Paying All Cash For Your Home Is Good - True or False?
Kevin J. Daum

This article was originally published in a 2006 edition of Log Homes Illustrated magazine.

People in this country must be rolling in cash.  Every time I stand in our lending booth at a Log Home Expo I am amazed at the number of people that walk by saying “Oh I don’t have to worry about financing; I am paying cash for my log home.”  Confidently they make this statement with pride.  Obviously they must be so awash with extra money that they can afford to part with hundreds of thousands of dollars into what they believe to be a safe and sound parking place for their hard earned dough.

I want to state clearly here at the beginning; paying cash for a home is not automatically a sound financial move.  I realize anyone born within two decades of the Great Depression is reading this thinking “Kevin must be off his rocker!  Real Estate should be owned outright and borrowing money from a bank is bad news!”  This philosophy may be fine if you live in the Great Depression but times and economics have changed.  Managing your real estate and money wisely requires serious consideration of the facts.

The truth is that putting money in real estate while generally a worthwhile endeavor requires more thought and research then simply writing a check.  Paying cash for a property may offer some benefits emotionally but financially it can be equivalent to taking your money and locking it up with a key in a poor returning investment.  Not too mention you could be throwing away additional money from investments and tax benefits.

I have put together this series of True/False statements with explanations so that you can test your own perspectives against the facts of managing your cash in real estate.  Slide a paper down the page to cover the answers and see if your knowledge meets up with the facts.

Paying cash for my home is the safest way to invest money.  True or False?

False - Actually depositing cash into a home purchase is not necessarily safer then putting your money in other more conservative investments such as a Certificate of Deposit. (CD) Every investment has some level risk and real estate is no different.

Home prices are subject to volatility and you can’t always control your need to sell the home.  This means you could have to sell in a down market.  If you paid cash and your home price deflates by $100,000 you have lost real money that cannot be recouped.

Cash put in a CD of $100,000 is insured by the government and would take a collapse of the federal banking system to put your funds at risk.  In fact it is highly likely that a banking collapse would be far preceded by a collapse in other major economic areas such as real estate.   In a major economic recession you might lose your job and your home but your money would be safe and available to you to survive and even purchase another home at a cheaper price.   

Paying cash saves money by not having to pay interest.  True or False?

 False – Money is money and every investment can be compared in terms of yield and risk. The yield you would get by paying cash for a home is equivalent to the interest rate offered by the bank for a mortgage.  If a mortgage rate is 5.5 percent for 5 years and you can invest the same amount of money in a 12 month CD at 5.5 percent then you have saved absolutely nothing. 

Additionally if you decided you needed to access that cash in the future for some reason you would likely pay a premium at that point to get a new loan or credit line.  In a rising interest rate environment you would have lost the opportunity to take that cash and invest it at higher yields with better security.  Most diversified investment portfolios have outperformed mortgage rates consistently for decades so there is little savings there as well.

Let’s also remember the best part of home mortgage interest… It’s generally tax deductible.  That means that in some states the government may refund you as much as 42 percent of the interest you have paid.  That gives you much better odds of investing at a better yield.  If you pay cash up front for the property you will permanently reduce your deductibility opportunity from day one even if you decide to borrow later.

If you lose your job you are better off with a loan on your home. True or False?

True – The biggest problem of not having a job is not having any money.  A sudden loss of income can be downright scary.  If your house is paid off you have a place to live but that won’t help you with food, healthcare, clothing, or anything else you may need to get you to be employed again.  If you need to get money from the home you may have difficulty getting a loan since now you have no job.  Even if you decide to sell, that will take time and you may need to do some work on the home to get it in shape costing money you no longer have.

If instead of paying cash for your home you decided to borrow $200,000 and put it in the bank you would be able to take your time and find the right job or prepare and sell your home without panic.  Yes you would have to carry roughly $1200 in payments but you would be getting almost that much in interest and the principal would cover the difference for decades before you would have to pick the new career of your choice.

Conservative wealthy people say own your homes outright.  True or False?

 False - Most wealthy people take great pains to maximize the return on their investment and manage their money.  They look to take advantage of every tax loophole they possibly can including the home mortgage interest deduction up to $1,100,000.  Wealthy people recognize that cash is king and if you put large amount of cash in your home it’s no longer cash.  

One of the best ways investors build wealth is through leverage.  In a good market your property will appreciate at the same rate regardless of whether or not you own it outright.  So if your property appreciates by 5 percent and you own it outright you make 5 percent return on your investment. 

However if your property is worth $300,000 and you owe $200,000, a 5 percent increase would make you $15,000 on your $100,000 cash investment yielding you a whopping 15 percent.  This is how the wealthy get wealthier.  They were busy investing the $200,000 they borrowed in other leveraged investments making even more money.

Also, many wealthy investors will also tell you that markets change and having the ability to move cash from one poorly yielding investment to one with better returns is the best way to hedge against changes in the market.  Since removing equity from a paid off home requires time, money and qualification, having money in the home can cause you to miss a short increase in interest rates.  In fact using the concept of “buy low, sell high”, many wealthy investors will borrow heavily at low long term rates at the beginning of a rising interest rate market so they can invest in higher long term rates later for a significant profit.  Of course this requires access to cash.

Emotional Security is the reason most people pay cash. True or False?

True - But not for the reasons you would think.  The peace of mind that comes from having a paid off home is like false hope.  People feel secure from not having to make a house payment for sure but if they knew they were likely giving up thousands of dollars in lost return and tax savings they might feel more uncomfortable. 

The real insecurity being pacified is the fear of mismanaging large sums of cash.  Most people buying homes with large sums of money are simply moving that money from another home.  They may have managed their retirement account or a small amount of savings.  But often the equity reward can be 3 to 5 times that amount.  It can stretch from a few hundred thousand dollars to even more than $1,000,000 for some.

The biggest reason that most people want to put their money in the house is their lack of confidence in being able to manage this money effectively.  Managing this kind of money can be scary if you don’t have the right resources for proper education and money management.  With Stock market bubbles and horror stories about dishonest brokers, people are afraid they are going to make bad investments and lose their windfall so they tuck the money in the house where they can’t touch it.

Ultimately this can be a mistake as well. Money management is not just a choice of investment and yield but one of time and education.  People who maximize their investments do so by committing the time and energy to read about and explore various investment possibilities.  At the very least they spend the time to find trustworthy advisors such as Certified Public Accountants (CPA) and Certified Financial Planners (CFP) to help guide them toward the best investment path.

Many of the concepts addressed relating to paying cash apply to other aspects of managing your home financing such as paying down principle on existing loans and maintaining liquidity when mounting a construction or rehab project on your loan.  The basic concept is simple.  If cash is accessible it can always get you out of a bind or be used to take advantage of opportunities.  Once it’s in the home you’ll pay a premium to put it back in your pocket where it belonged in the first place.

About the Author...
Kevin Daum is the Founder and CEO of Stratford Financial Services, a Real Estate finance and education company, founded in 1989. Stratford specializes in Purchase loans, Refinance loans and Custom Home Construction finance and has successfully financed thousands of clients. He is the author of "Building Your Own Home for Dummies" (Wiley), as well as "What the Banks Won’t Tell You." Mr. Daum was an Underwriter for Plaza Savings and Loan and Key Bank of New York. He is an INC 500 CEO and has been listed as one the 40 Most Influential People Under 40 in the San Francisco Bay Area. He is the Global Chair for the Edison Innovation Program with the Young Entrepreneurs' Organization (YEO) and is a founding Board member of the Bay Area Chapter of YEO.

Mr. Daum is a frequent contributor to numerous business publications on the subjects of Real Estate and Small Business leadership and speaks regularly on both subjects. He can be contacted at kevin@stratfordfinancial.com.