Paying cash for a house

[ERICOPOLY]

Again, if you have puts to protect your investment portfolio then the "Great Depression" scenario is a 0% risk.  We should stop using that as a reason given that it's so easy to hedge against that.  It's just impossible, never going to happen.  You just buy your puts.  Simple, easy, we all can do it.

 

To play devil's advocate, let's say one does that and there is a depression and the counterparty fails or something similar and now your puts are worthless. While I don't think that's very likely...well many didn't think the muni reset market would ever collapse back in 07 either.

 

You can construct the same position just buying the $10 strike call and writing a spread with the $17 strike calls.

 

So you are still hedged for any crash below $10 per share.  You just never put that $10 down on the table in the first place.

[stahleyp]

Again, if you have puts to protect your investment portfolio then the "Great Depression" scenario is a 0% risk.  We should stop using that as a reason given that it's so easy to hedge against that.  It's just impossible, never going to happen.  You just buy your puts.  Simple, easy, we all can do it.

 

To play devil's advocate, let's say one does that and there is a depression and the counterparty fails or something similar and now your puts are worthless. While I don't think that's very likely...well many didn't think the muni reset market would ever collapse back in 07 either.

 

You can construct the same position just buying the $10 strike call and writing a spread with the $17 strike calls.

 

So you are still hedged for any crash below $10 per share.  You just never put that $10 down on the table in the first place.

 

Eric, you know way, way more about options than I do.  So, I could certainly be wrong here. However, if the OCC were to default or not process trades. What type of coverage is there to make sure your options are going to go through like you think they will?

 

I took a look at their site,

http://optionsclearing.com/clearing/clearing-services/

 

And it says they have $3.5 billion in a fund to cover contracts.

 

"OCC is dedicated to promoting stability and financial integrity in the marketplaces it serves by focusing on sound risk management principles, including rigorous initial and ongoing membership standards, prudent margin requirements and a substantial $3.5 billion clearing or guarantee fund."

 

Now, I may be totally of base here, but $3.5 billion in a derivatives market doesn't seem like a great cushion.

[ERICOPOLY]

Again, if you have puts to protect your investment portfolio then the "Great Depression" scenario is a 0% risk.  We should stop using that as a reason given that it's so easy to hedge against that.  It's just impossible, never going to happen.  You just buy your puts.  Simple, easy, we all can do it.

 

To play devil's advocate, let's say one does that and there is a depression and the counterparty fails or something similar and now your puts are worthless. While I don't think that's very likely...well many didn't think the muni reset market would ever collapse back in 07 either.

 

You can construct the same position just buying the $10 strike call and writing a spread with the $17 strike calls.

 

So you are still hedged for any crash below $10 per share.  You just never put that $10 down on the table in the first place.

 

Eric, you know way, way more about options than I do.  So, I could certainly be wrong here. However, if the OCC were to default or not process trades. What type of coverage is there to make sure your options are going to go through like you think they will?

 

I took a look at their site,

http://optionsclearing.com/clearing/clearing-services/

 

And it says they have $3.5 billion in a fund to cover contracts.

 

"OCC is dedicated to promoting stability and financial integrity in the marketplaces it serves by focusing on sound risk management principles, including rigorous initial and ongoing membership standards, prudent margin requirements and a substantial $3.5 billion clearing or guarantee fund."

 

Now, I may be totally of base here, but $3.5 billion in a derivatives market doesn't seem like a great cushion.

 

Don't worry, the $10 is in cash.  Imagine the bargains to be picked over in that scenario.  There would be so many forced liquidations if puts were all torn up.  You might get KO for ten dollars!

 

[Uccmal]

Isn't the question somewhat contingent on both the housing markets and the stock markets?

 

We did a large addition to our house about 3 yrs. ago, increasing its value by at least the amount spent.  We took out a HELOC at the time in addition to a mortgage we still hold.  I recently paid a large chunk of the Line of credit down.  The reason for this is an overall derisking process.  I will be leaving my job within 6 months, probably permanently, although via an unpaid leave at first.  I am also finding less really compelling values in the markets.  I am trying to wring as much as I can out of existing ideas. 

 

This has been a recent shift.  When things were cheaper I felt less nervous about market risk.  I am running the least leverage I have ever used, since I have been a homeowner - 10 yrs next week, including the mortgage and HELOC.  With these multi-generationally low mortgage rates my principal is getting smaller on the mortgage by $1000 every six weeks.  Depending on what I can get a 5 yr. mortgage for in two yrs. when it comes up, I will decide then whether to pay the mortgage off completely, increase it somewhat, or do nothing of significance.  I guess there is a magic interest rate in there somewhere at which debt repayment makes more sense than buying low quality value stocks. 

 

Probably somewhere above 6%.  In Canada, I can write off the Heloc against my investments, but not the mortgage, contingent on interest rates, that may be the way to go.  The way I see it, one can also borrow against a home when the markets tank.  Mind you as Eric has discovered the banks want your first born as collateral if you dont have job,,regardless of passive income.  I should probably get the HELOC limit increased while I can.

[CorpRaider]

A "catastrophe" is you mailing the keys to the house to the bank and you're not much worse for wear.

[CONeal]

The older I get the more I am thinking like you, no_free_lunch and CONeal.  Does it make any sense to take any chance of watching your family get booted out in the street, even if 99 times out 100 it works out in your favor?

 

My main objective is to avoid catastrophe.  Philip Morris IV brings up a good point too about flexibility too.

 

For me personally my family would come first.  I do not view a house as an investment.  I view it more as a home to provide stability for the kids that come along.  Having it paid off reduces the stress.  Once the family is provided for, then I can focus my energy on the markets.

 

I know that my view is not the most efficient capital wise.  My counter to this is knowing that the family would be ok in the most adverse scenario provided comfort for me and I would expect the wife(not married yet) would have a similar view.  When kids come up asking, why their friends family is losing their house and are we going to lose ours also? The response of "no we are not going to lose our house because it's paid for" would provide releif to the homestead.

 

For me personally I work better debt free (excluding taxes) knowing I don't have to answer to anyone.  Others on the board have valid arguments but it doesn't work for me.  I can still make plenty of money my own way.

 

 

[Parsad]

Isn't the question somewhat contingent on both the housing markets and the stock markets?

 

We did a large addition to our house about 3 yrs. ago, increasing its value by at least the amount spent.  We took out a HELOC at the time in addition to a mortgage we still hold.  I recently paid a large chunk of the Line of credit down.  The reason for this is an overall derisking process.  I will be leaving my job within 6 months, probably permanently, although via an unpaid leave at first.  I am also finding less really compelling values in the markets.  I am trying to wring as much as I can out of existing ideas. 

 

This has been a recent shift.  When things were cheaper I felt less nervous about market risk.  I am running the least leverage I have ever used, since I have been a homeowner - 10 yrs next week, including the mortgage and HELOC.  With these multi-generationally low mortgage rates my principal is getting smaller on the mortgage by $1000 every six weeks.  Depending on what I can get a 5 yr. mortgage for in two yrs. when it comes up, I will decide then whether to pay the mortgage off completely, increase it somewhat, or do nothing of significance.  I guess there is a magic interest rate in there somewhere at which debt repayment makes more sense than buying low quality value stocks. 

 

Probably somewhere above 6%.  In Canada, I can write off the Heloc against my investments, but not the mortgage, contingent on interest rates, that may be the way to go.  The way I see it, one can also borrow against a home when the markets tank.  Mind you as Eric has discovered the banks want your first born as collateral if you dont have job,,regardless of passive income.  I should probably get the HELOC limit increased while I can.

 

Way to go Uccmal!  Enjoy your new life.  I would get the HELOC limit increased now, as if there ever is a crisis, banks won't want to lend at the most opportune time, or will cut back the limit anyway, as they did in 2008.  Cheers!

[oddballstocks]

I think this is very much an emotional decision, not a math one.  If you live your life in spreadsheets then under many scenarios it would make sense to lever up as much as possible and invest the cash.  There are many on this board who are wealthy from doing just that, it does work.

 

I look at things like this, will it cause me to lose sleep at night?  We have a small mortgage, everything else is paid for.  Our investments could pay off the house today if we needed, but I'm doing better than my interest rate (3.5% fixed) and we can easily pay the payments out of monthly cash flow, plus extra.  So we're happily paying down the house, but also investing.

 

I've never regretted paying something off completely, and thankfully if I did I could just go out and borrow against that item again to fix my regret if I did.

[Parsad]

Congrats Uccmal on your impending retirement from the corporate rat race!

 

I re-financed my house @ 2.8% for 15 year fixed last year. I promptly put the cash into BAC and it has worked out well thus far 8).

 

That said, everybody is different on how much risk they can tolerate. I like Mr Money Mustache's take on this, he is downsizing - http://www.mrmoneymustache.com/2013/09/23/rebuilding-our-new-old-house-want-to-help/

 

I think that was a terrific move.  I would try and keep the portfolio out of any sort of all or nothing bet (so no 100% BAC), but that's a terrific rate and I would do the exact same thing.  Actually, I did!  I have a 2.79% 5-year fixed...you can't get anything longer than 10 years in Canada. 

 

I wish we had 15 and 30 year mortgages, because I would have locked into multiple rental properties on 30 year fixed rates back in 2009-2010.  You guys are fortunate to have had that opportunity...granted it came on the back end of a catastrophe...to the prepared mind or bankbook go the spoils!  ;D  Cheers!

[ERICOPOLY]

Mind you as Eric has discovered the banks want your first born as collateral if you dont have job,,regardless of passive income.  I should probably get the HELOC limit increased while I can.

 

Make sure you draw it after you get it raised.  My brother in law (the responsible one that married my sister, not the derelicts on my wife's side) thought he had this reserve of liquidity in his HELOC -- then when things got tense in 2009 the bank froze the credit line. 

 

They never ran into any troubles, the bank was just trying to cut it's exposure in a scramble to cut risk.

[SharperDingaan]

We had to make a very similar decision when we withdrew capital from our portfolio to buy a property in London (UK). It has worked out very well, & the property is already worth 30-40% more than what we paid for it.

 

Use the opportunities. Mortgage rates, the word over, are at record lows - & likely to remain below the norm for a good many years; foolish to not take advantage. Governments are also giving some very rich incentives; & it requires very little deal structuring to take advantage of it.

 

Think risk reduction - not elimination. Assume you could withdraw 100K from an equity portfolio, or withdraw 50K from the portfolio & incur a 50K mortgage. You reduced total risk by 50K (DP) & swapped 50K of equity risk for mortgage risk. Given the typical casino effect that equity portfolios generate, & that you control the mortgage, there are major benefits. ..... and there is nothing to prevent you from doing multiple withdrawals from your equity portfolio over time to deleverage the property.

 

Think usage. Living in it, renting it, planning to be there a long time, significant others consideration, etc. Our London property is leased for its first 5 years, nephews will then live in it (& charge rent to flatmates) for 3-5 years while they attend university in London, & then it will be sold for a tax free gain. Over the 10yr holding period we expect at least a triple on the property itself, & that total nephew education costs will be minimal as much of the COL will be eliminated. Nothing new to this approach, & the highest & best usage (to us) is not to lease it out for the entire 10yrs

 

Remind yourself that money is the slave, not the master. There is no point to investing unless you intend to use the gains, & do it within your lifetime - while you are still able. Life is short, & it should be as well lived as you can possibly make it.

 

SD

 

 

[jay21]

If you are living in Canada and you MUST by a house right now, I would say to put at least 25% of the value of the house down. CDN housing market can easily correct 30% once interest rates rise. If that happens and you only put 5% down, you will easily have negative equity.

 

Wait, wouldn't you want to put less down then?

 

Say house is $100 and you put $25 down and get a $75 mortgages.  Prices decline 80% so now a $80 house with a $75 mortgage gives you $5 equity which is a $20 MTM loss.  If you put $5 down, you would only lose the money you put down and wouldn't sink more money into a depreciating asset.  Let the banks make the bad decision of financing an overvalued asset.  Agree or disagree?

[bookie71]

It doesn't matter what others think, this is a VERY personal decision.  You should go with what makes you more comfortable and fits your personality.  As I have aged I lean to pay it off and not having to worry about debts or payments, BUT again it doesn't matter what i think, it is what you think and what lets you sleep well at night.

Rationale is not as important as peace of mind.

jmho

[watsa_is_a_randian_hero]

Is the downside risk of having a house with a mortgage any different then being a renter?  I view it as the same risk.  If I get laid off, or if the market plunges, I still need a roof over my head.  So assuming you are a renter now, you already have that risk.

 

Also, if you own your home free and clear this does not eliminate your risk.  Plenty of people owned their homes free and clear during the depression and still lost their homes because they did not have the cash to pay taxes.  Point being, you are never really "free and clear," and so I'm not sure I would sleep any better at night.

 

Finally, I think if you are worried about sleeping at night, I would continue renting for yourself, and take the money and buy real estate that you rent out to another.  This way, you are supplied with a fixed income, but have the flexibility to downsize your self if you dire circumstances arrive.  I think this would be the ultimate "low risk" option.

[no_free_lunch]

Jay21,

 

Most mortgages in Canada are recourse, you are paying that money or it is messing with your credit.  I think you would need to declare bankruptcy to get out of an underwater mortgage (don't quote me on that though, never been there).

 

Also renting depends on your situation.  Very hard to do if you have family.  Just a few things off the top of my head:

 

- The people who rent your place can trash the place.  I know people who own rental properties, it happens, this is maybe not super common but it does happen.  Feel like spending your free time replacing dry-wall and flooring?  Where I live this stuff is super-expensive to get someone to fix.

- Tenants might not pay their rent and just disappear.  Again, too many stories.

- Your landlord can refuse to fix things.  There are numerous things that can happen here but the worst one is mold.  Landlords never do anything about mold.

- Landlords can invade your privacy.  There are rules around this but these guys are slimy and they will find ways around it.  (You: Were you at my place today?  Landlord: You were complaining last month about the furnace so I just popped in to have a look at it.)

- Landlords are well within their rights to sell the place, given the constraints of the lease.

- Yes, you can deal with some of the landlording issues by just moving until you get a good one but I just cannot stress enough what a big deal that is if you have a family.  Just completely not an option.

[stahleyp]

 

Don't worry, the $10 is in cash.  Imagine the bargains to be picked over in that scenario.  There would be so many forced liquidations if puts were all torn up.  You might get KO for ten dollars!

 

ahh, good point. thanks as always, man.

 

Uccmal, congrats on the retirement, too! :)

[jay21]

Jay21,

 

Most mortgages in Canada are recourse, you are paying that money or it is messing with your credit.  I think you would need to declare bankruptcy to get out of an underwater mortgage (don't quote me on that though, never been there).

 

 

Thanks for this.  I know that mortgage products differed a lot between countries, but for some reason always assumed that they would be non-recourse.  Not sure what the answer would be then.

[Mikenhe]

I bought a house in the early part of the last decade. Saw its value rise by a massive – 25%. More than I expected but not the huge boom numbers happening elsewhere. When the market crashed the value of my house dropped 40% from its high – 25% under the amount I bought it for.

Then I lost my job at the beginning of 2012. Looked for another but it took me 5 months to find another suitable one. That just about drained my reserves. Put the house on the market as I had to move 1,400 miles away. It then took a year to sell and it went on a short sale which killed my credit. Finally sold in July this year.

I rented an apartment at first but moved out due to domestic disputes with the neighbors’, police out regularly and just it not being a suitable place to live. I then rented a single family and that was fine – until about the time that the landlord had foreclosure proceedings started against him. So, finally free of the millstone of the house I had, and being forced to look for another place to live for my family I weighted up all the options and decided to buy. Cash. Prices were low enough that we could do it and we didn’t have to rely on banks (who had no intention of lending to me regardless of the amount I could put down). I cashed in 1/3 of my portfolio and last month I bought a 3 bed single family in a good school district for us to live.

The outgoings are now low enough that we technically could live off my wifes salary in retail.. I don’t actually need to earn. But I’ll carry on for the moment as we have debts related to renovating the house – and the fact that I like to drink good wine and eat steak rather than live on the bread line.

For the first time in my life I’m not reliant on a pay check in order to support my family – and I reckon that in comparing the running costs of the house compared to rent I’m better off by $10,000 to $15,000 a year. Net money. I can clear the final debts and be far better off than having a mortgage (which is all theoretical) or renting. I can decide what I want to do for a living and not concern myself about supporting my family on that alone.

As mentioned above – whats the true cost of the emotional relief it brings. We are no longer at the mercy of anyone regarding money. Most importantly Mama is happy – and when Mama is happy…..

 

It truly is freedom from the rat race and to get there is great. I’d like to add a huge up yours to BOA and Citibank for making my life a living hell for the last 18 months. And a huge thank you to BOA and Citibank for the rise in their share price that made this possible.

I write the last check for the renovation today – we move in Saturday. Sunday I shall be sitting on my patio and raising a glass to having no more rent or mortgage payments.

I may stay working to provide some of the college fund for the kids… the rest would be spent on travelling… theres a lot of places I want to go yet.

“When I was 5 years old, my mother always told me that happiness was the key to life. When I went to school, they asked me what I wanted to be when I grew up. I wrote down ‘happy’. They told me I didn’t understand the assignment, and I told them they didn’t understand life.”

― John Lennon

 

 

PS - I reserve the right to change my mind and get a mortgage later if it suits me :D

[Mikenhe]

 

 

 

 

I just wanted to add that the need to raise cash was very therapeutic – going through my portfolio and seeing what holdings I thought still had value, which ones had reached a reasonable value and those I should have sold ages ago.

As a person whose strategy often could be described as “The procrastination approach” it was good to review everything in detail rather than just a glance and not doing anything :D

 

[tooskinneejs]

matjone said: "I am thinking about purchasing a house and am trying to decide whether to borrow or pay cash.  Paying cash would probably cut my investment capital in half, but it would probably cut my heart rate a few BPM too."

 

Like deciding which supermodel to date, this is the kind of dilemma that many folks would love to be faced with.  So first off, congratulations on your financial position!

 

With today's low rates, the textbook answer is to maximize your mortgage to the extent of not paying PMI.  That said, there is a lot to be said for peace of mind and it sounds from your post that you really value security and peace of mind.

 

Therefore, I'd suggest considering one of the following options:

 

1.  Pay cash for the house and secure a home equity line for 50 percent of the value of the house.  Don't draw on it, just have it available.  Then use it when you run across that once in a few years homerun investment opportunity.  This strategy might also help prevent the temptation of keeping all investment capital deployed in stocks at all times (for those who have a hard time sitting in cash).

 

or

 

2.  Get a mortgage for 50 percent of the value of the house and put 50 percent down.  This way, you'll still be able to keep three-fourths of your capital working for you in the stock market and even though you will have a mortgage obligation, the monthly payment will be small enough that it will be very easy to manage under most likely scenarios.

[yseric]

Well,, even if you buy the house with mortgage and you lose your job, you can still rent it out.  :)

[Mikenhe]

Well,, even if you buy the house with mortgage and you lose your job, you can still rent it out.  :)

 

but you still have to live somewhere..

[locatevalue]

My experiences are in the +ve territory ,I agree with Eric on this one.

I got married when i was in LA , I started looking for a decent home but couldn't afford it or thought those doubling rates every year doesn't makesense(2003-2006 period). At first opportunity ,I moved to Dallas. I waited for 2 years and in 2008 i bought  a home in foreclosure following basic rule.

1. You always make money when you buy not when you sell.

My house is in a great location and i paid 210k , Original buyer paid 305k 2 years earlier. So , I thought i wont loose money and i used 20% down so i dont have to pay PMI with intrest rate of 5.5%.

2. I waited for close to 3 years(i was naive and should have done earlier) and cashed out equity and locked it for 15years at intrest rate of 2.75% (I thought its no brainer and invested in BAC, PCS and LEAP and they worked out really well, I haven't done options till today except BAC warrants but thought this is very safe to lock for 15 years as intrests are tax deductable and if everything goes bad, Banks will come back and as ask you , how much i am willing pay and keep the house, isn't it wonderfull my liverage account never asks me this questions and takes me to 0 and bankrupts me :)

3. My investments worked out and i dont see too many opportunities now, so i took some cash and bought an investor property recently with all cash as its a great deal again someone paid 170k few years back and i bought it for 150k and will get +ve cash flow as i manage it. Now i am looking to mortgage it ASAP and take out equity on first opportunity. These intrest rates are great and i can feel safe and they are locked for 15 or 30 years and govenments has incentive to keep you and make you confortable then taking leverage in my trade accuonts.

Thats my more than 2 cents to this discussion..

[matjone]

Well don't start getting envious of me.  I suspect I am willing to settle for a lot less house than most of the folks here.  And if I don't hurry up I have a feeling this opportunity is going to pass me by. 

 

I think Mikenhe deserves a big thank you for sharing a story where things didn't go well.  It's easy to share stories of success and much harder to share the stories of hardships.  I imagine there are many of us who have stories of tough experience that people could benefit from hearing, but we are too embarassed to tell them.

[Mikenhe]

Well don't start getting envious of me.  I suspect I am willing to settle for a lot less house than most of the folks here.  And if I don't hurry up I have a feeling this opportunity is going to pass me by. 

 

I think Mikenhe deserves a big thank you for sharing a story where things didn't go well.  It's easy to share stories of success and much harder to share the stories of hardships.  I imagine there are many of us who have stories of tough experience that people could benefit from hearing, but we are too embarassed to tell them.

 

I have no shame :D

 

I bought Lehman Bros shares as well :D