A: You’re right: Interest rates are at historic lows these days. If you factor in the rate of inflation, taking out a mortgage feels like borrowing money free.
You, however, are in a unique situation as you can choose to pay cash for your new home rather than taking out a loan. Since your cash really isn’t earning any interest from the bank, it would be less expensive over the long run to pay for the home in cash rather than taking out a loan. But if you have a place to invest your cash, or if buying the home for cash would leave you without any cash, taking out some sort of loan might be smart. You should certainly talk with the builder’s lender and get an idea of what mortgage products they are offering and what those fees, interest rates and terms would be.
Recently, Sam closed on a deal for a buyer who obtained a loan for around $200,000. He did not need the loan but wanted to have the cash on hand. The interesting thing about the loan, which carries an interest rate of 3 percent, is he paid over $5,000 in fees. That is a hefty upfront cost for a relatively small loan.
The buyer’s total loan costs were about average; but had he paid cash he could have saved over $5,000. These fees included around $1,000 loan processing fees, $650 appraisal fee and another $800 in other miscellaneous lender fees. Once you got through the lender fees, he also had to pay for the lender’s title insurance policy and other title company closing fees and charges. Those fees were another $3,000.
We point these fees out to make sure you understand what it might cost you to take out a mortgage instead of paying cash. As you begin to weigh the options, ask the builder’s lender for an estimate of fees (without formally applying for the loan or giving them your credit information). Once you have that information in hand, you can decide whether the fees are worth it or not.
If you do opt for the mortgage, what is your plan for the cash you have on hand? Some people are quite risk averse and may put the money in a savings account earning virtually nothing. Well, if you plan to have the money sit around earning no interest, you might be better off paying cash for the home and save paying all the extra fees associated with applying for and closing on the loan.
On the other hand, if you need the money for medical expenses, college tuition or travel expenses, or simply want to invest in something else, then taking out the loan may be right for you.
We have said this many times in the past: Investing your cash is fine and if you’ve got a place for those dollars, then taking out a mortgage is a smart idea — particularly at today’s historic low interest rates. But please understand and map out your investment strategy and the inherent risks that accompany it. And do not underestimate the power of living debt free.
Some of our readers cannot resist these super-low interest rates, and we often hear from them when we write how good some homeowners feel knowing their mortgage is paid off. To them, equity means your cash is trapped inside your home and they believe you should always make your money work as hard as it can for you.
We do not disagree, but not everyone shares that level of risk tolerance. As we have all seen over the past few weeks, the stock market can experience wild, jarring and painful swings. The trick is to sit tight and let your money ride out the storm.
No one can time the stock market. If you invest for the long run, history says you should do well. But if you needed your money on a day when the stock market drops 2,000 points, you might well wish you had your cash back in a savings account, even if it is not earning any interest.
Make sure you ask a lot of questions, understand your options and have thought through any ramifications. Good luck.