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If Paying For Your Home in Cash Is an Option, Is it the Right One?

Being a homeowner is often a lifelong dream for most people. And owning that home outright is something that might seem downright unattainable. But for individuals nearing retirement who have spent years making repayments on their mortgages or are considering downsizing to a more manageable property, it might not be so unthinkable.

This article does not constitute advice. Professional advice should be taken prior to acting on any part of it. Your home may be repossessed if you do not keep up repayments on your mortgage or any other debt secured on it.

The profits from the sale of their home could either be put towards buying a new property mortgage-free, or it could be spent on other investments to help supercharge savings. But if one can purchase a new home completely in cash, is it the right option?

Why is ‘leverage’ important?

When your investment’s anticipated rate of return is greater than the interest rate for a loan, that’s called ‘leverage’. Essentially, a loan makes sense if you can borrow money for less than you could earn by investing the same amount of cash instead. Leverage is really only one of the considerations when deciding between purchasing a home outright or securing a small mortgage, but it’s a good place to start.

Leverage works better for investors more comfortable with risk, when interest rates are low, and when seeking fixed-rate mortgages.

So, when would it be advantageous to use leverage?

Let’s take a look at an example:

If you plan to sell your home that’s currently worth £500,000 (with a £200,000 payoff) when you and your partner are 60 years old, but plan to work for at least another 6 years. You have your eye on a smaller property that’s valued at £300,000 and you can put a 20% deposit down. The mortgage deal you’re being offered is a 30-year fixed rate with a 4.5% interest rate and an expected rate of return on the property is 6%.

By taking out a mortgage, you’d be committing to making mortgage payments from your income until you retire and then using funds from your investments once you stop working.

In this case, using leverage works out for you because, thanks to compounding, in 30 years, you’ll be hundreds of thousands of pounds better off by having a mortgage rather than using cash.

Other considerations

Of course, this is really a case of comparing apples to oranges unless you can guarantee all variables are the same when pitting cash purchases against those using bank assistance. As mentioned, leverage is really only the first consideration, here are a few others:

  • Market performance – In the example above, we assumed a 6% annual return rate, but this will vary from year to year. A fluctuating rate of return could severely impact the profitability and skew the results of any analysis you might have done before your decision – in either direction.
  • Variable-rate mortgages – Fixed-rates are usually better for long-term stability, but variable rates offer competitive rates during the introductory period and for those not planning on staying in the home for the duration of the mortgage, they could be appealing. Since these rates are based on the BoE base rate, changes to the broader economy might influence a rate hike.

Deciding between making an all-cash offer or taking out a mortgage to purchase a new home is a tough decision with complicated variables that need to be evaluated during the decision process.

Connecting with your IFA who specialises in running the types of calculations necessary will help expedite the process and they can help clarify what the results mean, so don’t hesitate to get in touch with us today.

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Dental & Medical Financial Services have been helping doctors and dentists to build and protect their wealth, whilst saving tax for over 25 years.
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