House: Pay Cash then Mortgage (Delayed Financing) - worth it?

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craiggsean
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House: Pay Cash then Mortgage (Delayed Financing) - worth it?

Post by craiggsean » Thu Mar 09, 2017 12:12 pm

Hello Boglehead fellows,

I need your help deciding to do a "delayed financing."

I just bought a small co-op with cash due to a time crunch.
I also learned about "delayed financing" - taking a mortgage out within 3 months to get the tax deduction.

Question: IS DELAYED FINANCING worth the additional cost?
Is there a calculator for this (mortgage vs buying with cash)

Here are the numbers:
To do delayed financing,
Mortgage amount would be $250K.
Tax Rate: 39% federal 6% State
additional closing cost would be: $3.5k (1%)
The mortgage rate is about .125% higher than traditional.

Thank you. :D

craiggsean
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Re: House: Pay Cash then Mortgage (Delayed Financing) - worth it?

Post by craiggsean » Thu Mar 09, 2017 1:38 pm

Here's the explanation for Delayed Financing

https://mymortgageinsider.com/paying-ca ... ance-7654/

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jimb_fromATL
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Re: House: Pay Cash then Mortgage (Delayed Financing) - worth it?

Post by jimb_fromATL » Thu Mar 09, 2017 2:35 pm

If I understand it correctly, the only signficant difference between refinancing to get cash out at some future date and the DELAYED FINANCING program is that you typically must wait 6 months after the purchase to do a refi for cash out, but can do a "delayed" mortgage essentially immediately.

It seems like it would require a really sharp pencil to figure out whether there's any advantage in getting what appears to be perhaps an extra 5 or 6 months deduction on the mortgage interest, assuming the rate would be slightly higher than financing now. There are no closing costs for your cash, and both rates would cost you a hekkuvva lot more net interest than not having a mortgage at all.

Is this for your own residence?

What kind of account was holding the money you used to pay cash for the home?

Presumably you would be paying the closing costs out of pocket?

jimb

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White Coat Investor
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Re: House: Pay Cash then Mortgage (Delayed Financing) - worth it?

Post by White Coat Investor » Thu Mar 09, 2017 3:04 pm

Interesting concept. Sounds like the only benefit of doing delayed financing instead of traditional financing up front is to be able to offer cash and close faster.

But if you're going to finance it, I guess delayed is probably better than refinancing after 6 months.

Great question.
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course

Tal-
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Re: House: Pay Cash then Mortgage (Delayed Financing) - worth it?

Post by Tal- » Thu Mar 09, 2017 3:29 pm

White Coat Investor wrote:Interesting concept. Sounds like the only benefit of doing delayed financing instead of traditional financing up front is to be able to offer cash and close faster.

But if you're going to finance it, I guess delayed is probably better than refinancing after 6 months.

Great question.
Bingo,

I don't know the OP's situation, but RE investors often use delayed financing for rentals. This may be because the property was bought through a wholesaler, or was time-sensitive transaction, or the house had issues that would not allow for financing to be attained (e.g. no water heater), or simply to make the offer more appealing.

One strategy that has gained fair traction is for an investor to get a HELOC on their primary house, purchase a rental in cash, then use delayed financing to finance the rental and use that money to pay off the HELOC. It's a way to compete in a cash market without holding oodles of cash while waiting.
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craiggsean
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Re: House: Pay Cash then Mortgage (Delayed Financing) - worth it?

Post by craiggsean » Thu Mar 09, 2017 3:53 pm

Thanks for the replies so far.
Yes, due to time, cash (liquidated from investments) had to be used.
It is for primary residence. Currently liquidity is not a big concern.

My question is:
How to calculate the NPV of

1. Just forget and live mortgage free

2. Get delayed financing of 250K to invest and get interest tax deduction
- which involves 3.5K additional re-closing costs and investment risk.

Is there a calculator to compare
the NPV of scenarios 1 vs 2?

In other words,
is "delayed financing" worth it
for this amount (250K), at this tax rate (39%), interest rate (~4.3%?) with the added closing cost (3.5K)?

an_asker
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Re: House: Pay Cash then Mortgage (Delayed Financing) - worth it?

Post by an_asker » Thu Mar 09, 2017 4:01 pm

I guess here we have the answer to the age-old Dave Ramsey (or whoever's got it patented) question: Would you take out a mortgage on a free-and-clear home? I would not, and am still struggling to figure out the rationale for doing so ... unless someone is absolutely sure that the money can generate more money elsewhere, NOT to save on taxes! :oops:

PS: I can understand real estate investors doing it as well ... to increase their leverage. But don't think it would be a good idea to do so with one's primary residence.

mister37
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Re: House: Pay Cash then Mortgage (Delayed Financing) - worth it?

Post by mister37 » Thu Mar 09, 2017 4:09 pm

Is this the same as asking if you should use a windfall to payoff the mortgage vs. use it to invest? I would say that you can take your expected mortgage payment and use that to invest. Having a paid-off home is great and having the flexibility to use you income to save for retirement, take a vacation, or an emergency is an awesome feeling.
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MP123
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Re: House: Pay Cash then Mortgage (Delayed Financing) - worth it?

Post by MP123 » Thu Mar 09, 2017 4:13 pm

I'd say spending a dollar on interest to save 39 cents on taxes isn't a great move as long as you have the cash.

Your deduction may be limited too depending on where you are in the 39.6% bracket.

I'd just enjoy owning it free and clear.

craiggsean
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Re: House: Pay Cash then Mortgage (Delayed Financing) - worth it?

Post by craiggsean » Thu Mar 09, 2017 4:18 pm

Yes, in essence, the equivalent as
payoff mortgage with a lump sum or invest the lump sum with debt?

It really depends on the individual's goal and situation
so I was asking for a calculator.

The question comes down to:
Can I get more than ~2.3% after-tax return on 250K by taking on a mortgage?

Thank you for your insights.
I thought it'd be a good calculator exercise before making a decision.

MarkNYC
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Re: House: Pay Cash then Mortgage (Delayed Financing) - worth it?

Post by MarkNYC » Thu Mar 09, 2017 4:20 pm

There is another issue to consider. If the purchase of a principal or second residence is all cash and a mortgage is taken out within 90 days, the loan qualifies as acquisition debt and the interest is deductible up to $1million of debt. If the loan is taken out more than 90 days after purchase, the loan becomes home equity debt and the interest deduction is limited to $100K of debt and is not deductible for AMT, unless the funds are used to substantially improve the property.

craiggsean
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Re: House: Pay Cash then Mortgage (Delayed Financing) - worth it?

Post by craiggsean » Thu Mar 09, 2017 4:29 pm

Thank Mark,
yes, that is why I have to decide soon in order to get the full interest deduction (if I go with it)

I haven't found a suitable spreadsheet calculator for this scenario.

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jimb_fromATL
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Re: House: Pay Cash then Mortgage (Delayed Financing) - worth it?

Post by jimb_fromATL » Thu Mar 09, 2017 4:58 pm

craiggsean wrote:Thank Mark,
yes, that is why I have to decide soon in order to get the full interest deduction (if I go with it)

I haven't found a suitable spreadsheet calculator for this scenario.
There's not likely to be any spreadsheet available that address the exact issue.

However, spreadsheets have lots of standard functions for the math of compound interest on loans and investments. Here are some threads with discussions and examples of using the standard math library functions in spreadsheets: If you want to post the information such as the closing costs and rate for each type of loan, how long it might be before you can close on either loan, and whether you'll be paying the closing costs out of pocket or rolling them into the loan, we can help you make some educated guesses.

My question about where the money came from, the rates for each loan, and what you might do with the lump sum if you get it back out of the home are important in order to make a guess at the lost opportunity to invest the lump sum elsewhere compared to dollar-cost-averaging by investing the payments that you won't have if you don't have a mortgage.

jimb

craiggsean
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Re: House: Pay Cash then Mortgage (Delayed Financing) - worth it?

Post by craiggsean » Thu Mar 09, 2017 7:10 pm

Thanks Jimb for volunteering to make a cost-benefit analysis.

Here are the numbers and assumptions:

Loan Rates:
15 year fixed rate is currently 4% with an APR of 4.084
30 year fixed rate is currently 4.625% with an APR of 4.667

Loan Amount: 250K

Closing cost: $3.5K
will probably pay out of pocket

The cash came from after tax investment account.
IF I get the loan, it'd be invested into a tax-exempt bond fund (intermediate or MUNI) in lump sump.

Is this enough info for you to model it?
Thanks!

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Watty
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Re: House: Pay Cash then Mortgage (Delayed Financing) - worth it?

Post by Watty » Thu Mar 09, 2017 8:26 pm

There is a wiki that is basically the same as the choice you are looking at.

https://www.bogleheads.org/wiki/Paying_ ... _investing

Be cautious about the sequence of returns risk. The example I have posted about this is.
 If you do not pay it off then you will have more sequence of returns risk. For example in rough numbers if you just kept a $100K mortgage and also put $100K into a separate investing account which you also pay a $500 a month mortgage out of then;

a) If you get unlucky and get a modest 10% decline in the portfolio the first year then it would be down to $90K
b) You would also need to pay the $500 a month mortgage($6,000) so your portfolio would be down to $84K
c) To break even the next year you would need to gain back the $16K and another $6,000 for the next years mortgage payments which is $22K. That would take a 25.6% return on the remaining $84K just to break even.

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grabiner
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Re: House: Pay Cash then Mortgage (Delayed Financing) - worth it?

Post by grabiner » Thu Mar 09, 2017 9:31 pm

craiggsean wrote:Thanks Jimb for volunteering to make a cost-benefit analysis.

Here are the numbers and assumptions:

Loan Rates:
15 year fixed rate is currently 4% with an APR of 4.084
30 year fixed rate is currently 4.625% with an APR of 4.667

Loan Amount: 250K

Closing cost: $3.5K
will probably pay out of pocket

The cash came from after tax investment account.
IF I get the loan, it'd be invested into a tax-exempt bond fund (intermediate or MUNI) in lump sump.
This is a fair comparison, and these rates make it just barely worthwhile in your 39.6% bracket, assuming that the APR includes all the closing costs. A 15-year mortgage has about a 7-year duration, and the APR of 4.084% is 2.47% after tax. Admiral shares of Vanguard Long-Term Tax-Exempt have a 7-year duration, and a yield of 2.80%. In a 33% bracket, the after-tax mortgage rate would be 2.74%, which would be only break-even.

The tax exemption on municipal bonds is what makes this work; you can borrow at a lower after-tax rate than you can lend.
Wiki David Grabiner

craiggsean
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Re: House: Pay Cash then Mortgage (Delayed Financing) - worth it?

Post by craiggsean » Thu Mar 09, 2017 10:14 pm

Thanks David, as always, your analysis are so practical.

So in the future, when the tax bracket decreases (which is likely),
delayed mortgage won't be a good choice...

Good point.

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BrandonBogle
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Re: House: Pay Cash then Mortgage (Delayed Financing) - worth it?

Post by BrandonBogle » Thu Mar 09, 2017 10:23 pm

craiggsean wrote:Loan Rates:
15 year fixed rate is currently 4% with an APR of 4.084
30 year fixed rate is currently 4.625% with an APR of 4.667

Loan Amount: 250K

Closing cost: $3.5K
will probably pay out of pocket
Hmmm. My initial thought would be that extra .125% of interest to get this product would stick for the life of the loan and it's hard to accept that when you could wait 3 months and avoid it. However, generally speaking, it is more likely that rates would be higher in 3 months than they are now.

However, MarkNYC brings up a good point b/c of interest deduction limits. That extra $150k of eligible deduction could make a big difference.

But those rates would make me seriously consider just being mortgage-free if it wouldn't otherwise impact you.

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Re: House: Pay Cash then Mortgage (Delayed Financing) - worth it?

Post by grabiner » Thu Mar 09, 2017 10:29 pm

craiggsean wrote:Thanks David, as always, your analysis are so practical.

So in the future, when the tax bracket decreases (which is likely),
delayed mortgage won't be a good choice...
And if that happens when you have a municipal bond fund, you can sell your municipal bonds to pay off your mortgage. (Or you could decide not to sell; if interest rates have risen, the after-tax rate on your munis could still be more than the after-tax rate on your mortgage.)
Wiki David Grabiner

craiggsean
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Re: House: Pay Cash then Mortgage (Delayed Financing) - worth it?

Post by craiggsean » Fri Mar 10, 2017 8:34 am

So numbers wise, it sounds like it may be a breakeven...?

I guess it comes down to the value of liquidity.

craiggsean
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Re: House: Pay Cash then Mortgage (Delayed Financing) - worth it?

Post by craiggsean » Mon Apr 17, 2017 4:24 pm

I had an update with new rates -
Question was -
should I finance a (delayed) mortgage based on:
- today's rates?
- tax bracket
- plan to live here for >5 yrs

If I don't finance, I would put it in the tax exempt bond funds (muni or intermediate)
Which is the better financial choice?

Here's the new summary:

"Today’s rates are as follows.

15 year fixed

4% with a credit of $225 towards your closing costs. The payment would be $1,849
3.875% with a cost of .22 points or $550. The payment would be $1,834

30 year fixed

4.5% with a credit of $225 towards your closing costs. The payment would be $1,267
4.375% with a cost of .554 points ($1,385). The payment would be $1,248

The estimated closing costs of $3500 are in addition to any points paid and are not included in the rate.
If you choose a higher rate, we can cover most or all of the costs."

marginal bracket:~39.6%, State:6% (not sure if this will keep up)

I'm wondering what the benefit is to justify the risk and the hassle of refinancing, monthly tracking of a mortgage, etc.

Thank you so much.

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Re: House: Pay Cash then Mortgage (Delayed Financing) - worth it?

Post by grabiner » Mon Apr 17, 2017 9:49 pm

craiggsean wrote:Here's the new summary:

"Today’s rates are as follows.

15 year fixed

4% with a credit of $225 towards your closing costs. The payment would be $1,849
3.875% with a cost of .22 points or $550. The payment would be $1,834

30 year fixed

4.5% with a credit of $225 towards your closing costs. The payment would be $1,267
4.375% with a cost of .554 points ($1,385). The payment would be $1,248

The estimated closing costs of $3500 are in addition to any points paid and are not included in the rate.
If you choose a higher rate, we can cover most or all of the costs.

marginal bracket:~39.6%, State:6% (not sure if this will keep up)
The closing costs of $3500 are equivalent to 1.2 extra points, but since they are non-deductible, that has the same effect as two deductible points. Therefore, the 3.875% 15-year mortgage (probably the best deal) effectively has 2.25 points, which would make the APR about 4.2%. In your tax bracket, the after-tax mortgage rate is 2.54%.

The yield on Admiral shares of Long-Term Tax-Exempt is 2.70%. Therefore, if you stay in the 39.6% bracket, the delayed financing is just barely worth it, as in my previous estimate.
Wiki David Grabiner

craiggsean
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Re: House: Pay Cash then Mortgage (Delayed Financing) - worth it?

Post by craiggsean » Tue Apr 18, 2017 9:37 am

Thank you David!
Always grateful and amazed by your expertise in these areas...
and taking the time to help others

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Re: House: Pay Cash then Mortgage (Delayed Financing) - worth it?

Post by seawolf21 » Mon Sep 10, 2018 8:14 pm

Anybody aware of TCJA affect on this?

Thinking of the following:
1. Use HELOC from current primary residence and savings to purchase new secondary residence.
2. Apply for delayed financing after close to pay off HELOC.

Is the mortgage on the the 2nd residence deductible? Is it considered home acquisition debt since it is cashed out to repay 1st residence's HELOC?

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Re: House: Pay Cash then Mortgage (Delayed Financing) - worth it?

Post by grabiner » Tue Sep 11, 2018 8:55 pm

seawolf21 wrote:
Mon Sep 10, 2018 8:14 pm
Anybody aware of TCJA affect on this?

Thinking of the following:
1. Use HELOC from current primary residence and savings to purchase new secondary residence.
2. Apply for delayed financing after close to pay off HELOC.

Is the mortgage on the the 2nd residence deductible? Is it considered home acquisition debt since it is cashed out to repay 1st residence's HELOC?
I don't think the new tax law has changed the definitions of what mortgage interest is deductible, except for reducing the limit to $750K. However, the lower marginal tax rate would have an effect, as it increases the effective interest rate of the mortgage.

But the effect of the lower marginal tax rate isn't much for the OP, because of the loss of the marginal deduction of state income tax (with the state tax already exceeding the $10K SALT limit). Previously, the tax rate of 39.6% federal and 6% state was 44.2%, because the 6% state became 3.6% after deduction from federal. Now, the tax rate is 37% plus 6% non-deductible state, which is 43%.

One other concern is whether all of the mortgage interest is deductible. A married couple would need $14,000 in non-tax deductions (such as charity) to deduct all the mortgage interest. Many married couples in such a high tax bracket do donate a lot to charity, and thus will still deduct all their mortgage interest. But a couple donating only $4000 to charity would lose the deduction on $10,000 of the mortgage interest, which makes the delayed financing much less attractive.

You'll have to redo the math for your own situation.
Wiki David Grabiner

seawolf21
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Re: House: Pay Cash then Mortgage (Delayed Financing) - worth it?

Post by seawolf21 » Wed Sep 12, 2018 7:17 am

Thanks. It also appears the new mortgage has to close within 90 days of property purchase for interest for this mortgage to be even deductible.

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