- Business Advocacy
Purchasing a piece of real estate with an all-cash offer can have advantages. But buying a home with the help of a mortgage can also have advantages and benefits to buyers. The value of each approach will vary for each buyer, but having a general appreciation of these benefits helps buyers become more informed consumers.
In today’s competitive market, sellers sometimes prefer an all-cash offer to avoid the probing analysis and elongated schedule of bank appraisers and underwriters. Also, properties sometimes referred to as “distressed properties” are not in the condition to even be financed under a conventional mortgage, but may be transacted with all-cash offers. So, in a highly competitive market like ours today, an all-cash offer can catch the favorable attention of sellers.
But often buyers are not in the financial position to even consider using all cash to purchase a home. And in this situation buyers can also employ the use of money that is not actually their own through arranging financing through a mortgage. A mortgage is a loan that is secured by using the real estate itself as collateral (i.e., security for repayment of the loan). Financing a real estate purchase allows people to achieve a goal that otherwise is unachievable due to their lack of funds. And with current low interest rates, buyers are obtaining financing at some of the best rates in a generation.
In financing the purchase of a property, the principal is the amount of money you borrow when you originally take out your home loan. To calculate your principal, simply subtract your down payment from a property’s final selling price. Interest is paid on the amount borrowed and can be a write-off on taxes. Also, in arranging a mortgage, buyers generally pay origination fees (also known as “points”) to the lender and other closing costs. A drawback on an all-cash acquisition is that it may consume a significant amount of the buyer’s cash reserves.
By utilizing a mortgage, home owners tap into something called leverage. Leverage is the use of debt (i.e., borrowed capital) to undertake an investment in something such as real estate. In other words, it is borrowing money to invest. Leverage can increase an investment’s return when the return on the investment is greater than the interest on the loan. Leverage increases the home owners return by using other people’s money and less of their own funds to purchase the property. The difference between a home’s value and what is owed on it is referred to as equity. As the value of real estate rises, the owner’s equity in the property increases.
Lower down payments on mortgages often lead to buyers having to pay mortgage insurance, which is an additional cost. The larger the down payment, the lower the risk for the lender. Often down payments below 20% pay mortgage insurance. Buyers can refinance their property as they build equity in it and avoid mortgage insurance.
Some mortgage lenders offer borrowers the ability to make half-payments twice a month on their mortgages. These payments are made bi-weekly instead of a full payment once a month. This approach can significantly reduce interest paid over the life of a loan.
By not incorporating a mortgage and using an all-cash offer, buyers can avoid paying interest over the life a loan. When the monthly principal and interest payments are added up over the life of a mortgage, the total amount paid by a buyer can be over twice the value of the initial mortgage. All-cash purchases avoid loan origination fees and some other closing costs, but may also drain cash reserves of the buyer.
The optimal down payment percentage will vary depending on each buyer’s own financial position. Larger down payments approaching 20% often receive the superior terms and avoid mortgage insurance. Larger down payments also lead to lower monthly payments and more equity in the property.
An all-cash offer can elevate a buyer’s offer into a powerful position in bidding wars. One way to experience the benefits of an all-cash offer and still ultimately rely on a mortgage is to engage in delayed financing. Delayed financing allows buyers to use cash, and in some cases stocks, to buy a house and obtain a mortgage after the home is purchased. Essentially, they are enjoying the advantages of being a cash buyer while still getting the benefits of using a mortgage for leverage. Borrowers must maintain the integrity of their credit and employment status between the time they buy the house and when they get their mortgage.
All of this is a lot to absorb. But gaining a general understanding of these advantages and trade-offs helps buyers make good decisions and support meaningful discussions with trained financial professionals.
Gary Frueholz is a realtor with Dilbeck Real Estate, a past member of the Alhambra Planning Commission, a Certified Senior Real Estate Specialist, and a Certified International Property Specialist. He can be reached at 626-318-9436. See his stories at www.garysstories.com.