For what it's worth, at 2.675% interest on a 30-year fixed, buying a house in cash makes very little sense, and a mortgage can counterintuitively earn you money.
1. In general, since the 1970s, house prices have across the United States tracked inflation. The price per square foot on a house, on average, is exactly the same as it was back then (houses are more expensive because the average US house has gotten bigger, and in some metros like SF, city councils have flatly refused to allow building to buff up house prices).
2. A mortgage is basically free when you discount inflation and deduct the interest. The fed target for in the US is roughly 2%. This means that a 2% interest mortgage is free money, i.e. while you pay a 2% interest rate, the principal is worth 2% less, as you get to pay off the 2020 house price using 2021 dollars. So a 2.675% APR mortgage has an effective cost of 0.675%.
3. If you're working you get to deduct the entire 2.675% (of the first $750,000 in mortgage), so you get back up to 45% of it if you're in the top tax bracket. As such, the effective interest rate discounting inflation and interest tax deduction is negative, -0.53% APR.
4. On top of the interest rate on a 30-year fixed being effectively negative (i.e. generating value), you can invest the other 80% of $450,000. You should have no trouble generating 7% per year on that $360,000.
5. In aggregate, your return on capital by making a 20% down-payment on a $450,000 house at 2.675% APR in the top tax bracket could easily be ((0.53% + 7%) * $360,000) per year, plus your house should appreciate in value at inflation, but because it's a 5X leveraged investment, you're generating (2% * $450,000) per year on a $90,000 down-payment.
So, your total return could be:
1. $90,000 @ 10% + $360,000 @ 7.53% or...
2. $450,000 @ 2%.
Given the lack of fees or penalties for pre-payment, you can always pull the ripcord if your situation no longer makes sense by just paying it off.
With the new tax laws the home mortgage deduction is useless for most people. If you are married filing jointly, the standard deduction is $24000. I paid around $10K in interest last year on a $330K mortgage in its fourth year.
Indeed although you own the house in both cases right, so you can factor that out when making the comparison. It'll impact your total returns equally in both cases, unless I'm misunderstanding you?
On average this analysis makes sense but cash flow is also important to consider. If the thing you’re investing in to get 7% doesn’t make payments, or has a single bad year and doesn’t yield like it’s supposed to, you could be up the creek.
Indeed, I was basing the 7% return on the S&P hence assuming liquidity in the investment. Liquidity matters and, yeah, YMMV. Still works if you invest in CDs instead but it’s not nearly as attractive.
Option 1 is a 20% down payment on a $450K mortgage, so a $90K down-payment (10% yield) and a $360K investment in the market (7%) and a $360K mortgage (0.53%).
Option 2 is a $450K cash purchase of a house, which, on average, appreciates at the fed target inflation rate of 2%.
Indeed although in both cases you own the home and are subject to the same depreciation risk right? Although if you're willing to take a credit hit, I suppose you're shifting that depreciation onto the bank.
1. In general, since the 1970s, house prices have across the United States tracked inflation. The price per square foot on a house, on average, is exactly the same as it was back then (houses are more expensive because the average US house has gotten bigger, and in some metros like SF, city councils have flatly refused to allow building to buff up house prices).
2. A mortgage is basically free when you discount inflation and deduct the interest. The fed target for in the US is roughly 2%. This means that a 2% interest mortgage is free money, i.e. while you pay a 2% interest rate, the principal is worth 2% less, as you get to pay off the 2020 house price using 2021 dollars. So a 2.675% APR mortgage has an effective cost of 0.675%.
3. If you're working you get to deduct the entire 2.675% (of the first $750,000 in mortgage), so you get back up to 45% of it if you're in the top tax bracket. As such, the effective interest rate discounting inflation and interest tax deduction is negative, -0.53% APR.
4. On top of the interest rate on a 30-year fixed being effectively negative (i.e. generating value), you can invest the other 80% of $450,000. You should have no trouble generating 7% per year on that $360,000.
5. In aggregate, your return on capital by making a 20% down-payment on a $450,000 house at 2.675% APR in the top tax bracket could easily be ((0.53% + 7%) * $360,000) per year, plus your house should appreciate in value at inflation, but because it's a 5X leveraged investment, you're generating (2% * $450,000) per year on a $90,000 down-payment.
So, your total return could be:
1. $90,000 @ 10% + $360,000 @ 7.53% or...
2. $450,000 @ 2%.
Given the lack of fees or penalties for pre-payment, you can always pull the ripcord if your situation no longer makes sense by just paying it off.