When it comes to financing investment properties, there are two major schools of thought: buying a house in cash vs. mortgage. This is a never-ending debate among real estate investors as one group believes it is wiser to pay all out cash when buying a rental property, while the other group believes it is more profitable to buy a leveraged investment property. In this blog, we present the case for both arguments, discussing the pros and cons of each.
Buying a house in cash vs. mortgage: The cash argument
Being in a position to pay cash when buying an investment property can be rewarding. At the end of the day, not carrying a loan on your real estate investments is a major relief since you don’t have to worry about paying your mortgage payments. The method of financing you choose depends on your financial situation: if you have a roof over your head and enough cash, then buying a rental property with cash is something to think about.
Buying a house in cash vs. mortgage: Pros of cash financing
Buying a real estate investment with cash has several advantages for real estate investors that include:
1- Attractiveness to sellers
With a cash buyer, property sellers have no concerns about the loan process, which makes the whole process faster and more flexible. In many situations, closing the sale is delayed due to mortgage pending. Therefore, buying in cash saves the property seller’s time. Moreover, a cash buyer has more leverage to negotiate a better deal.
2- Owning 100% of the equity
Buying an investment property in cash means that your equity is 100 percent of the home’s value. This means that later on if you run into financial troubles, you can pull out some money from the property by getting a bank loan.
3- Immediate cash flow
If you pay cash when buying a rental property, you can start making money and a positive cash flow since you are not paying monthly mortgage payments, which can eat up a large portion of your net rental income. You just have to find tenants to eliminate vacancy costs.
4- No interest payments
Not having to pay interest on your mortgage payments is very advantageous when buying an investment property. Paying interest eats up your equity unless the property’s price appreciates, which is not always guaranteed.
Buying a house in cash vs. mortgage: cons of cash financing
1- Trapped capital
Let’s be honest, paying that much money for a single investment property will cost you a lot of liquid assets. Real estate investors should never opt for this method of financing unless they have a large pool of extra cash laying around.
2- Missing out on tax benefits
Financing investment properties with cash means that you have to pay tax on all your rental income (minus the rental expenses), thus missing out on the benefit of rental property tax reduction. A major advantage of buying a house in cash vs. mortgage is that with mortgage financing you can deduct interest payments from your taxable rental income.
3- Less diversification
Diversification is one of the fundamental rules of real estate investing as it lowers the risk of losing money. When you use all your cash to buy an investment property, you are tied up with a single investment in your property portfolio which can be a massive loss in case of depreciation of property’s price.
Buying a house in cash vs. mortgage: The mortgage argument
Real estate investors in favor of mortgage financing argue that higher returns are achieved. The logic behind this argument is that when prices appreciate, investors make more money since they receive far more than the original invested capital. Nevertheless, mortgage financing has its pros and cons. Carefully examine each when you hesitate between buying a house in cash vs. mortgage.
Buying a house in cash vs. mortgage: Pros of mortgage financing
1- Potential for higher returns
If you pay $100,000 cash to buy a rental property and it appreciates at 4% per year, then your return on investment is accumulating at $4,000 per year. Now assume you divide the cash you have into four bundles of $25,000 and buy 4 investment properties adding a $75,000 loan to each, then at a 4% appreciation rate, your wealth is accumulating at $16,000 per year. So, with the same cash invested, there are potentials to make a higher return.
2- Tax benefits
As mentioned earlier, mortgage interest can be deducted from taxable income- an advantage to real estate investors to lower cost of investment.
3- Buying a house with limited funds
With mortgage financing buying a house with little or no money is possible. You just need good credit to get a bank loan.
Buying a house in cash vs. mortgage: Cons of mortgage financing
1- Risk of foreclosure
This is the nightmare of every real estate investor. Defaulting on a loan puts you at risk of losing the investment property to the lender.
When you are using mortgage financing, you rely on tenants to pay off the mortgage, which makes vacancies the main threat to your investment due to the risk of negative cash flow.
3- Mortgage process
Opting for this strategy requires you to go through the mortgage process. After the housing crisis of 2008, banks have become stricter with issuing mortgages. However, if you have a good credit score and can pay mortgage payments, then you’re ok!
Buying a house in cash vs. mortgage: Conclusion
Both financing strategies have their advantages and disadvantages and to take sides in this debate is difficult. One important thing to note is that each real estate investor is free to choose his or her preferred strategy based on the resources available. Once you know which financing method suits you more, head to Mashvisor to find great real estate investment opportunities.
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