Should You Buy a Home With Cash?
By: Jeff Brown

Here’s a milestone you wouldn’t expect in a weak economy with high unemployment: in September, a record share of home purchases were made with cash instead of loans. If you had that kind of cash lying around, is it really smarter to pay cash than get a mortgage?

Like all financial matters, it depends.

The Campbell/Inside Mortgage Monthly Survey of Real Estate Market Conditions reports that cash transactions accounted for 30.5% of home purchases in September, up from a recent low of 21.4% this time last year.

Usually, loans backed by the Federal Housing Administration take the biggest share of the market, but that fell to 28.6%, down from 37.4% a year ago. Loans backed by Fannie Mae (Stock Quote: FNMA) and Freddie Mac (Stock Quote: FMCC) continue to be the third largest source of home financing, at 13.6%, down from a high of 18.65 in Sept. 2009. Veterans Administration loans and private mortgages make up the rest.

“A combination of more distressed properties on the market and an ongoing slide in first-time homebuyer activity created a very unusual home purchase market in September, where cash was the number one source of new financing,” Campbell said.

A key factor, the firm said, was the increase in the number of “distressed properties” for sale. Those include “real estate owned” properties, such as those taken over by lenders after foreclosure, and “short sales” in which the lender agrees to accept less than it is owed after the owner sells.

Because it is difficult for buyers to get loans for distressed-property transactions, many resort to cash.

A second factor, said Campbell, is the reduced number of first-time homebuyers. Since they typically take out loans, this reduction helps push up the share of cash deals. There are fewer first-time buyers because of toughened lending standards and the expiration of the government’s $8,000 tax-credit program.

The classic cash purchaser is the older homeowner who “downsizes,” or sells a home on which the mortgage has been paid off, and then uses the proceeds to buy a smaller, less expensive property for retirement.

Many of these homeowners have to use cash to buy their next home because they don’t have the steady income required to secure a mortgage.

But if one had a choice of paying cash or getting a mortgage, which would be better?

Today’s extraordinarily low mortgage rates do make borrowing appealing. With the average 30-year mortgage charging just 4.35%, a borrower in the 25% tax bracket would pay only 3.26% after deducting the interest payments on the federal return.

Borrowing would leave the cash available for other purposes, such as investing or an emergency fund. On the other hand, interest payments do add up, even at today’s low rates. A $300,000 mortgage at 4.35% would cost nearly $538,000 over 30 years.

A home buyer concerned about running short of cash for a child’s college education, emergencies or ordinary living expenses should probably opt for the mortgage, especially as today’s low rates offer a very rare opportunity.

Buyers without concerns about their finances should weigh the cash-purchase option against the savings and investment alternatives. Avoiding mortgage debt at 4.35% is like earning 4.35% in guaranteed savings, and these days it’s very hard to earn more than 2 or 3% with safe savings like certificates of deposit.

Keep in mind, though, that savings yields could improve some day. If cash is tied up in the home, it obviously won’t be available for more profitable investments.

So it boils down to this: If you’re happy earning 4.35% on your cash and won’t need it for a long time, use it to buy a home. If not, the mortgage is a better option.

—For more ways to save, spend, invest and borrow, visit MainStreet.com.

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