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Invest or pay cash for house?

Dear Dr. Don,
I have saved $20,000 for a down payment on a home, and I also have a mutual fund of about $100,000, which I have been saving for retirement (I'm 48). I can find a home suitable for me for about $80,000. I am tempted to just pay cash and avoid 30 years of paying interest, but would then lose a lot of the interest from the mutual fund. I'm a good saver and would build another retirement fund. Do you think it's a good move to pay cash for a house?
-- Paula Payments

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Dear Paula,
If your $100,000 retirement portfolio is in a tax-advantaged account, like a 401(k), 403(b) or IRA then cashing out to buy a home isn't the right idea. You'll owe income taxes on the early distribution and a 10 percent penalty tax on most, if not all of the proceeds.

Even if you have the $100,000 in a taxable account, I'd still lean toward financing the house with a mortgage, assuming you can use the mortgage interest deduction on your taxes. As long as you can earn a higher after-tax rate of return on your investments than you pay on an after-tax basis on your mortgage, you're better off keeping the money invested and financing the home. A CCH calculator will help you to figure out the effective interest rate on the mortgage.

Putting $20,000 down on an $80,000 home is a healthy 25-percent down payment. You won't need to have private mortgage insurance, or PMI, on the loan since the loan-to-value is less than 80 percent of the home's value. With 25 percent down, you may be able to afford a 15-year mortgage, versus a 30-year mortgage. A 15-year mortgage is also likely to be a better fit with your retirement plans, since you would have the note paid off at age 63. The table below compares the total interest payments on two loans before considering any tax effects. The rates may vary.

With such a small difference in the two interest rates, you could opt for financial flexibility and take out a 30-year mortgage and then decide whether to make additional principal payments each month to work toward paying the note off early, or depending on investment opportunities, invest that money for retirement.

Bankrate.com's corrections policy -- Posted: Jan. 11, 2006
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