To Mortgage or Not to Mortgage? That Is the Question
For wealthy people, the main question when buying a home is often whether to mortgage it. If you’re sitting on a large sum of cash or liquid assets, you can choose whether to pay for the house outright, or just use cash for the down payment and take a mortgage out on the home.
Let’s look at two scenarios for a 35-year-old couple, Marc and Melinda, buying a $1 million home. In the first scenario, they purchase it outright for $1 million. In the second, they put down 20%, or $200,000, and take out a 30-year fixed-rate mortgage at 4.3% for the remaining $800,000.
Which strategy would add most to the couple’s target financial capital—the wealth they need to support themselves when they stop working? They’d like to spend $200,000 a year, inflation-adjusted, beginning at age 65.
The results may be surprising. Whether they purchase the home outright, or take out a 30-year mortgage, we estimate that their target-financial capital requirement would be the same: about $4 million, in typical markets. That’s because the benefit of eliminating monthly after-tax mortgage payments would be offset by the investment returns forgone over decades, if the money to buy the home comes from their target financial capital.
From a target-financial-capital perspective, Marc and Melinda should be indifferent. Whether to mortgage is less a financial decision than an emotional decision for them: Would they simply feel better if they had less debt? If so, they should probably consider first paying off any higher-cost debt they have.
In our view, the best way to think about a mortgage is in terms of how it affects your overall asset allocation. If you own your home outright, you may have too large a portion of your net worth exposed to residential real estate, which can be risky in the short run. A mortgage enables you to diversify, by retaining or increasing your exposure to financial assets that provide either stability or growth opportunities to your overall wealth.
For entrepreneurs, taking out a home mortgage has another benefit: It may preserve liquidity, perhaps to fund a new venture. If you don’t take out a mortgage to buy your house, you’ll probably be able to mortgage it later if you need cash—albeit at potentially higher rates. The rules regarding tax-deductibility are also somewhat different in these circumstances.
The views expressed herein do not constitute and should not be considered to be legal or tax advice. The tax rules are complicated, and their impact on a particular individual may differ depending on the individual’s specific circumstances. Please consult with your legal or tax advisor regarding your specific situation.