Dear Dr. Don,
I am 58 years old and do not currently own a home. I have a monthly income of $1,500, $200,000 in liquid cash and $400,000 in retirement money. I would like to buy a home. Should I pay cash for it (about $150,000) or finance the purchase with a 30-year mortgage?
— Ellen Entryway
Homeownership isn’t for everybody. That said, you can make a convincing argument that today’s low interest rates and low housing prices — at least in many markets — make it an opportune time to consider buying a home.
A common question in this column is whether a consumer should prepay his or her mortgage. My rule of thumb is that if the individual expects to earn more after tax on their investments than they pay after tax in interest on their mortgage, they shouldn’t prepay the mortgage. The more conservative the investor, the easier it is to make the argument that he or she should prepay the mortgage.
You can use the same rule for whether you should take out a mortgage. What kind of return are you earning on your cash investment? Odds are that even in the current low interest rate environment your mortgage rate will be 2 percent to 3 percent higher than the yield on your cash investment. I’m assuming your cash is held outside of a tax-advantaged retirement account because you list your retirement balances separately.
Another reason to consider paying cash for the house is how close you are to your planned retirement. You’re in your late 50s. I’d guess your planned retirement would be within the next decade. Taking out a 15-year fixed-rate mortgage will have you making monthly mortgage payments into your early 70s.
I used Bankrate’s mortgage payment calculator to calculate a monthly mortgage payment on a 15-year fixed-rate mortgage at 3.5 percent for a $120,000 loan, assuming you would make at least a 20 percent down payment on the $150,000 purchase price. That monthly mortgage payment is approximately $858, well over half your monthly income. I’d rather see you pay cash for the house and set money aside to rebuild your savings each month than commit to this monthly payment.
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