Liam Croke: A nice dilemma - cash or mortgage for that house?

I received a call from a reader last week who had a financial dilemma most of us would envy – he is looking at buying a property for investment purposes but he’s not sure whether he should pay for it outright in cash or take out a mortgage.

I received a call from a reader last week who had a financial dilemma most of us would envy – he is looking at buying a property for investment purposes but he’s not sure whether he should pay for it outright in cash or take out a mortgage.

He is in a great position because he has accumulated a sizeable sum of money, primarily through a combination of regular savings over the years, a redundancy package he was in receipt of two years ago and more recently an inheritance he has just received from his late mother’s estate.

This money is sitting on deposit earning less than 1% and – fed up with this abysmal return –he wants his money to work harder for him. So faced with the prospect of rates staying low for the next number of years, he has decided to purchase a property that he will rent out and use the rental income to supplement his other income.

While he has the money to buy a property outright, he wanted to know if it would be the right thing to do. Should he exhaust the majority of his savings, or should he borrow the money and get mortgage instead?

This gentleman is far from alone because buying a property for cash is not as unusual as you would think. You would think that the majority of people buying properties struggle just to save a 10% deposit – and they do – but they are primarily first-time buyers. There is still a cohort of people who are buying properties for cash and a report recently carried out by, in association with Davy’s, found that cash buyers accounted for 50% for all transactions in the housing market in the first six months of this year.

So, why would you buy a property for cash? There are many obvious reasons and the first would be the interest payments you would save by not having to take out a mortgage. When you look at the overall cost of buying a house with a mortgage over, say, 20 years at an average interest rate of 5%, the eventual difference between using a mortgage and paying for it in cash is huge.

Let’s take an example of buying a property costing €200,000 where a mortgage is taken out for €140,000 i.e. 70% of the purchase price. The interest paid over a 20-year period is c. €81,745. Of course, you will be allowed to offset 75% of the interest payments against your rental income and in this case, assuming the borrower was taxed at the higher rate of 40%, the net cost of borrowing that €140,000 is €57,222.

Sometimes people overestimate the value of being able to offset the amount they pay in interest to their bank and whilst it is absolutely welcome and a big benefit for people who have to borrow money to buy an investment property, unfortunately it is not nearly as big a benefit as some people think. In no way doesit compensate those people who have the cash to buy a property – you will without question repay significantly more over time if you borrow money as opposed to using cash. You would think this is very obvious – and it is – but there is a lot of misinformation out and some people people mistakenly think they will be better off if they borrow money than if they use their own – they won’t.

Another big advantage to buying a property for cash is how attractive a cash buyer is, particularly to vendors who want a quick sale. Being able to close a purchase within a very short time period, avoiding all the paperwork that comes with someone who is getting a mortgage and going through that process, gives cash buyers a significant edge. And buying in cash also means you are more likely to get a better deal as well – if I am selling a property and a cash buyer is offering me €200,000 for but I have offer of €210,000 from a first- or second-time buyer who has yet to secure a mortgage, or who has a property to sell themselves, I might be more inclined to accept the lower bid, safe in the knowledge I will be getting money sooner rather than later.

There’s a big downside to buying a property for cash – and it was a concern to the reader who contacted me. He worried that he was exhausting the majority of his savings. Buying a property for cash, for many people, means that the majority of their money is tied up in one asset, leaving little if any funds to invest in other assets.

Having your eggs all in one basket is not a good strategy in my opinion and whilst some people are fearful of investing in the stock market, and feel safer investing in bricks and mortar, the actual long-term returns on housing fall well below returns on stocks.

According to a study carried out on the Irish market by a Nobel prize winner in economic science, Robert Shiller, from 1890 to 2014 house prices rose by 0.3% per annum after accounting for inflation. So if you were to take his data into account, it would suggest that property doesn’t make a very good investment at all, whether you are paying for it in cash or not.

If you are in that position that you can buy a property for cash, either for investment purposes or as your primary residence, paying for it in cash will work for some people and not for others. I would advise readers to avoid borrowing money at all if they can help it, provided they don’t exhaust all of their cash.

I read somewhere recently where someone said buying a property for cash was similar to investing in an investment bond that pays the same interest rate you would pay on a mortgage. I thought this was a great way of describing it. Opting not to pay a 20-year mortgage with a 5% rate is essentially realising a 5% return on the purchase price – something to think about.