Sold Home - $300,000 Profit - Invest or Pay Cash For New House?

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills
KyleAAA
Posts: 7305
Joined: Wed Jul 01, 2009 5:35 pm
Contact:

Re: Sold Home - $300,000 Profit - Invest or Pay Cash For New House?

Post by KyleAAA » Wed Aug 07, 2019 9:41 am

It sounds like there is very low risk for you to take out another mortgage, and rates are low. I would do that. If one of you became disabled could you still afford the mortgage? I guess your main action item would be to make sure you have adequate life and disability insurance.

Dave55
Posts: 485
Joined: Tue Sep 03, 2013 2:51 pm
Location: Colorado

Re: Sold Home - $300,000 Profit - Invest or Pay Cash For New House?

Post by Dave55 » Wed Aug 07, 2019 10:20 am

I would pay cash for the new house. I was a business owner for 25 years, and lived with great uncertainty year to year. When times were good I paid off the mortgage on the 4 homes I owned during that 25 year period. I never regretted doing so. (I also invested fully every year in the defined benefit plan/profit sharing the company had for myself and the employees over the 25 years in addition to investing a taxable account for wife and myself).

Why pay all that interest over a 15 or 30 year period if you don't have to?

Dave

User avatar
Brianmcg321
Posts: 34
Joined: Mon Jul 15, 2019 8:23 am

Re: Sold Home - $300,000 Profit - Invest or Pay Cash For New House?

Post by Brianmcg321 » Wed Aug 07, 2019 11:03 am

If your house was paid off, would you borrow against it in order to invest? I bet the answer would be no.

Having a paid off house does wonders for your cash flow.

rascott
Posts: 485
Joined: Wed Apr 15, 2015 10:53 am

Re: Sold Home - $300,000 Profit - Invest or Pay Cash For New House?

Post by rascott » Wed Aug 07, 2019 11:10 am

Dave55 wrote:
Wed Aug 07, 2019 10:20 am
I would pay cash for the new house. I was a business owner for 25 years, and lived with great uncertainty year to year. When times were good I paid off the mortgage on the 4 homes I owned during that 25 year period. I never regretted doing so. (I also invested fully every year in the defined benefit plan/profit sharing the company had for myself and the employees over the 25 years in addition to investing a taxable account for wife and myself).

Why pay all that interest over a 15 or 30 year period if you don't have to?

Dave
OP has a MUCH different career/income situation.

Dave55
Posts: 485
Joined: Tue Sep 03, 2013 2:51 pm
Location: Colorado

Re: Sold Home - $300,000 Profit - Invest or Pay Cash For New House?

Post by Dave55 » Wed Aug 07, 2019 11:17 am

rascott wrote:
Wed Aug 07, 2019 11:10 am
Dave55 wrote:
Wed Aug 07, 2019 10:20 am
I would pay cash for the new house. I was a business owner for 25 years, and lived with great uncertainty year to year. When times were good I paid off the mortgage on the 4 homes I owned during that 25 year period. I never regretted doing so. (I also invested fully every year in the defined benefit plan/profit sharing the company had for myself and the employees over the 25 years in addition to investing a taxable account for wife and myself).

Why pay all that interest over a 15 or 30 year period if you don't have to?

Dave
OP has a MUCH different career/income situation.
Yes, understood. I would still pay cash.

Dave

Miakis
Posts: 378
Joined: Sat Aug 16, 2014 6:40 pm

Re: Sold Home - $300,000 Profit - Invest or Pay Cash For New House?

Post by Miakis » Wed Aug 07, 2019 12:00 pm

We just got a mortgage quote for 3.5% on a 30 year fixed mortgage.

It's hard to leave that kind of super low fixed rate on the table.

I'm a debt-free kind of gal, but I can't deny that grabbing up a mortgage at that rate and letting it ride makes the most sense vs paying cash for the house.

And, for the record, we are actually borrowing to invest. We paid cash outright to build our new house and we're doing a cash-out refi on it.

User avatar
Ben Mathew
Posts: 750
Joined: Tue Mar 13, 2018 11:41 am
Location: Seattle
Contact:

Re: Sold Home - $300,000 Profit - Invest or Pay Cash For New House?

Post by Ben Mathew » Wed Aug 07, 2019 11:56 pm

Watty wrote:
Tue Aug 06, 2019 10:18 pm
Ben Mathew wrote:
Tue Aug 06, 2019 10:01 pm
Watty wrote:
Fri Aug 02, 2019 8:40 am
Investing the money and earning a higher rate of return sounds easy but it really is not as easy as it sounds because you have a large "sequence of returns risk"
Watty, you are right that if you focus on the $300K investment account being drawn down for mortgage payments, there is more sequence of return risk vs paying off the house. But if you look at the bigger picture for a young couple who are still saving, this will usually not be the case. Taking out a mortgage to invest will most likely reduce, not increase, sequence of return risk of their overall portfolio. That's because their annual savings create a sequence of return risk in the opposite direction--returns later in life have bigger impact because more savings will have flowed in. Taking out the mortgage works in the opposite direction and increases the impact of earlier returns. So the overall sequence of return risk will be lowered. This is why the lifecycle investing approach advocates leveraging to increase stock exposure early. By leveraging early and reducing stock exposure later, you reduce the overly high impact of later returns that a more traditional glidepath will have.
That sounds interesting but I don't really follow it. I agree that using a mortage for leverage will work out well a lot of the time but there will also be a significant percentage of the time when it does not work out well.

Could you give a simple example of what you are saying with some numbers like my example where there is decline in the investments the first year?
Sure. Consider this example (highly simplified to bring out the main point):

A person has $500,000 saved up and decides to buy a house that costs $300,000. Choices are:

(a) Pay cash for the house. Invest the remaining $200,000.

(b) Take out a mortgage at 3% interest. For simplicity, assume all $300,000 financed with an interest only mortgage. Invest $500,000.

Saves $50,000 per year. But mortgage interest @3% is $9,000 per year. So saving is reduced to $41,000 if one takes out the mortgage.

Let's focus on just the first two years--that's enough to illustrate the point. Compare results from three sequences of returns, all of which averages 3% per year.

Case 1 (benchmark): Investment account returns 3% both years, matching the mortgage rate.
Case 2 (good return first): 10% first year, followed by -3.5545% second year.
Case 3 (bad return first): -3.5545% first year, followed by 10% second year.

CASE 1 (BENCHMARK): 3% BOTH YEARS

Both (a) pay cash and (b) take out mortgage results in wealth of $613,680 after 2 years. This is to be expected since the investment account yield matched the mortgage interest in each period.

CASE 2 (GOOD RETURN FIRST): 10% first year, followed by -3.5545% second year

(a) pay cash - wealth becomes $610,403, which is a loss of $3,277 relative to benchmark.
(b) take out mortgage - wealth becomes $610,993, which is a loss of only $2,687 relative to benchmark. This loss is about 18% less than the loss in case (a) above.

CASE 3 (BAD RETURN FIRST): -3.5545% first year, followed by 10% second year

(a) pay cash - wealth becomes $617,180, which is a gain of $3,500 relative to benchmark.
(b) take out mortgage - wealth becomes $616,550, which is a gain of only $2,870 relative to benchmark. This gain is about 18% less than the gain in case (a) above.

So taking out the mortgage reduced the sequence of return risk in this example by about 18%.

User avatar
Watty
Posts: 16849
Joined: Wed Oct 10, 2007 3:55 pm

Re: Sold Home - $300,000 Profit - Invest or Pay Cash For New House?

Post by Watty » Thu Aug 08, 2019 7:37 am

I think that using an interest only loan and -3.5545% as a bad year is not very realistic and understates the possible impact of the sequence of returns risk.

A lot of years will have a lot worse investment return. A quick search found this website which indicated that the stock market had about a 15% chance of having more than a 10% decline in a year, that is a 1 in six chance. For a $500K portfolio that would be a $50K decline.

https://www.visualcapitalist.com/stock- ... 1872-2018/

Image

A 3% thirty year mortage would also have mortage payment of $1,250, or $15,000 a year, but you would build up around $6,000 a year in home equity.

Combined that would reduce the portfolio by $65K to $435K.

If the portfolio gains 10% the second year that would be a $43,500 gain but you would have to pay another $15K in mortage payments. That would leave your portfolio at $463,500 but you would have added around $12,000 in home equity for a total of $475,500.

That is still pretty simplistic and you could make a much more complex model.

According to that chart there is about 6% chance that the stock market would decline by more than 20% which would make the numbers a lot worse.

That said the most probable outcome is that the sequence of returns risk will work out in your favor and you could get good investing returns the first year so it might not be a bad bet but I would not recommend betting with hundreds of thousands of dollars unless you have millions of dollars.

Chadnudj
Posts: 791
Joined: Tue Oct 29, 2013 11:22 am

Re: Sold Home - $300,000 Profit - Invest or Pay Cash For New House?

Post by Chadnudj » Tue Aug 13, 2019 10:26 am

KlangFool wrote:
Tue Aug 06, 2019 4:43 pm

Chadnudj,

<<You're missing option C: OP and/or OP's spouse retires early/goes part-time such that their combined income is low enough to qualify for financial aid when their kids start entering college in 7 years. >>

For (C), if the income is low enough, they can move all their money from the taxable account to the retirement accounts over the 7 years. It is only 300K.

<<And I'm not sure A is at all accurate. You have to make a LOT of money to be ineligible for any financial aid when you have 2 kids in college at the same time>>

Let's be clear here. We are talking about need-based financial aid. Merit-based financial aid do not subject to the same restriction.

<<Stanford, for instance, provides free tuition to any student with family income below $125k (just below OP's combined income of $145k), >>

Please check out other normal FAFSA based universities.

<<There's also an additional reason to buy the house, and then defer what OP was paying for housing to retirement accounts: liability protection.>>

1) If you want to go that route, unemployment has a higher likelihood. Hence, you need to protect against. And, if someone is really worried about liability protection, umbrella insurance of 1 million only costs about $300 per year.

2) Without umbrella insurance, the person would need to hire a lawyer to fight the lawsuit. After that, there may not be any money left.

The OP only has 220K if he buys the house with the 300K cash. It does not take a big financial emergency to wipe him out.

KlangFool
I was talking about need-based financial aid. You have to make a lot of money to eliminate ALL need-based financial aid, as the Stanford example demonstrates -- family income under $125k entitles you to free tuition, but income levels over $125k still entitle you to some level of need-based financial aid (like tax deductions, they get gradually phased out), particularly when (as OP will have) you have multiple kids in college at the same time.

And on C), my idea was the OP/spouse "retires early/goes part time" in, say, 5 years, not today. That way they use the 5 years to max out retirement accounts with what they would have spent on a mortgage, and then one retires/goes part time and they qualify for need-based financial aid on the single worker's income for the two years prior to the oldest child going to college (which is still plenty because they have a fully paid off house, with heavily maxed out retirement accounts to boot).

As for the "house is safe from liability protection," while unemployment has a higher likelihood, (a) OP/spouse are both teachers in the state system, generally considered a very safe job, (b) if they own their house outright, they are more capable of weathering one spouse losing their job early, and (c) buying the house outright means you don't need the umbrella insurance at all versus maybe needing it (however low in cost it is) if you invest the $300k.

And $220k with a paid off/judgment proof house and two steady jobs (plus, presumably, term life insurance on both OP/spouse -- if not, get some) is a huge amount of savings that should survive all but the most insane/unlikely of financial emergencies.

Post Reply