By June Fletcher
Question: My fiancé and I disagree on whether or not we should purchase our first home outright or get a mortgage. Our situation is this: He has a nice nest egg of $900,000 cash and a home he purchased with a business partner for $1 million (they each paid $500,000 cash) in North Carolina. I think we should get a mortgage, but his rationale is why should he pay the bank approximately 6%? He says a mortgage only makes sense for people who aren't cash rich. Assuming we purchase a home for $300,000, we will still have $600,000 in the bank, which is plenty in case of an emergency, and we always have the option to borrow against the house once we purchase it. What should we do?
-- Savannah Ziegler, Boca Raton, Fla.
Savannah: Wow, this is a problem most of us would love to have. It helps, I think, to think about spending in its simplest terms. That is, if you pay for something now, what won't you be able to buy in the future?
The money you put into your house is an investment. Whatever you spend on it can't be "grown" in other investments, like stocks, bonds, rental properties or a cousin's plan to open a chain of organic fast-food eateries. So you need to compare what you'd pay on a mortgage against potential returns in other investments. In other words, if you take out a 30-year fixed-rate mortgage at 6%, your other investments will have to average more than a 6% return over three decades for the mortgage to be worthwhile.
Of course, there are other factors to consider, too.
On the "don't pay cash" side: Many popular alternative investments, namely stocks and bonds, can be sold much more quickly than a house -- especially in a sagging housing market like we're in now, where supply far outstrips demand. So if you find yourself in a financial pinch, you can cash out other investments more quickly than you can liquidate the assets in a home. And the interest paid on a mortgage is tax-deductible.
On the "pay cash" side: You must have the financial discipline to invest all the money that you would have paid for a mortgage, and to keep it invested over the long haul -- come new babies, vacations, college bills and 400-point drops in the Dow Jones Industrial Average.
Eventually, though, it all comes down to temperament and tolerance for risk. Are you and your fiancé the sort of people who want to keep every last nickel leveraged and "moving" in various investments, and are you willing to devote considerable time and energy chasing after the best return? Or would you rather make one purchase and forget about it, content that your house might only appreciate at a rate only slightly better than inflation over your lifetime?
Given that your fiancé has already expressed a preference for Door Number Two -- and you'll have plenty of money left over after buying your home-- I'd say put at least part of that nest egg into a nice new nest.
-- June Fletcher is a staff reporter at The Wall Street Journal and the author of "House Poor" (Harper Collins, 2005). Her "House Talk" column appears most Mondays on RealEstateJournal.com. Email your questions about the residential real-estate market. Please include your name, city and state. If you don't want your name used in our column, please indicate that. Due to volume of mail received, we regret that we cannot answer every question.
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-- March 05, 2007