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hypothetical question, use cash or finance

Posted by willinak (My Page) on
Sat, Jul 17, 10 at 23:19

Own first home outright worth $100k. Want to buy 2nd home (vacation) for $100k.
On good fixed income. Got out of the stock market in 07 and put $500k in bank CD's (now earning whopping 1%). Afraid to get back in market.
Can get mortgage for 4 3/4% 30yr. fixed.
Should I pay cash or mortgage? If you say mortgage, where do I put the remaining cash?


Follow-Up Postings:

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RE: hypothetical question, use cash or finance

I'd do cash.


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RE: hypothetical question, use cash or finance

Since interest rate payouts are so low, I'd do cash. You can't earn 4 3/4% on your money from a bank, so it would be like you were paying yourself that. I just paid cash for my new house and even though I have great monthly cash flow, it's great not having to make a mortgage payment every month!


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RE: hypothetical question, use cash or finance

Cash is probbaly a good option since it is only a fraction of your available cash.

It appears you will still have adequate cash reserves.


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RE: hypothetical question, use cash or finance

Thanks! In this case there are adequate cash reserves I believe, and my instinct was to "pay with cash", however after searching here on the subject, Dave, et.al. says in essence "in every situation, use borrowed money", so I started to doubt myself. Now to be fair, most of the situations were not like mine, where there was adequate reserves.

Is there a "rule" or calculation of what constitutes adequate reserve cash?

As far as where else to put cash, I'm starting to see a few muni bonds that are netting in the 4-5% range, but that's about all I know of.


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RE: hypothetical question, use cash or finance

I agree with paying cash. I had similar situation as you a year or two ago and decided to pay off my primary home. It was an excellent decision.

For earning money on your $400k. If you want to stay in CDs or Money Market - at least for some portion of your money - you should shop around for better rates. I just got a Money Market last month and it pays 1.75%. Sure, it is low, but it is a lot more than the 1% you are getting. Also I have have a 11 month CD that is 2.25%. Again, it is low, but more than 1%. You can get a longer term CD for a bit higher interest rate.

Shop around at local banks and credit unions. There rates can vary greatly. The bank that has the 1.75% MM is M&I Bank. I think it stands for Marshal and Isley or something like that. They have many brick and mortor branches in various states and they have been in business for decades.

Consider splitting up the $400k into various banks/accounts to make sure all of it is FDIC insured.

Some credit unions offer great rates on MM or CDs and if you find one, you might qualify to become a member to get their good rates. Also look into some dividend paying stocks. Some pay 3%-6% a year in dividends. But there is always the risk of the stock price going down. So pick those wisely and don't put too much in the market.


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RE: hypothetical question, use cash or finance

Even though money in the bank won't earn quite as much as the interest you'd pay, if you finance the house, you'll still have your money in the bank.

As much money as you're talking about, you really ought to consult a money management expert.


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RE: hypothetical question, use cash or finance

"Is there a "rule" or calculation of what constitutes adequate reserve cash?"

Not a hard rule, but 6-months or more expenses for everything is usually a decent cushion.

If your income is higher you might want more since it takes longer to find a job.
The old rule of thumb was a month per $10k.

It is probably worse now, at least in some areas.


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RE: hypothetical question, use cash or finance

Hi Willinak,

In this case there are adequate cash reserves I believe, and my instinct was to "pay with cash", however after searching here on the subject, Dave, et.al. says in essence "in every situation, use borrowed money", so I started to doubt myself.

Hoooold on there, partnah... Dave does *NOT* say 'in EVERY situation, use borrowed money.' Au contraire... what Dave says is;
A) Use leverage when it makes more sense defensively and cost-wise than using cash,
B) Us the PROPER AMOUNT of leverage (which is a much more important question than simply "yes or no.")

Further, Dave says;
C) EVERYONE ought to become debt free... but not a day earlier nor a dollar faster than is safe for their financial freedom*. (*Of course, this demands brain cells to determine... "rules of thumb" generally fail ;~)

Is there a "rule" or calculation of what constitutes adequate reserve cash?

The MOST CONSERVATIVE rule is;
When you have enough cash throwing of enough passive and safe income such that you can apply your ADDITIONAL cash to leverage retirement, and not dip into your "seed corn" so much that it drops your cashflow below the level of lifestyle you want to live.

The more AGRESSIVE rule (generally for those still building toward their financial freedom) is;
Cash equal to a minimum of 12 month's total costs of living.

The SUPER-aggressive rule is;
Cash equal to a minimum of 6 month's total costs of living,
Standby available revolving no/low-annual-fee credit (cards, personal lines, HELOCs, etc.) equal to a minimum of 6 month's total costs of living,

As far as where else to put cash, I'm starting to see a few muni bonds that are netting in the 4-5% range, but that's about all I know of.

There are principal-guaranteed fixed/indexed accounts provided by insurance companies that are paying 5% fixed, tax-free, or alternatively they'll offer an account that equals the annual upside of the S&P500 except never lower than 2% (if the S&P goes negative, you still get a positive 2%,) and a ceiling of 14%. These indexed accounts historically average 6-8%... again, all tax-free.

The costs of these insurer-provided accounts are generally far less than most mutual funds (let alone funds with additional "management/advisory" fees,) and have equal or greater protection to Money Market Accounts, with similar ease of access to your money.

few people in the general public are aware of these, banks don't like selling them because it takes deposits away from their internal reserves (competes with CDs,) and securities people *HATE* them because it dramatically reduces ongoing fee revenues for securities. The only people who have them are the FIXED/INDEXED insurance people, and the cheapest programs with the best performance are called SURVIVORSHIP programs. They're used virtually exclusively for safe money growth, and not for any insurance benefits (other than the insurance against any losses.)

(*DISCLAIMER; YES, I do manage these types of accounts for my clients, but not soliciting here... you can take the above info to any similar professional, and they'll know how to analyze your overall portfolio for risk versus safety & design a recommended plan of action.)

Hope that's helpful!
Dave Donhoff
Leverage Planner


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RE: hypothetical question, use cash or finance

I thought this would flush you out! ;-)

"Hope that's helpful!
Dave"

Very helpful Dave, as always!
Thanks.


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RE: hypothetical question, use cash or finance

My view is do what is best for you!!!! Though you could pay cash, what happens if housing continues to tank, and loses another 20%? Your OUT 20k CASH,likley for a long time unitl market comes back,if it does at all..If you financed it, yes your home is valued 20k less,and you still make the same monthly payments,but you have ACCESS to your CASH...Best of luck in your decision, as it is YOUR decision, and whatever makes you sleep better..


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RE: hypothetical question, use cash or finance

Cash is king! If the above scenario occurs, you could always get a mortgage to unlock your money. That's how I feel about my house being mortgage free. But, that said, it would take a lot for me to go get a mortgage on it!!!


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RE: hypothetical question, use cash or finance

" If the above scenario occurs, you could always get a mortgage to unlock your money. "

If only it worked that easily.

You have to have income to support the mortgage, and cannot borrow more than you can support.

Being house rich and cash poor is NOT a good situation.

Try borrowing to pay property taxes with no income and see what happens.


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RE: hypothetical question, use cash or finance

If you have 500k in CD's and a 100k home, you definitely aren't "house poor." Unless you've got a race car habit you haven't disclosed, it sounds like you are living well within your means.

There is no way I would borrow money in your situation. You've got the cash, so use it.

As for what to do with the rest of your money, that really depends on the rest of your finances. If you plan on living another 30 years, it doesn't make much sense to have 100% of your money in CD's and houses. I'm all for conservative investing, but you can't be so conservative that you are swamped by inflation. You don't necessarily need fancy products, but you should have some of your money in products with growth potential and some in "safe" products.

Just a note on "principal-guaranteed" products. There is no such thing as a free lunch. You can't get high guaranteed returns and no risk. These are individual companies "guaranteeing" their products. That brings its own level of risk that isn't easily quantified. The overall investment is ultimately only as "safe" as the underlying investments (ie stock market) even if there are multiple levels before it gets to the final investor. The risk is only being spread, not eliminated.


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RE: hypothetical question, use cash or finance

Hi billl,

Just a note on "principal-guaranteed" products. There is no such thing as a free lunch.

Of further note; COMPLETELY agreed. HOWEVER, there ARE currently principal-guaranteed products that are both significantly cheaper, safer, and better in performance than the alternatives in non-guaranteed securities (money market accounts, CDs, managed investment accounts and index mutual funds.)

You can't get high guaranteed returns and no risk.

Unfortunately, we can't have "no" risk anywhere, actually... but the exposures to risk *CAN* be dramatically reduced by proper reserves management by the firms, and conservative hedging.

These are individual companies "guaranteeing" their products. That brings its own level of risk that isn't easily quantified.

Pretty easily evidenced though... all one has to do is look at the historical track record of the firm offering the gaurantees (and especially in comparison to the non-guarantee security firms... if there are any that have remained in business long enough to have a history to compare.)

The principal safety track records of insurance deposits are equal (if not better) than the track records of the FDIC & NCUA ('better' in the manner that the insurance deposits are guaranteed at much higher balances... up to twice as much as FDIC in some states... and the rate of failures of the insurance companies themselves is virtually zero in comparison to the banks & securities firms that have been dropping like flies.)

The overall investment is ultimately only as "safe" as the underlying investments (ie stock market) even if there are multiple levels before it gets to the final investor. The risk is only being spread, not eliminated.

Dead on! Risks exist, always, and need to be properly avoided. Risks that are competently managed so well that firms can offer principal-guarantees, and show a track record (often of CENTURIES) of never defaulting on their guarantees... that works!

The non-guarantee security (stocks, mutual funds, bonds, notes, etc.) world *COULD* cobble together a complex structured offering that might come close to the safety and tax efficiency... but the internal expenses would be so high it would destroy any chance of competitive returns.

I used to run a hedge fund that offered a principal-guarantee to our partners (just like the insurance companies do.) I discovered its too expensive to try to beat the insurance world at its own game *UNLESS* you accumulate enough in assets to actually BECOME insurance-regulated as a carrier (and can then offer tax-free status ALONG WITH the principal guarantees.)

In addition, its always been illegal for your common stockbroker to guarantee principal (or guarantee *anything* really... but to take your money,) and with financial regulation of hedge funds its not even legal today to offer the kinds of guarantees we used to ON A PRIVATE basis.

If the regulatory world shifts to make it plausible for non-insurance managed accounts to beat fixed-indexed resetting accounts, I'll fire up a new securities division immediately... but I am definitely NOT holding my breath on that.

It *ALL* boils down to;
A) who carries the deepest reserves (so they can always honor their guarantees,)
B) who manages risks the best (so they can outperform the other guarantors.)

Of course, the tax-free growth & access adds nicely to the benefits.

Cheers,
Dave Donhoff
Leverage Planner


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RE: hypothetical question, use cash or finance

Bill and Dave, wow, and to think I get all this advice for free! Gotta love the internet, in spite of these #%&*$ pop-ups!


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RE: hypothetical question, use cash or finance

I think cash is the way to go.


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