With U.S. mortgage rates above 7%, paying cash for a home may look more appealing. But buyers who need to sell investments to raise the money also face potential capital-gains taxes, less liquid cash and the opportunity cost of taking assets out of the market. Financial advisers say the choice is about more than rates and monthly payments: taxes, investment horizons, risk tolerance and cash reserves all matter. Some buyers may also split the purchase between cash and borrowing.
Mortgage rates are only part of the calculation
Thomas Pontius, director of financial planning at Kayne Anderson Rudnick Investment Management, said buyers should start with their overall portfolio and consider which assets they would sell to fund a purchase. If they can manage the tax cost of selling investments while keeping some assets invested, potential returns could help offset borrowing costs. Those returns are uncertain, however, and are not guaranteed.
Rachel Scholl, a mortgage executive at Merrill Lynch, said borrowing is not necessarily a poor choice; the key is how the debt fits with a buyer’s investments, emergency funds and housing plans. Some clients may be able to negotiate mortgage rates of around 5.5% to 6% through their banking relationships or based on the size of their assets, she said. Actual terms vary by borrower.
Borrowing costs remain an important consideration. Rich Arzaga, founder and chief executive of The Real Estate Whisperer, expects rates to keep rising. Lawrence Yun, chief economist at the National Association of Realtors, recently said buyers should regard rates of about 7% as the “new normal.”
Selling investments can create a tax bill
Paying cash avoids monthly mortgage payments, but selling investments to fund a purchase could lead to a significant capital-gains tax bill. Jason Juhl, a partner and wealth adviser at Carson Wealth, said being able to afford a home and choosing the most suitable way to pay for it are separate decisions.
The type of account used to raise funds also matters. Juhl said taxable investment accounts are often more favorable: assets held for more than a year generally qualify for long-term capital-gains tax rates of 0% to 20%. Withdrawals from traditional IRAs or 401(k)s are usually taxed as ordinary income. The tax bill depends on individual circumstances, and early withdrawals from retirement accounts may also incur additional penalties or fees.
Buyers do not have to choose only between paying in full and taking out a conventional mortgage. Juhl said many of his clients use a roughly 50-50 mix of cash and financing. Borrowers may later be able to make a large payment toward principal and ask their lender to recast the loan, recalculating future payments based on the lower balance. Buyers should confirm availability and terms with their lender.
Retirement and cash needs can change the balance
Age, the reason for buying and a buyer’s tolerance for risk can all affect the financing decision. Pontius said advisers need to understand whether a client is downsizing or buying a larger home to accommodate family needs. People nearing retirement may be less comfortable carrying substantial debt into retirement.
Liquidity is also important for retirees. Juhl said advisers should help clients weigh the reassurance of holding liquid assets against potential investment returns, and discuss whether to sell investments, pay cash or keep some mortgage debt based on the client’s needs.
Interest-only loans, which do not pay down principal, are another option. Pontius said they can reduce current expenses, but the outstanding principal does not shrink with monthly payments. Buyers need to account for that in their longer-term cash-flow and debt plans, rather than focusing only on the initial payment.
Compare financing options with scenario analysis
Even when financial advisers do not help clients apply for mortgages, they can help compare rates and incorporate a home purchase into a broader financial plan. Arzaga recommends using planning software to model different options, including tax costs, the cost basis of investments and any penalties or fees from early withdrawals.
The key question is not simply whether mortgage rates are high. Buyers also need to consider how raising a down payment or the full purchase price would affect taxes, their investment portfolio and emergency cash. Paying cash reduces debt but can limit liquidity; borrowing preserves some cash but adds interest costs. The right mix depends on a buyer’s assets, loan terms and plans for the money.