The decision to pay all cash for a home is certainly a sound one in some situations. However, there are three very important factors that must be considered before allocating a portion of your personal wealth into one area. Since your home is also considered a large investment, there are a few questions that you should ask yourself before making a decision to allocate a significant amount of funds to your home versus putting these same funds to work for you in alternative investments.

1. Is this the BEST use of my money?

If you pay cash for your house, you will be stashing quite a bit of money away in an investment – an asset (real estate) that has a particular average annual return. Remember, there are always several forces at work depending on HOW you own your home. Inflation will always eat away at your assets/cash, and you will always enjoy the appreciation from your house whether it’s mortgaged or not. When rates are low, your mortgage acts as an investment just like your home, but only if it is used correctly. Also keep in mind that interest paid on a mortgage is tax deductible. There is no deduction if there is no mortgage. 

2. Will I need this money later?

One other important factor to consider is liquidity. In the face of changing economic environments and a softening housing market, liquidity challenges can impact your personal bottom line. If you invest all of the money necessary to pay a house off, and later need that money, turning your money from equity to dollars will be more expensive than cashing out another type of investment. Keep in mind that cashing out would most likely mean taking a second mortgage or an equity line of credit that would have a much higher variable rate attached to it, and then you would also have an extra (probably unplanned) monthly payment. An important note here is that there is less safety and predictability with a variable rate loan.

3. Will I be properly diversified?

If you were to invest a large portion of cash into your homes equity, then a certain portion of your wealth is tied up in the potential returns of one asset (real estate).  If your money is diversified into different types of financial assets (real estate, stocks, bonds), then one area can face disaster while the others are doing well. If a majority of your wealth is tied up in your home, it’s all or nothing. Currently the housing slump has had a major negative impact on real estate, and returns have been minimal, if any. Those who have a majority of their wealth tied up only in real estate now face a declining net worth.

In some economic environments it makes sense to put as much cash down as possible. But, relative to other markets, mortgage money is cheap right now, and you want your money to work as hard for you as it possibly can. To help you avoid putting all of your eggs into one basket, these are just a few of the questions you should ask yourself before tying up a large amount of cash in your home.

Contributors:

1. Dr. Dorla A. Evans, Finance Professor and Chairperson, Department of Accounting and Finance at the University of Alabama in Huntsville.

2. Libba Hartzog, High School Literacy Coach, Gwinnett County Board of Education, Georgia.

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