LOUISE FAIRSAVE: Home-buying option
A case has been made previously for purchasing one’s home for cash. It has been demonstrated that by disciplined saving, investing and taking advantage of tax-saving incentives, a would-be homeowner could build a cash fund that would serve to purchase the home and still have a tidy sum of cash in hand.
The example presented asks: Do you have the discipline and patience to save $1 500 per month for 25 years, including pro rata increases in pay, and exploit tax-saving incentives?
If you can do this and achieve an average rate of return of five per cent compounded, you will have a fund large enough (over $1.3 million) to purchase your home cash and still have a significant amount of cash in hand.
Financially, this approach makes sense. The major drawback is that the would-be homeowner would have to delay his satisfaction in owning and living in his home until the fund has sufficiently built up.
On the other hand, if the would-be home-owner had undertaken a mortgage, at the end of the mortgage, as mortgagor he would probably have arrived at the point where he was contented to have paid off his mortgage.
The mortgagor would then be the proud owner of a debt-free home for which he would have expended more in absolute cash in making cash mortgage payments, than the capital appreciated value of the property at the end of the mortgage.
Additionally, unless the mortgagor has adequately maintained the property over the period of the mortgage, the property would have appreciated in value to a lesser extent or even deprecated in value. Thus, the mortgagor has the added costs of the annual maintenance of the property that he does not fully own (the maintenance of a liability really).
To crown it all, the mortgagor will be required to insure and pay property tax annually on the property – taxes and insurance on essentially what is a liability. The would-be homeowner who saves to buy his home cash, while modestly renting, avoids these costs; these costs would be for the account of the landlord during the saving period.
An alternative involves saving a sizeable downpayment for say, a ten-year period. Such a downpayment can provide a good middle ground in reducing a full mortgage commitment and in reducing the time before owning the home. For example, after ten years, that home will likely be worth more following the assumed rate of capital appreciation.
Yet, the savings and investment pool would have grown significantly.
The general rule for improving your personal financial position is to limit your involvement in the mortgage arrangement: shorten the period either upfront, by repaying faster or both; make as substantial as possible a downpayment or just take the time to gather the full cash payment.
The challenge for the cash purchaser is mastering the art of navigating among the various investment options in optimizing the rate of return earned on the investment pool, given the level of risks he is willing to tolerate. Yet, the experience, understanding and judgment gained would be very, very valuable.
That knowledge and confidence would come in handy in building another important fund, a retirement fund. But, more on that later.