Dear MarketWatch,

My wife and I are Americans living in London. We currently rent, mainly because London real estate is hugely expensive but also because we know London is not our long-term future. In the next year or so, we have plans to move back to the U.S., where we’ll purchase a house and start settling down a bit.

My wife and I are in our mid-30s. We have no kids and no desire to have a family, and we’re currently sitting on about $580,000 in our investment portfolio. This amount does not include our retirement savings.  

We think we know where and how much we want to spend on a house (around $400,000), but we don’t know how we should buy that house. Is it better to take out a mortgage and have the gains from our investments pay off the mortgage over time? Or should we just purchase the house outright? We’re obviously thrilled to even be in a position where that’s even a consideration, but we just haven’t found any solid advice for which is better. 


Returning to America

Dear Returning,

I must commend you for being so proactive in planning for such a major financial step. Often I hear from MarketWatch readers who appear to be rushing into homeownership. Maybe they’re attempting to keep up with the Joneses, or perhaps they’re worried about home prices getting too expensive for their wallet. Whatever the case, you and your wife are certainly in an enviable and comfortable position, and the fact that you’re not running headlong in buying a house suggests to me that whatever decision the two of you ultimately make will be well-considered and appropriate for your financial situation.

For those who can buy a home outright, it can very much be a tough call — especially in today’s market. The low supply of homes for sale throughout the country has created a situation where listings are attracting multiple offers. As a result, many prospective buyers are opting to make all-cash bids to come out on top.

Buying a home without a mortgage can give you a leg up on the competition. It allows for a much more flexible and streamlined closing process, without the headaches involved with relying on a lender for the financing. Sometimes sellers are so smitten with the idea of such an uncomplicated deal that they will even accept a bid at a lower price if the buyer in question is paying all in cash.

Not to mention, avoiding a lender means avoiding fees and closing costs that can quickly rack up, plus the interest involved with a loan. So it’s easy to see how buying outright could create savings. For many people, there’s a psychological benefit to going mortgage-free as well. You wouldn’t feel the weight of a large debt on your shoulders, and it can be easier to manage your cash flow on an ongoing basis without that burden.

But there are drawbacks to buying a home outright, to be sure. Top of the list is the potential opportunity cost involved: If you’re cashing out around two-thirds of your investment portfolio to purchase a home, you’re missing out on the money those investments might earn. The average annual return on the S&P 500 is around 10% historically — and those earnings compound over time. With interest rates still below 3% these days, it’s easy to see how the earnings from maintaining a larger portfolio can more than make up for the costs.

“Compare the average return of the S&P 500 with the average interest rates on a mortgage to see which might be the best route.”

There’s also the risk that the home could be a poor investment. Yes, home prices are increasing and have been for some time. But what if the house gets flooded, or your particular market sees a downturn? Then suddenly you’ll have sunk most of your non-retirement savings into a single asset, rather than having a more diversified investment portfolio.

Even setting potential earnings and portfolio diversity aside, going this route would mean drastically reducing the amount of liquid funds at your disposal (unless you’ve got other resources you didn’t mention.) You’d have only $180,000 left in your investment portfolio — so how would you pay for furniture, renovations and ongoing maintenance — not to mention any other non-home-related luxury you might want to spend money on?

Dennis Nolte, a financial advisor with Seacoast Investment Services in Winter Park, Fla., puts it succinctly: “You can’t eat your house.” What good is being mortgage free when it means draining so much of your resources?

In reality, I think your situation is less black and white than you’re making it out to be. One route many financial advisers I polled suggested is buying the home outright, but then applying for a cash-out refinance. This would be the best of both worlds: You could make an attractive bid that would appeal to buyers and benefit from a streamlined closing to start. But then later on you could cash out a chunk of the home’s equity to reinvest or to use for whatever you want, be it plush furnishings or a newly-renovated kitchen.

There are many other options you could consider. Since you do have the funds necessary to buy the home outright, you could waive the financing and appraisal contingencies from any offer you make. This means that you’d cover any gaps caused by issues with the mortgage lender you chose.

You could also make a larger down payment than 20%, which would reduce the size of the loan and how much you’d spend in interest, without fully draining your investment accounts.

In the meantime, you may want to reconsider your investment strategy if you’re completely relying on those funds for a down payment or more.  

“The value that they have accrued in their investment portfolio is highly at risk right now if it is mostly in equities,” said George Gagliardi, founder of Coromandel Wealth Management in Lexington, Mass. His advice: Consider de-risking your portfolio and moving a chunk of the money toward safer investments such as short-term investment grade bonds to ensure that any potential market downturn doesn’t jeopardize your opportunity at homeownership.

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