially. (Bangs head on table)

So - what is the case for taking on a mortage?
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admin
Site Admin


Joined: 14 Jul 2005
Posts: 1826
Location: Greater Boston

PostPosted: Sat May 23, 2009 7:32 pm GMT    Post subject: Reply with quote

I think your reasoning is sound. One thing that I would be concerned about, though, is losing more than the 20% that you expect. You say you expect to lose "another" 10 - 20%, but the losses which have occurred thus far have not been evenly distributed. In particular, the bulk of declines so far have been in the low tier, which is not what you're looking at for ~$500K. It may be that the market in aggregate has another 10 - 20% to fall but that the high tier is more vulnerable because it hasn't had much of a correction so far (of course, it didn't have as much of a run-up either, but it did still have one). The declines that have occurred thus far have happened before the recent swelling in unemployment, and unemployment could be a catalyst that effects serious declines across all tiers. You may feel that your job is secure, but will all of your neighbors also have secure enough jobs with high enough incomes to support that price level for the neighborhood?





As per the mortgage question, a benefit to taking out a mortgage is that if inflation shoots up after you buy, having a 4.5% rate locked in will probably be phenomenal. In a high inflation environment, you could probably earn more than 4.5% interest on relatively safe investments and pocket the difference. I'm with you in that I wouldn't want to take on an additional $100K - 150K in debt beyond what I had saved, but I might take the gamble that inflation will pick up and take out a mortgage for what I could otherwise pay with savings (and which I would keep in low risk savings). That is a gamble, though - inflation could of course remain low.

- admin
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GenXer



Joined: 20 Feb 2009
Posts: 703

PostPosted: Sat May 23, 2009 8:36 pm GMT    Post subject: Reply with quote

This is actually the best method - pay cash for the house. However, depending on your finances, this may or may not reduce your risk. What if you had to move in 5 years? And you must sell the house, or else you don't have a job? This is an instant loss. Now think about the case where you lost your job. Will you be able to borrow money from the house if you needed it? How much? All in all, locking so much money in a house is a terrible idea if you finances are not up to the task. You may lose a lot more money than you realize, so I think your wife has a point and you must consider different scenarios.

There are many more considerations here, and unless you have a good financial plan to which both of you agree, this issue may divide you in ways you never imagined, especially if you end up on the wrong end of the market.
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balor123



Joined: 08 Mar 2008
Posts: 1204

PostPosted: Sat May 23, 2009 8:46 pm GMT    Post subject: Re: Pay in Cash - Why not? Reply with quote

RandomWalker wrote:
Hey All,
I want to pay <500, and fully expect real estate to lose another 10-20%. I'm OK with losing $ on this "investment".


The average American home is about $150k. I'm not saying it will hit that but there's more at risk than 10-20%. If you're paying cash, then you should be ok losing 50%.

RandomWalker wrote:

What I'm not OK with is paying interest, or taking on debt. The average American family pays 14% of household income in debt service... no thanks. I want the peace of mind of low overhead.


Most of that interest is to cover inflation. If you pay cash, then your house is still subject to that cost. Right now, thanks to government subsidies, the rate is below forward looking inflation expectations so you actually do quite well by borrowing.

RandomWalker wrote:

Peace of mind: This is *huge*. This is a respite from the state of the world/economy/country. I don't want to give that up. Listening to radio today, a woman called in to say she had to stay in her house and could not follow her transferred military husband. Reason: they were underwater 20K.


You still have to pay taxes and other bills, which in many places can be quite substantial. When figuring your budget, you might want to set aside a substantial amount of rainy day fund money like $100k (only suggesting this because you are looking for peace of mind).

I also like having peace of mind but I don't get it from owning a house. I prefer to have a large amount of investments, knowing that I can always liquidate them to cover an emergency and still get the long term growth as I'll never likely liquidate them. It's also nice to know that I can pull in decent investment income even when I don't get the raise that I like. I'd actually feel less secure liquidating it all and buying a house with it because houses are illiquid. If I have a medical emergency, then I can't tap my house very easily.

RandomWalker wrote:

Negotiations: Paying in 100% cash should give us a edge. Risk Reduction to the seller should be worth.... mmm, maybe as much as 5%?


Definitely will but also keep in mind that many homeowners are already taking a loss and won't budge much.

[quote="RandomWalker"]
Opportunity Cost: Interest Rates are ~4.5%. To get the same return would require 6% pretax. Nothing qualifies that I can see; best return is to avoid debt.

Mortgage interest rate is deductible so you actually only need a 4.5% return. By pretty much any historical standard in this country over the term of the mortgage you have very little risk of not beating this rate. Even today you can find high yield checking accounts paying 4 - 5.5%!

RandomWalker wrote:

Inflation: a wash. When inflation hits, those with cash will be eroded.. and our place will be worth less. C'est la vie.


You can protect cash from inflation easier than a house, which is tied to one commodity. You can place cash in TIPS, i-bonds, or a basket of commodities and also in stocks as earnings typically grow as well. One likely scenario you want to consider is stagflation, where cost of goods rise while incomes stagnate. In this scenario, which could happen with a falling dollar or rise in demand for commodities from emerging markets like China, Americans can't afford more house so housing prices stagnate or fall while your house can be exchanged for less and less other goods.

RandomWalker wrote:

Wife: not happy, wants to up the budget and take on 100-150 mortgage. Despite many people we know losing jobs or being right on the edge financially. (Bangs head on table)


Same situation. I've convinced my wife to consider moving to another city. We'll see if it actually happens once she finishes grad school. If I get my way, then I'll use my downpayment here to pay for most of the house there.
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balor123



Joined: 08 Mar 2008
Posts: 1204

PostPosted: Sat May 23, 2009 8:48 pm GMT    Post subject: Reply with quote

GenXer wrote:
This is actually the best method - pay cash for the house. However, depending on your finances, this may or may not reduce your risk. What if you had to move in 5 years? And you must sell the house, or else you don't have a job? This is an instant loss. Now think about the case where you lost your job. Will you be able to borrow money from the house if you needed it? How much? All in all, locking so much money in a house is a terrible idea if you finances are not up to the task. You may lose a lot more money than you realize, so I think your wife has a point and you must consider different scenarios.

There are many more considerations here, and unless you have a good financial plan to which both of you agree, this issue may divide you in ways you never imagined, especially if you end up on the wrong end of the market.


Also consider that if you need to move you'll have to borrow to buy the second house.
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RandomWalker



Joined: 23 May 2009
Posts: 4

PostPosted: Sat May 23, 2009 9:55 pm GMT    Post subject: Reply with quote

A big question is cost of the place, and the risk associated. When I say 500, that's below what wife sees as getting a nice place in our target town. Price determines how much our rainy day fund is.

Admin, I agree that high-end housing has not fallen. Still, we can't wait forever. I agree losses of >20% are quite possible.

GenXer, I hear the following scenarios:
1) Forced relocation. This is extremely unlikely. In any case, if you have to sell (at a loss), you have to sell. I'd take my lumps. At least we wouldn't be leveraged, or be trapped like the woman underwater for 20K getting sucked into a death spiral.
2) Job loss: If I lost my job, our overhead should be quite low, and could survive on wife's income I believe. It is worth running the numbers, of course.

We do have extra cash, and monthly savings. Emergency fund is important. If we don't have a mortgage, we can and should pay ourselves to further build it up.

The point that wife refuses to see is that bigger house=more risk.

balor123-
>> The average American home is about $150k. I'm not saying it will hit that but there's more at risk than 10-20%. If you're paying cash, then you should be ok losing 50%.

150? This is Boston we're talking about Smile Yes, I am ready to lose that amount... but you'd lose the same amount regardless of payment method.

Overhead includes taxes, upkeep, heat. Noted, agree.

>> I also like having peace of mind but I don't get it from owning a house.
I'm with you.

>> keep in mind that many homeowners are already taking a loss and won't budge much.
Yes. Redfin did meta-analysis on 'tells' for lowballing. http://www.newsweek.com/id/141958/output/print

>> Even today you can find high yield checking accounts paying 4 - 5.5%
I'm dubious about the mortgage deduction. Where are you seeing those accounts...are they signup promos? ongoing?

>> Also consider that if you need to move you'll have to borrow to buy the second house.
I'd take my lumps if this happened. Should be able to buy a roughly equivalent place (minus realtors pound of flesh) for whatever it fetches.

I don't understand all these sellers holding out, chasing the market down, or renting their places (at a loss). It's Sunk cost fallacy meets the five stages of grief.

Meta-consideration I have here is: Leverage bad. Leverage amplifies movement; given current trends, why would you want to be leveraged? Great going up, but hell going down.

Meta-consideration: Debt=risk, loss of control. Especially credit-cards. Low overhead=freedom (not geographical, but Boston isn't a bad place to be). Germany has very little culture of borrowing, and they are faring the best.

Don't buy stuff you can't afford! Smile - http://consumerist.com/consumer/clips/snl-skit-dont-buy-stuff-you-cant-afford-252491.php
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GenXer



Joined: 20 Feb 2009
Posts: 703

PostPosted: Sat May 23, 2009 11:04 pm GMT    Post subject: Reply with quote

I've been preaching 'don't buy if you can't afford' here since I joined. 'Financial plan' isn't just an empty phrase. It means having a plan, not a knee-jerk response to whatever comes your way. If you guys have a good plan for how to save for retirement/financial independence while you buy the house, fine. If you think your house will be your 'investment' - not fine. I think you guys need to solve this problem amongst yourselves. We seem to be preaching to the choir, but your significant other is not here to debate this issue with you. It is better to see a financial adviser than it is to see a marriage or a legal one. The important thing is that you guys must have a written plan on which both of you agree, and which contains enough details on how you plan to make your financial and investment decisions. Otherwise, its no good that people agree with you - its your wife that has to be convinced. The best way to convince her is to take her to your financial adviser and to discuss your financial and investment plans with him/her, as well as to come up with a framework on which both of you can agree, so that there is no misunderstanding or hurt feelings. Although most of my work is related to portfolio management, recently I've had a number of requests of this kind of service as people increasingly are trying to buy very expensive houses relative to their income, and many are justifiably worried about their investment. There are plenty of disagreements too, and if not taken care of, these disagreements can potentially get very nasty (plenty of divorces happen because of money problems).
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melonrightcoast



Joined: 22 Feb 2009
Posts: 236
Location: metrowest

PostPosted: Sun May 24, 2009 2:07 am GMT    Post subject: buying and selling Reply with quote

GenXer said:

Quote:
This is actually the best method - pay cash for the house. However,


I see where you stand on this now Wink.

RandomWalker said:

Quote:
I don't understand all these sellers holding out, chasing the market down, or renting their places (at a loss). It's Sunk cost fallacy meets the five stages of grief.


I think some of these sellers cannot afford to sell at a loss. Meaning they have heloc'd the heck out of their homes and need some money from the sale so they can buy their next place ... eventually. And/or, if they are underwater, the bank won't approve them for a short-sale because they have too many other assets. And don't forget pride. Some people just won't sell (anything) at a loss, unless they are forced to. I have family in this situation and we are very fearful that they will lose their home of 25+ years due to bad stock and real estate "investments".

GenXer: any suggestions on how to deal with that family situation? We've had open, civil, and frank discussions with my in-laws, but they still keep on making VERY risky decisions. We are getting concerned that we will be financially supporting them sooner, rather than later.
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melonrightcoast



Joined: 22 Feb 2009
Posts: 236
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PostPosted: Sun May 24, 2009 2:37 am GMT    Post subject: peace of mind Reply with quote

Quote:
Listening to radio today, a woman called in to say she had to stay in her house and could not follow her transferred military husband. Reason: they were underwater 20K.


I've already told my husband that if he had to find a job in another city, I wasn't going to relocate. Reason: as a kid/teenager I experienced both situations of 1) being moved around and then 2) my father living in a different location for a few years (although my parents are still married). Moving around was MUCH more traumatic to us kids.

It sounds like YOUR peace of mind is owning your home free-and-clear. And your WIFE'S peace of mind is having a nice home, vs. a nice-enough home. Marriage is compromise. Don't dismiss what your wife wants because it is not perfectly aligned with your wants, as she will GREATLY impact YOUR future happiness and YOUR financial well-being.
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GenXer



Joined: 20 Feb 2009
Posts: 703

PostPosted: Sun May 24, 2009 3:13 am GMT    Post subject: Reply with quote

melonrightcoast: Buying a house with cash is not a bad idea. Very few can pull it off, though...unless they have some inheritance money to spend, or they amassed a decent cash stash.

However, I'm always skeptical when somebody says that they can pay cash for the house. There are very few people who can afford to do that. This is a huge risk, and this is why I believe RandomWalker needs an unbiased assessment of his finances, as well as a mediated discussion with his wife on their finances and goals.

Quote:

GenXer: any suggestions on how to deal with that family situation? We've had open, civil, and frank discussions with my in-laws, but they still keep on making VERY risky decisions. We are getting concerned that we will be financially supporting them sooner, rather than later.


It appears that the only way to get them talking is to bring them in, and to start this discussion in the presence of a mediator. You present your evidence, they present theirs. Mediator has to provide them with an unbiased assessment without sugarcoating anything (Suze Orman style). Unfortunately, many people can only accept the opinion of an outside 'expert', as opposed to listening to well-meaning in-laws (been there, done that). Not all in-laws are able to take criticism, but if they agree to a mediated discussion - that is your chance.

Remember - you don't want to come out the bad guy. Let the mediator come out the bad guy bearing the news. This is much easier to take on their part than a 'scolding' from their daughter-in-law.
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melonrightcoast



Joined: 22 Feb 2009
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PostPosted: Sun May 24, 2009 3:32 am GMT    Post subject: inlaws Reply with quote

Quote:
It appears that the only way to get them talking is to bring them in, and to start this discussion in the presence of a mediator. You present your evidence, they present theirs. Mediator has to provide them with an unbiased assessment without sugarcoating anything (Suze Orman style). Unfortunately, many people can only accept the opinion of an outside 'expert', as opposed to listening to well-meaning in-laws (been there, done that). Not all in-laws are able to take criticism, but if they agree to a mediated discussion - that is your chance.

Remember - you don't want to come out the bad guy. Let the mediator come out the bad guy bearing the news. This is much easier to take on their part than a 'scolding' from their daughter-in-law.


A mediator. I like that idea. We did encourage them to see a financial planner, but my f-i-l left after not answering a few basic questions. You are so right I don't want to be the bad guy - we just want them to have a plan and choices for retirement, and the way things are going, they might not have anything. Geography is the tricky part, as they are on the West Coast.
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GenXer



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PostPosted: Sun May 24, 2009 3:49 am GMT    Post subject: Reply with quote

Which questions did he not want to answer?
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melonrightcoast



Joined: 22 Feb 2009
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PostPosted: Sun May 24, 2009 2:11 pm GMT    Post subject: mediator Reply with quote

Quote:
Which questions did he not want to answer?


From what my m-i-l said, who was present during the meeting, he didn't want to divulge personal information to a stranger (financial planner).

I'm going to send you a private e-mail about the rest.
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PostPosted: Sun May 24, 2009 2:38 pm GMT    Post subject: Reply with quote

>> It sounds like YOUR peace of mind is owning your home free-and-clear. And your WIFE'S peace of mind is having a nice home, vs. a nice-enough home. Marriage is compromise. Don't dismiss what your wife wants because it is not perfectly aligned with your wants, as she will GREATLY impact YOUR future happiness and YOUR financial well-being.

Very true.

My frustration is that this is a once-in-a-lifetime windfall. I want to take the opportunity to be debt-free and reduce risk, not expand our appetites. Debt and leverage are what's gotten everyone in trouble.

It frustrates me that she doesn't see the upside in this situation... is now focused on the gap against her raised expectations, wants to raise the budget -- by her salary*4.

I have a recommendation on a financial guy with good counseling/communication skills.. it may come to that, because we're both very stubborn Smile

Still have not heard of any financial instrument with a risk-free return of 5%.
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melonrightcoast



Joined: 22 Feb 2009
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PostPosted: Sun May 24, 2009 2:54 pm GMT    Post subject: compromise Reply with quote

RandomWalker,

It may make you feel better to know that my husband and I are in a very similar situation, only reversed. Meaning we are debt free, $$ in bank, and I want to buy a modest home so we have a small mortgage and still have a good $ cushion. Husband wants the 3000sq ft house in top neighborhood. So what do we do?

Keep on renting for now Very Happy. Houses are getting cheaper by the day.
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