My wife and I are American and live in London. We are currently renting mainly because London properties are hugely expensive, but also because we know London is not our long-term future. In the next year or so we plan to return to the US where we will buy a house and settle down a bit.
My wife and I are in our 30s. We have no children or desire to have a family, and we are currently sitting with about $ 580,000 in our investment portfolio. This amount does not include our retirement provision.
We think we know where and how much to spend on a house (around $ 400,000), but we don’t how We should buy the house. Is it better to take out a mortgage and let the profits from our investments pay off the mortgage over time? Or should we just buy the house outright? We’re obviously thrilled to be in a position where that’s even a consideration, but we just haven’t found any sound advice that’s better.
Kind regards
Return to America
Dear return,
I have to commend you for being so proactive in planning such a big financial move. I hear a lot from MarketWatch readers who seem to be falling into their homes. Maybe they’re trying to keep up with the Joneses, or maybe they’re worried that property prices are getting too expensive for their wallets. Anyway, you and your wife are sure to be in an enviable and comfortable position, and the fact that you are not rushing when buying a home suggests to me that every decision you both ultimately make is well considered and will be appropriate for your financial situation.
For those who can buy a home straight away, this can be a difficult decision – especially in today’s marketplace. The low supply of homes for sale across the country has created a situation where listings attract multiple offers. As a result, many potential buyers choose cash bids to assert themselves.
Buying a home without a mortgage can give you an edge over the competition. It allows for a much more flexible and streamlined closing process without having to rely on a lender for funding. Sometimes sellers get so excited about the idea of such a straightforward deal that they will even accept an offer at a lower price if the buyer in question pays everything in cash.
Not to mention avoiding a lender means avoiding fees and closing costs that can rise quickly, as well as the interest rates associated with a loan. So it’s easy to see how a direct purchase can result in savings. For many people, being mortgage-free also has a psychological benefit. You wouldn’t feel the weight of a large debt on your shoulders, and it can be easier to continually manage your cash flow without that burden.
But of course there are also disadvantages to buying a house directly. At the top of the list is the potential opportunity cost: if you spend around two-thirds of your investment portfolio buying a home, you are missing out on the money those investments can potentially bring in. The average annual return on the S&P 500 has historically been around 10% – and those gains add up over time. With rates still below 3% these days, it’s easy to see how the income from running a larger portfolio can more than offset the cost.
“Compare the average return on the S&P 500 to the average mortgage rates to see which route is best.”
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There is also a risk that the home could be a bad investment. Yes, home prices are rising and have been for some time. But what if the house floods or your particular market experiences a downturn? Then suddenly, instead of having a more diversified investment portfolio, you have sunk most of your non-retirement savings into a single asset.
Even leaving aside potential returns and portfolio diversity, going down this route would mean a drastic reduction in available cash (unless you have other resources that you didn’t mention). You’d only have $ 180,000 left in your investment portfolio – so how would you pay for furniture, renovations, and ongoing maintenance – not to mention other luxuries you might want to spend your money on?
Dennis Nolte, a financial advisor at Seacoast Investment Services in Winter Park, Fla., Puts it in a nutshell, “You can’t eat your house.” What good is being mortgage free when it means using up so much of your resources?
In reality, I think your situation is less black and white than you portray it. One way that many of the financial advisors I interviewed suggested is to buy the home outright but then apply for a payout refinance. This would be the best of both worlds: You could place an attractive bid that would appeal to buyers and benefit from an optimized deal at the beginning. But later on, you could cash out a portion of the home to reinvest or use it for whatever you want, be it fine furniture or a newly renovated kitchen.
There are many other options that you could consider. Because you have the funds to buy the home outright, you can avoid financing and valuation risks with every offer you make. This means that you would fill in any loopholes caused by problems with the mortgage lender you choose.
You could also pay a down payment greater than 20%, which would reduce the size of the loan and interest expense without completely draining your investment accounts.
In the meantime, if you are completely relying on these funds for a down payment or more, you should reconsider your investment strategy.
“The value they have amassed in their investment portfolio is currently at great risk if it is primarily stocks,” said George Gagliardi, founder of Coromandel Wealth Management in Lexington, Massachusetts. His advice: Consider scaling down your portfolio and moving some of the money to safer investments like short-term investment-grade bonds to ensure a potential market downturn doesn’t jeopardize your home ownership chances.
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