Often, I’ll see people proclaim that they’d love to save up enough for a house and pay for it in cash. I assume they mean cutting a cheque for the thing and not bringing a suitcase full of $20s to the showing, which would be awkwardly hilarious. Can you imagine?
Buyer: Oh, I can afford it. Take a look at this. (Opens briefcase, reveals neat rows of $20s)
Realtor: Uh, thanks. But I said I believed you. Honestly, I don’t really care, as long as someone is willing to lend you the money.
Buyer: I swear, I don’t sell drugs.
I find that people who insist on paying cash for a house are people who have been burned with debt in the past. They’ve worked hard to pay back those student loans or credit cards or whatever, and they’re never going back into debt again, dammit. It’s sort of the opposite extreme of the lackadaisical attitude that got them into debt into the first place. Is there anything more sanctimonious than the newly debt free? We get it. You paid off your debt. So do most other people.
But there’s a couple of huge flaws in the pay for a house in cash argument. They demonstrate pretty nicely how the people who advocate the plan really don’t have a solid understanding of inflation.
This is especially true for American readers, since they’re able to lock in mortgages for 15 or 30 years at a time. If you pay $1000 a month for 30 years, by the end of the mortgage the $1000 per month is worth a hell of a lot less than $1000. It deteriorates down to being worth less than $400 per month – in purchasing power terms – assuming 2% inflation per year.
So providing you don’t constantly cash out your home’s equity to buy crap, you’ll have a mortgage payment that’s constantly getting cheaper after inflation, which should put less pressure on you to cover it every month. Which leaves you with more excess cash to invest, which is all but guaranteed to grow at faster than inflation. You see how this works?
Also, while you’re saving up for the house, you lose all sorts of money in lost opportunity costs. There’s a story I’m sure you’ve heard before about two investors. One invests $2,000 per year from 18-25, the other one invests $2,000 every year from 25 to 65. And thanks to compound interest, the first one ends up with more money, and probably all the attractive retired ladies.
How can you be that first guy if you’re saving all your money to buy a house? Don’t be fooled by short term real estate performance either, since all real estate has returned over the years is barely above inflation. It’s a really crummy asset class, because there are too many people who do dumb things like decide that mortgages are bad.
This is exactly the reason why you should stretch out your amortization too. A mortgage – especially these days – can be a really cheap form of financing. If you managed to lock into a mortgage at less than 4% for 30 freakin’ years, that’s gonna look really good at some point. It’s also why I continue to suggest Canadian homeowners find themselves a nice 10 year rate (currently at 4.29%) and increase investments as time goes on.
Anyway, just don’t pay cash for your house. It’s okay to finance it.