Choosing to buy a house with an all-cash offer can be a strong tactic to outshine competitors and secure a better transaction.
When you opt for a cash purchase, you bypass the need for mortgage approval, which can be a hurdle for sellers. This can increase your chances in a bidding war and might allow you to negotiate a significant discount. For example, in my 2019 home purchase, I was able to negotiate a price reduction of around $100,000 to $150,000 off the asking price. Factors like being a neighbor, opting for dual agency, writing a sincere buyer’s letter, and promising a quick close also played a crucial role in clinching the deal.
While a cash purchase can streamline the buying process, it’s essential to recognize its potential drawbacks. Let’s explore these.
Potential Pitfalls of a Cash Home Purchase
As time has passed and interest rates have climbed, my interest in taking out a mortgage for a home purchase has diminished.
The process of getting pre-approved for a mortgage can be daunting, with a lot of paperwork and a need for patience. Moreover, the fees associated with mortgage applications can be substantial, ranging from $2,000 to $10,000. Therefore, if financially feasible, I lean towards cash purchases.
However, every choice comes with its cons. Here are some key downsides to consider when making a cash purchase.
1. Capital Gains Tax
Acquiring the cash for a purchase might mean liquidating other investments, potentially triggering capital gains taxes, especially after a long bull market. Ideally, you’d want to offset gains by selling some underperforming assets. If you’re using cash on hand, you might mitigate some tax impacts since cash itself isn’t taxed until invested. Nonetheless, investment sales are often inevitable, and capital gains taxes will apply.
2. Forgone Investment Returns
The S&P 500 historically yields about a 10% annual return, whereas real estate returns average around 4.6%. Thus, diverting investments into real estate might not yield as much over the long term, potentially slowing wealth accumulation. However, utilizing idle cash for a purchase could enhance your net worth, especially if real estate values surge unexpectedly.
3. Diminished Returns Due to No Leverage
An all-cash purchase means you miss out on the potential returns leverage could bring. A 5% increase in property value yields just a 5% return on a cash purchase, whereas a 20% down payment could significantly boost that return. Although leverage can dramatically increase wealth through real estate, a cash-out refinance is always an option later, depending on the market.
4. Loss of Risk-Free Income
While paying cash might seem more secure, it also means forgoing guaranteed income from safe investments. For example, $2 million in a money market fund yielding 5% would bring in $100,000 annually. Using this for a home purchase cuts off this income and incurs additional expenses like taxes and maintenance.
5. Lingering Doubts After Paying Cash
Even after a cash purchase, you might still experience anxiety. The transition of assets, be it from cash or other investments, can lead to second-guessing about potentially better uses for that money. It often takes meaningful experiences in the new home to justify the expenditure.
6. Decisions Regarding Your Current Home
If you’re already a homeowner and looking to buy another property with cash, you’ll need to decide what to do with your current residence. Selling it or converting it into a rental for passive income are options to consider.
7. Risk of Being Underinsured
With no mortgage lender to require comprehensive insurance, paying in cash might lead to underinsuring your home. This could save money initially but result in significant financial loss in case of a disaster.
Hesitations About a Cash Purchase
I’m currently pondering over another all-cash property acquisition. Even though I’ve entered into a contract, I’m reevaluating the need to liquidate assets for this purchase, particularly due to the lengthy escrow period. My strategy included making a compelling offer below the listed price, complemented by a personal letter to connect with the seller.
Eventually, I managed to lower the price by also having the listing agent represent me, thereby reducing her commission. This approach was part of a broader plan to secure the property without an urgent need, aware that it would push me to replenish our cash reserves and possibly seek new revenue streams.
In conclusion, several factors need careful consideration before opting for an all-cash home purchase. While it may lead to a favorable deal, swiftly rebuilding your cash reserves after the purchase is crucial to alleviate any financial concerns and fully capitalize on your investment.
