Purchase Second Home with Cash or Mortgage?

[7004]

I’m considering buying a vacation home and was planning on paying cash, but before talking the leap, wondering if a mortgage is the better choice. Interested what others’ thoughts are.

[HomerJ]

Mortgage rate would likely be 6.5% to 7.0%

Pay Cash.

That's a math decision.

As a secondary consideration, my personal opinion is to "Always buy luxuries with cash". If you can't afford to pay cash for extras, you can't afford the extras.

[cchrissyy]

+1 to HomerJ

[Squirrel208]

Pay cash. A 30 year mortgage on a $500K home at 7% interest with 20% down payment will cost you $558K in interest, or $958K total, if paid according to the original amortization schedule.

[ichee_marone]

My philosophy is to finance things that appreciate, if you can invest cash and make a return over the mortgage interest rate. You should also consider if financing can allow your itemized deductions > standard deduction. Good luck

[7004]

My philosophy is to finance things that appreciate, if you can invest cash and make a return over the mortgage interest rate. You should also consider if financing can allow your itemized deductions > standard deduction. Good luck

That was always my philosophy when rates were low and is why I will keep paying the minimum payment on my primary house as long as possible. I always mentally thought my cut-off point for paying cash versus financing was around 5.5-6.0%, but this is close enough to the cusp where I'm questioning it.

I've already lost out on about $100k of appreciation since I pulled the $550k out of VOO last year to set it aside for the second home search, and that has me thinking again about whether I'm making the correct decision paying in cash. I know the past year has been an outlier, but already feeling the sting of the choice somewhat.

[7004]

Pay cash. A 30 year mortgage on a $500K home at 7% interest with 20% down payment will cost you $558K in interest, or $958K total, if paid according to the original amortization schedule.

It would, but the tax benefit would be minimal given that the standard deduction is already close to $30k and the itemized deductions with the added interest would not be much higher than that.

[Watty]

Mortgage rate would likely be 6.5% to 7.0%.....

I would pay cash. A risk free tax free return like that would be too good to pass up.

I like to turn this question around and ask it this way, "I have a paid off house, should I take out a new mortgage so I can invest the money?". That is really just about the same question but it sounds a lot risker when asked this way. You likely have no interest in taking out a home equity loan on your primary residence just to invest the money and you might think someone was crazy if they suggested that you should.

Taking out a mortgage just to invest the money is in many ways like getting a negative bond in your asset allocation.

If you pay cash you can then get the advantages of investing the monthly mortgage payment to get the advantages of dollar cost averaging if the stock market dips.

Investing and getting a higher investment return is also a lot harder than it sounds even a few years ago when interest rates were lower because you have a sequence of returns risk. Here is a very simplistic example of that which I wrote up when interest rates were lower. You might want to play with your actual numbers looking at it this way.

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 pay off the mortgage at the end of the second year you would need about $96.5K so you would need to gain back $12.5K and another $6,000 for the next years mortgage payments which combined is $18.5K. That would take a 22% return on the remaining $84K to get back to the point where you could pay off the mortgage.

In the past portfolios have declined in roughly one of four or five years depending on the asset allocation. (20 to 25 percent of the time)

https://investor.vanguard.com/investing ... allocation

The sequence of returns risk can also go the other way and you could get lucky and have the first couple of years get good returns that would put you on the path for large gains over the years. There will sometimes be very optimistic projections on just how much better not paying off the mortgage could be but one limiting factor that needs to be considered is that few people actually keep a 30 year mortgage for the full 30 years. It is difficult to put a number on it but many people who own a home will sell it in less than 10 years.

[7004]

Mortgage rate would likely be 6.5% to 7.0%.....

I like to turn this question around and ask it this way, "I have a paid off house, should I take out a new mortgage so I can invest the money?". That is really just about the same question but it sounds a lot risker when asked this way. You likely have no interest in taking out a home equity loan on your primary residence just to invest the money and you might think someone was crazy if they suggested that you should.

That is a good way of framing it. I wish I did a cash-out refi with my primary home and invested the proceeds when rates were 2.75% but I'm not sure I'd even do it at 5.5% and certainly wouldn't do it now at 6.5%.

[bombcar]

The only reason I can really see to consider a mortgage is if you can use non-recourse purchase money loans (such as in California, not sure if it applies to non-homestead properties) as part of bankruptcy and loss diversification.

E.g, you buy $500k house with cash, house drops to $250k for whatever reason, bye bye $250k.

You borrow $400k to buy $500k house, drops to $250k, you walk away in a non-recourse state, bank gets the house; you're out the down payment ($100k).

This is .... unlikely. But it's theoretically possible.

[7004]

Mortgage rate would likely be 6.5% to 7.0%.....

Investing and getting a higher investment return is also a lot harder than it sounds even a few years ago when interest rates were lower because you have a sequence of returns risk.

The sequence of returns risk can also go the other way and you could get lucky and have the first couple of years get good returns that would put you on the path for large gains over the years. There will sometimes be very optimistic projections on just how much better not paying off the mortgage could be but one limiting factor that needs to be considered is that few people actually keep a 30 year mortgage for the full 30 years. It is difficult to put a number on it but many people who own a home will sell it in less than 10 years.

Unfortunately the reverse already happened to me.

[bltn]

Mortgage rate would likely be 6.5% to 7.0%

Pay Cash.

That's a math decision.

As a secondary consideration, my personal opinion is to "Always buy luxuries with cash". If you can't afford to pay cash for extras, you can't afford the extras.

I completely agree with Homer J. A second/vacation home is a luxury. And it will be an ongoing maintenance expense. No question, with the current mortgage rates, getting a mortgage is not a good move financially. Getting more than 6.5-7% annually over the next 10 years from a balanced portfolio is by no means a given.

We ve had a vacation home for the last 15 years. While a very nice addition to our lives, the expense has taken its toll on our travel budget. 95% of our vacations now are to our 2nd home. At our age and after our years of various travels, we re ok with that. But at your age that may not be a trade off you want to make.

We bought our vacation home with cash in stages. We bought the lot. Nine years later we finished building our house. It was the right choice for us. But it has been an expense rather than an investment.

[AnEngineer]

Pay cash. A 30 year mortgage on a $500K home at 7% interest with 20% down payment will cost you $558K in interest, or $958K total, if paid according to the original amortization schedule.

It would, but the tax benefit would be minimal given that the standard deduction is already close to $30k and the itemized deductions with the added interest would not be much higher than that.

This is changing in a couple years when many TCJA provisions expire.

[7004]

This is changing in a couple years when many TCJA provisions expire.

That is not a given either.

[7004]

Mortgage rate would likely be 6.5% to 7.0%

Pay Cash.

That's a math decision.

As a secondary consideration, my personal opinion is to "Always buy luxuries with cash". If you can't afford to pay cash for extras, you can't afford the extras.

That doesn’t make sense. If I wanted to buy a sports car and could afford to pay cash for it and there was zero percent financing available, why shouldn’t I finance it just because it’s a “luxury?” The fact that it’s a luxury shouldn’t be the end of the analysis.

[AnEngineer]

This is changing in a couple years when many TCJA provisions expire.

That is not a given either.

It's the law right now.

[7004]

This is changing in a couple years when many TCJA provisions expire.

That is not a given either.

It's the law right now.

Right. Certain enough that you’d make a major financial decision banking on it? Can always cash out refi later if that in fact happens.

[bombcar]

That doesn’t make sense. If I wanted to buy a sports car and could afford to pay cash for it and there was zero percent financing available, why shouldn’t I finance it just because it’s a “luxury?” The fact that it’s a luxury shouldn’t be the end of the analysis.

Zero percent financing is basically the same as cash if you have the cash (though with a car often taking the zero percent misses out on a cash discount).

It's also not 7%, or anywhere close.

The rule of thumb is "if it's a luxury, and you can't buy it with cash, you can't afford it". Part of the problem with using loans for luxuries is that the same "I could buy it with cash $500k" could be used to justify a house, the car, the boat, the plane ... soon enough you're drowning in payments for luxuries you "could afford with cash".

[AnEngineer]

This is changing in a couple years when many TCJA provisions expire.

That is not a given either.

It's the law right now.

Right. Certain enough that you’d make a major financial decision banking on it?

As much as for planning that any other tax law will stay the same.

Can always cash out refi later if that in fact happens.

My point wasn't that therefore you should take a loan.

[Gennaro Dillinger]

I’m considering buying a vacation home and was planning on paying cash, but before talking the leap, wondering if a mortgage is the better choice. Interested what others’ thoughts are.

I would say 'yeah, pay cash' unless to get the cash you have to realize gains at a hefty tax rate. I went down this road before with calculations.

[White Coat Investor]

I’m considering buying a vacation home and was planning on paying cash, but before talking the leap, wondering if a mortgage is the better choice. Interested what others’ thoughts are.

We didn't buy a second home, but we did a big renovation. We had cash so we used it. Determining which is the better choice depends on what you do with the money instead of using it to avoid a mortgage. And if that's another investment, how it performs.

What's your alternative and how do you expect it to perform?

[David Jay]

I would pay cash. A risk free tax free return like that would be too good to pass up.

I like Watty's construction. A risk-free return on short term treasuries (long term treasuries aren't risk free considering liquidity) is around 4%. You are getting 6.5% or 7% on your purchase capital compared to taking out a mortgage.

There were a number of topics here on BH a few years ago when 2% to 2.5% mortgages were available, saying don't pay down the balance. Interest rates change all that.