The Downsides Of Paying All Cash For A House

Paying all cash for a house is one of the best ways to beat out your competition and get a better deal.

With all cash, you don’t have to submit an offer with a financing contingency, which sellers dislike. As a result, you increase your chances of winning a bidding war at a reasonable price. Further, with all cash, you might be able to get a larger discount.

I paid all cash for a home in 2019 and was able to save about $100,000 – $150,000 off the market purchase price. Being a neighbor, going dual agency, writing a solid love letter, and having a fast close were also important variables.

Although paying all cash makes the home-buying process easier, there are still some downsides to be aware of. Let’s discuss!

The Downsides Of Paying All Cash For A House

The older I’ve gotten and the higher interest rates go, the less motivated I am to take on a mortgage to buy a house.

Getting pre-approved for a mortgage is a cumbersome process that requires a lot of paperwork and a tremendous amount of patience. There is also the mortgage application fee, which could easily run between $2,000 – $10,000. Hence, if I’m able to pay all cash for a house, it is my preference.

However, there are downsides to everything. These are the main ones if you’re considering paying all cash for a home.

1) Capital gains tax

One way to pay all cash for a home is to raise funds by selling other investments. The longer you own your investments, usually, the greater the gains. The key is to try and sell your investments in a way that matches enough losers with winners to minimize your capital gains tax.

But after a long bull market, paying capital gains taxes on asset sales might be an inevitability. You may eventually be overwhelmed with too many winners.

The only way to avoid capital gains tax is if you can utilize uninvested cash to buy a home. You might even reduce your tax liability because you’ll no longer have to pay federal and state income taxes on the income earned by your cash.

But unless you never plan to sell your investments, you will eventually have to pay capital gains tax. It’s good to sell stocks on occasion when you’ve earned enough to buy whatever you want. Otherwise, what’s the point of investing in the first place?

2) You might miss out on further gains

The S&P 500’s historical annual return is about 10% compared to only a 4.6% historical annual return on real estate. Therefore, chances are high if you sell the S&P 500 index to buy a home with all cash, your transferred capital will underperform over the long run.

The greater the percentage of your net worth is in a home compared to stocks, the slower your net worth may grow. Of course, your net worth could also outperform if you so happen to sell stocks before a crash and home prices outperform stocks, as they did from 2000 – 2006.

But overall, paying all cash for a home by selling stocks will likely cause a slowdown in the pace of your net worth growth. Alternatively, if you are rich enough to pay for a home with idle cash, then you have a better chance of accelerating your net worth by buying a home with all cash.

For example, in 2023, you’re able to earn ~5% in a money market fund. But if real estate prices rise by 6.5% by July 2024, as Zillow predicts, then the transfer of your cash to a home might make you richer. This would especially be true if interest rates start to decline and real estate prices start to accelerate upward.

3) Paying all cash reduces your potential returns on your home

Leverage is great on the way up and damaging on the way down. If you pay all cash for a home and prices go up by 5% in one year, you earn a 5% gross return. However, if you only put down 20%, then your gross return on your cash increases by 25%.

The main way to grow your net worth faster with real estate compared with stocks is with a mortgage. Even though real estate is usually considered less risky than stocks, you can ironically make a lot more. But this is an article about paying all cash for a home.

Perhaps one strategy is to pay all cash for a home, assess the real estate market over the next year or two, and then do a cash-out refinance if you are bullish. This way, you buy yourself more time to make a potentially more optimal cash utilization decision.

Just be aware that when it’s time to access your home’s equity, some banks may no longer offer Home Equity Lines of Credit (HELOC) or cash-out refinances. Best to double check with your bank now.

4) You lose a tremendous amount of risk-free income and security

You would think paying all cash for your home would provide you a greater amount of security. Once you’ve got your home fully paid off, life is much easier.

However, here’s the irony in a high interest rate environment. If you can pay all cash for a house, it means you also have the ability to earn a hefty amount of risk-free income. This also means you could be forgoing financial security.

Let’s say you can pay $2 million cash for a house. If you were to just invest the $2 million in a 5%-yielding money market fund, you’d earn $100,000 a year risk-free. The vast majority of us with no major health issues and no debt should be able to happily live off $100,000 a year in gross income. Some might even consider this a Fat FIRE lifestyle in lower-cost areas of the country.

But if you decide to utilize your $2 million cash to buy a home, your $100,000 in risk-free income goes away. Not only that, but with a new home, you will now have to pay additional property taxes, insurance, HOA (where relevant), and ongoing maintenance expenses forever.

Hence, even if you plan to buy a home with all cash, I recommend following my net worth guide for home buying. See the right three columns of the chart below. I’m going to tailor the guideline in the future for cash buyers in a new post.

5) You will still feel anxious despite paying all cash for a home

You’d think paying all cash for a home would give you tremendous peace of mind. After all, with no mortgage, there is no bank out there than can take your home away from you. Even the government will have a tough time kicking you out if you don’t pay your property taxes. Meanwhile, a downturn in the real estate market won’t wipe away 100% of your equity.

Paying all cash for a home is simply an asset transfer. The transfer can be from your idle cash or from other investments like municipal bonds, stocks, and private real estate investments. That said, you will still feel unsettled about the asset transfer because the cash you inject into a new home becomes unproductive.

You will constantly wonder whether there were better uses for your cash than tying it up in a home you may not need. The only way to quiet these doubts is by creating wonderful experiences in the new home for several years. But that takes time.

Your anxiousness may make you more irritable or stressed. And a sour mood is not good for your family and friends.

Hence, if you are going to pay all cash for a home, you had better have even more cash and liquid securities behind. Over time, the anxiety should fade as you rebuild your cash or liquid reserves.

6) You have to figure out what to do with your old home

If you’re currently renting and pay all cash for a new home, then you have no worries. Give your landlord a 30-day notice or longer that you’re moving out, and you’re good to go. Just make sure your new home is actually ready to move in once your lease is over.

But if you own your existing home and buy a new home with all cash, then you’ve got to figure out what to do with your existing home. Will you hire a real estate agent to sell it? Or will you try to find renters and build your passive income portfolio for financial freedom?

Personally, I like buying a property every 3-10 years and then renting it out when it’s time to buy another primary residence. Do this over thirty years and you’ll be able to fund your retirement with rental properties no problem.

Feeling Nervous About Buying A Home With All Cash

I’m considering buying another home with all cash. But now that I’m in contract with contingencies, I’m second-guessing my decision, as I always do.

Maybe I didn’t need to sell as many assets and pay all cash in the first place. Given how long the escrow period has been, taking out a mortgage would have been just fine. But that’s kind of like saying maybe I didn’t need to have good grades and test scores after I got accepted to a great college!

There’s a comfort in seeing other people buy homes during a bull market. It means that other people want what you want and are helping justify your decision, even if it may be the wrong one. But during a bear market, you feel like a lonely fish out of water, wondering whether the tide will ever return.

Can people simply not afford to pay all cash or take out a mortgage at these rates? Or are people waiting because they expect real estate prices to crash? It’s a disconcerting feeling not knowing what’s keeping people from taking advantage of deals.

Why I Offered All Cash

I wanted to make my offer enticing enough for the seller to accept. I was offering to pay 14% below last year’s asking price and 7.5% below this year’s new asking price. By offering to pay all cash, I hoped to make my offer attractive enough for him to consider. Insulting a seller with a low-ball offer is not the way to win deals.

Initially, the seller declined my offer via his listing agent. But then a month went by and the listing agent contacted me again to say they would be taking the home off market. This was my last chance to make a competitive offer!

I didn’t feel much real estate FOMO given I was happy with our existing home, so I just stood firm on my offer price. But I also decided to spend 35 minutes writing a real estate love letter, explaining why my family would be a great choice.

The seller wrote back a letter of his own saying how much he appreciated my letter. I had touched upon everything from how much I valued his remodeling, to the importance of family, to our mutual love of tennis, and our similar culture. Maybe writing 2,200+ articles on Financial Samurai since 2009 has some benefits after all!

Then I was able to convince the listing agent to reduce her overall commissions by 2.5% in lieu of her also representing me through dual agency. She initially refused because she didn’t want to earn less. But I explained to her she wouldn’t be earning less because she would have had to have paid the 2.5% commission to a buyer’s broker anyway.

I was thus able to convince her to give me at least a 2.5% price discount and just represent me. It was that, or no transaction at all.

Raising The Stakes By Buying Something I Don’t Need

As I mentioned to my wife in a previous podcast episode (Apple), “Nobody needs nothing.” We don’t need anything more than a studio apartment, water, and cereal to survive. As a result, I often question the point of buying anything we don’t really need. We are frugal folk.

Paying all cash for a new home raises the financial stakes because it reduces our passive retirement income. As a result, I will feel more pressure to make more money and grow our net worth further.

The first two years of ownership will keep me in a heightened state of anxiety because our finances will be most at risk. The anxiety won’t be debilitating to the point where I won’t be able to sleep or function. It’ll just be higher than I’m used to since leaving work in 2012. I hope I’ll be able to adapt.

Maybe I will use this anxiety as motivation to write more books and/or find a well-paying job. When my son was born in 2017, my motivation to earn shot through the roof! Further, I plan on giving up on early retirement anyway once both kids go to school full-time in 2024. So the stars seem to align.

In conclusion, be aware of the downsides of paying all cash for a home. Use your all-cash offer to get a lower price and then quickly replenish your cash reserves after you close. If you do, you’ll feel much better about your purchase.

Reader Questions And Suggestions

Have you paid all cash for a home before? If so, how did you feel? What are some other downsides to buying a home with cash?

Instead of paying all cash for a home, you can invest in private real estate with Fundrise. With just $10, you can diversify into in a Fundrise fund that primarily invests in residential and industrial properties in the Sunbelt, where valuations are lower and yields are higher.

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