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If you could, would you rather pay cash for a house or invest that cash in Berkshire and get a ~6.7% 30-year fixed-rated mortgage?

Thanks,
Carol

If you could, would you rather pay cash for a house or invest that cash in Berkshire and get a ~6.7% 30-year fixed-rated mortgage?



A lot of us are probably thinking about this right now, with our mortgages coming due for more expensive renewals and our Berkshire shares looking at us and daring us to sell them to pay off our mortgage.

Here's how I've been thinking about it. First of all, a lot depends on where you are. I understand that US-Americans often get a tax deduction for their mortgage payments, while this is certainly not true in Canada and probably not true in most places. So that will bear on what anticipated return is necessary for Berkshire to be a better choice. In my case, with no mortgage deduction available, I figure if I have to renew a mortgage this year, with 5-y rates at about 6%, and given my marginal income tax rate (about 50%), a 12% before tax return on Berkshire will only give me 6% if it is not tax-sheltered. If it is tax-sheltered, then the breakeven rate depends a lot on how long it is tax sheltered for, so to keep things simple, let's say I need an 8% return to break even with my 6% mortgage rate.

The other major consideration for mortgage vs Berkshire, as an investment destination, is the certainty. I am certain to save 6% on my mortgage if I pay it off; I am far from certain of making 8-12% on my Berkshire investment, and I think it is fairly unlikely that Berkshire's return will be higher than 8-12%.

As a result, I have been selling down my stock positions (not just Berkshire) and freeing up cash to pay off mortgages as they come due. Your calculation will be different since you are probably in the US (judging from the fact that 30-year fixed rate mortgages are available) and so you probably get a tax benefit from your mortgage payments. You might come out ahead by owning Berkshire shares, but the difference is probably small enough that it is not worth the substantial risk of doing worse. Munger's aphorism comes to mind: leverage is one of the 3 ways smart investors go broke.

Regards, DTB

I actually did just that - paid cash for a house for the first time, raising the funds by selling BRK and some other investments.

My rationale for doing so mirrors DTB's.

For me, it comes down to the simple equation of (highly conservative) expected BRK return minus current interest rates on a mortgage, and taxes too.

That difference was not large enough right now to sway me, but that could certainly change in the future.

The only other thing I'd add is that paying cash now does not preclude you from taking out a mortgage later.

You'd still have the flexibility to take out a mortgage and deploy the equity in your home into stocks if/when rates drop significantly lower, and/or BRK becomes even more attractive in price.

Once again , many Americans might not know that the USA may be the only country that offers, 30 year fixed rate mortgages. As mortgages reset around the globe, it remains to be seen how many homeowners get in serious financial trouble.

If you could, would you rather pay cash for a house or invest that cash in Berkshire and get a ~6.7% 30-year fixed-rated mortgage?

This is such a personal decision and goes well beyond the math and tax calculations. I suggest you get really introspective about this if its what you're considering.

Now what I'd do--- I'd put 20% down like most Americans and try to find myself a good deal in the market I'm looking in, I'd buy the school system if I had young kids, I might get a little fixer upper, I'd look for some inexpensive ways to improve the value (maybe a new kitchen or a new bathroom, etc.) Also, buying new construction can be a great deal as there will be no maintenance needed in the first 10 years or so. Then I'd let inflation take the value higher(3-5% inflation is really good when you're a homeowner leveraged 5 to 1). I'd want a really affordable payment, I'd also look to refinance at a lower rate in the next few years. Maybe I'd try to pay it off in 10-15 years, but not right away.

With the remaining 80% I'd probably put 20% of it in an emergency fund at a bank and then I'd layer into Berkshire with the rest when I thought prices were low. And I'd add to it and read these pages to figure out how to build a portfolio.

For another perspective, Morgan Housel wrote in his book "The Psychology of Money" that he paid off his home. It helps him sleep at night knowing that no matter what happens in the markets his home is paid for.

Other things to consider: Your investing temperament, stage of career, other assets available, other large expenses in the near term and job security.

Hope this helps.

Best,
Chris

'If you could, would you rather pay cash for a house or invest that cash in Berkshire and get a ~6.7% 30-year fixed-rated mortgage?'

In my circumstances, I would choose the latter. With the U.S. mortgage interest tax deduction (up to $750K I think for a couple), the effective rate might then adjust to a net of 5%. If BRK compounds at average rate of inflation + 8% or so, I'd much rather be invested in BRK purchased at an attractive price/ peak BV than to allocate a huge sum of cash to purchase a house. We are 6 years into a 30-year fixed 3.75% mortgage (put 20% down) and very pleased with this decision thus far.

The optionality is key to me, but my brother elected to completely pay off his house as peace of mind was his highest priority. If my memory serves me, even WEB stretched out his Laguna Beach house 30-year fixed mortgage payoff for nearly the entire term before he sold it.

Good luck and keep us posted as to your ultimate decision!

Why is it only the US that offer 30 year fixes?

I've searched high and low in the UK for long term fixes and the best I could find with reasonable rates was 5 years only. I still have 4 years on my current interest only fixed rate (not tax deductible) after this, who knows.

Why is it only the US that offer 30 year fixes?
Because you didn't look at Germany which has that since ages.

You can get a 30-year mortgage in Canada, but only if your down payment is more than 20%.

The regs in Germany seem fairly borrower friendly. https://www.iamexpat.de/housing/german-mortgages/t...

Per WEB's With the U.S. mortgage interest tax deduction (up to $750K I think for a couple), the effective rate might then adjust to a net of 5%." - a slight clarification.

The standard US deduction was spiked to @$25,000 a few years ago as part of that tax bill. That means that the benefit of carrying a big mortgage interest load was decreased. My mortgage interest + property taxes before then (200K mortgage, 3.7%, @25 years left) was enough to itemize deductions and realize that full benefit of mortgage interest.

Now, I get that much larger deduction automatically (because I'm not close to having >$25K itemizable) - so, the more I *minimize* expenses, the better.

Just remember that banks don't lend you anything without some kind of income - so if you burn down your savings too closely to pay off the mortgage, but have limited income, it makes it very hard to get a loan in case you need emergency cash. Stock is liquid, the house isn't.

The apparent end (?) of ZIRP makes this judgement call much harder to make, IMO - expensive debt eliminates the net return margin we have gotten for years investing in stocks.

FC

Maybe a heresy, but I don't believe Buffett when he said the only certain stock tip is to buy Berkshire when it tanks after he has moved on.

There is a large cone of uncertainty around Berkshire's future returns. Say 8% +/- 4%.

So even for a US homeowner with a 30Y 6.7% pre-tax or 4-5% post tax mortgage; paying down mortgage may be better.

Of course this is a false dichotomy. There are multiple other options including buying a 60-40 stock-bond portfolio (or just buy VBIAX). Berkshire is nothing special anymore.

You can get a 30-year mortgage in Canada, but only if your down payment is more than 20%.

Really? I live in Canada and I've never seen one offered, and I've never known anyone who had one. I am intrigued that Germany has these also - I thought it was only the USA. I also don't know why banks in Canada and most other places cannot offer a 30y fixed rate mortgage. In fact, it is usually even better than a 30y fixed rate - if I understand correctly, most long-term US mortgages can even be renegotiated to a lower rate if rates fall (and can be held onto for dear life if rates rise.) How this would even be possible for banks to offer is beyond me, but maybe someone familiar with US banking can explain.


dtb

The only other thing I'd add is that paying cash now does not preclude you from taking out a mortgage later.

Yeah it actually mostly does. In America at least, don't know about Canada. We also don't need to worry about resets of the interest rate. A purchase mortgage has *much* better terms and fees than a cash-out mortgage.

30 year fixed-rate mortgage is the thing for us. Doesn't matter what the current interest rate is. When rates go down, refinance to a new 30 yr FRM at the lower rate. As long as you just refi your existing mortgage and don't take any cash out you get the same low terms & costs as a purchase mortgage.

This is as strictly America deal, I understand that most other countries your mortgages reset the rate every few years.

{You can get a 30-year mortgage in Canada, but only if your down payment is more than 20%.}

Really? I live in Canada and I've never seen one offered, and I've never known anyone who had one.

To clarify, and you can get a 30 year amortization, but mortgage terms are typically 5 years at a time.

You can get a 30-year fixed rate term, but you will pay through the nose for it. A quick Google search shows a rates of 7.05%.

I am intrigued that Germany has these also

dtb, Germany has 30-year fixed mortgages because those fit our character perfectly well. The typical German of the first after WWII generations is extremely risk averse, especially in financial matters. What he craves more than anything else is safety.

This shows in our insurance policies. That typical German of old is insured against everything, has numerous policies. Whatever may happen, it won't be a financial catastrophe. Naturally that is concerns very especially the for most people greatest investment of their life: Building a house (We more build, once only, to live there for the rest of our lifes, than buy and sell repeatedly).

It shows in stock ownership too. That typical German puts his life's savings into low paying saver account, into life insurance, into government bonds => into investmens you can exactly calculate what they are worth one year from now --- but not (or only very little) into those risky stocks where you never know what they'll do tomorrow.

Same with mortgages: 30 year fixed means you are safe. As you know exactly how much it will cost you in 30 years, and know exactly you'll still have your job at BASF or Siemens in 30 years*, you can rest assured that there won't ever be a danger to lose your house. And as this has absolute priority for that typical German**, he preferred the longest running fixed mortgages available - and therefore those 30 year fixed ones were always offered and in high demand.


*That's how it WAS for that typical German for half a century, until the fall of the wall, even until nearly the year 2000. As we know that's not even here the case anymore.

**That typical German is a thing of the past too, with the percentage of people with "migration background" and their very different personalities more and more increasing. Regardless of my name (father immigrated) I feel like one of the "last man standing" --- why else would I own mostly Berkshire? 😉

'To clarify, and you can get a 30 year amortization, but mortgage terms are typically 5 years at a time.

You can get a 30-year fixed rate term, but you will pay through the nose for it. A quick Google search shows a rates of 7.05%.' That is what my Canadian friends told me. The question is, how many homeowners outside the US have 30 year fixed rate mortgages, below 4 percent, fixed for the life of the loan? Sadly, for the past few years, American idiots have been offered , creative mortgages, again. You can bet taxpayers will be expected to bail them out in bulk, this time. Little down, Interest only or teaser rates for 2-3 years should be outlawed.

Bingo, here it comes. https://www.zerohedge.com/markets/fha-floats-new-p...

You can get a 30-year fixed rate term, but you will pay through the nose for it. A quick Google search shows a rates of 7.05%.'

Hmm, perhaps, but I find that deeply suspect.
Many sites conflate the amortization period with the mortgage contract term.

A couple of top rate comparison sites both say nobody offers 30, and only one [major] lender offers 25.
They too could be wrong, but FWIW, RBC offers 25 years fixed at 9.75% right now.

The reason that 30 year fixed rates are so widely available in the US (with the right of renegotiation, no less) is that the US mortgage market is in effect government run.
Without agency guarantees, those products would not exist.

Jim

If you could, would you rather pay cash for a house or invest that cash in Berkshire and get a ~6.7% 30-year fixed-rated mortgage?

This is a really hard question, almost the same as the more common question about whether to use money to pay down an existing mortgage or invest.
But a couple of random thoughts--

It's after-tax real money that counts.
So---

First, bear in mind that the (relatively) higher future inflation is, the (relatively) better Berkshire will look as the choice.
That's because Berkshire's revenues and profits and value will tend to get pulled up along with inflation being a wash (I expect inflation+7%),
whereas the money saved on debt will not: you're paying for real estate now in "big" dollars when you could be paying it back later in "little" dollars.
Inflation is good for people with big debts.
If you have some reason to expect inflation to remain high, that gives bonus points to the borrow-and-invest strategy versus the pay-cash-now strategy.
Maybe not enough to change the decision based on other considerations, but it's a big input to the decision.

And second, the tax matters a whole lot.
You have to estimate it on both sides: what you'll ultimately pay on your BRK profits, and what the net tax cost is of your interest, both with time value adjustments.


My usual first response would be to lean towards investing, provided one is in the situation that the mortgage in question is far from being onerous or disproportionate compared to the rest of your financial situation.
As you are considering paying cash for a property, my guess is that you aren't close to the line on that front.

Jim

if I understand correctly, most long-term US mortgages can even be renegotiated to a lower rate if rates fall (and can be held onto for dear life if rates rise.) How this would even be possible for banks to offer is beyond me, but maybe someone familiar with US banking can explain.

Oh you naïve Canadian person!

US bankers have perfected the art of privatizing profits and socializing losses. As soon as they write a (conforming) mortgage they turn around and sell it to Fannie Mae and Freddie Mac. Backed by the full faith and credit of the US government. Do you not remember the fiasco in 2008-09 when they had to be bailed out by me and my compatriots?
For the ones that banks do keep on their books, what happens when rates rise and they have to mark them to market, making a leveraged bank like First Republic bank? Bailout, that's what. JPM Chase demanded and got its pound of flesh from FDIC in that - my compatriots and I are in a five-year risk-sharing agreement with Jamie Dimon. We share risks, he keeps the profits (as old mortgages roll off and First Republic issues new ones at higher rates).
It's good to be acUS banker!

Everyone should read The Bankers' New Clothes by Admati and Hellwig. US banking does not have to be this way. But no one can bell the fat cats.

....The only other thing I'd add is that paying cash now does not preclude you from taking out a mortgage later.

Yeah it actually mostly does.... A purchase mortgage has *much* better terms and fees than a cash-out mortgage.

Cash-out refinances do come with higher interest rates from purchase mortgages, but based on evidence I've seen, that difference is not huge.

Some numbers from briefly looking it up again:

- Cash-out refinance are reportedly 0.25% to 0.5% higher than a normal refinance typically.

- A normal (not cash-out) refinance at the moment from some popular quote cites has a 0.3% higher interest rate than a purchase mortgage for a 30-yr fixed.

So combining those two, that would make the interest rate of a cash-out refinance (paying cash now for purchase but taking out a mortgage later) 0.5% to 0.8% higher than an outright purchase mortgage.

This doesn't seem huge. I recall fees being higher too when I originally looked, but I don't recall that difference being huge either.

If you have evidence to the contrary though, I'd love to see it.

So combining those two, that would make the interest rate of a cash-out refinance (paying cash now for purchase but taking out a mortgage later) 0.5% to 0.8% higher than an outright purchase mortgage.

I didn't say "cash-out refinance", I said "cash-out mortgage". Which corresponds to the original's statement of "... paying cash now does not preclude you from taking out a [new] mortgage later."

The other issue is that you may be unable to get a mortgage at all. If they change or tighten up the qualification requirements, you may not be able to get a new mortgage at all. All FNMA needs to do is issue a (temporary?) rule "No cash-out mortgages, period."

"cash-out mortgage"...

...purely out of curiosity, in the US does it make any difference for tax purposes whether the mortgage was taken out at the time of property purchase, or later?

Canada is a bit unusual.
Mortgage interest is not in general tax deductible.
But that's because the deductibility of ANY interest is not a function of what security was used (a house, say), but rather what the loan proceeds were used for (buying a house, versus some other purpose).

Most mortgages are used for purchase of the property which was used as collateral, which is not "valid" purpose of funds for tax deduction, so most mortgage interest isn't deductible.
But if you pay off that mortgage, then take out an identical new mortgage and use the proceeds for investment, the interest is deductible thereafter because the loan proceeds were for a business purpose rather than to purchase a dwelling.
"Interest paid on money borrowed to earn investment income" is a valid deduction, no matter what the collateral was.
This is not nearly as widely known a "loophole" as you would expect.
Traditionally there were LOTS of people who would be much better off selling their portfolio, paying off their mortgage, getting the mortgage again, then repurchasing their portfolio.

I even did this half-and-half once: I switched my mortgage to a HELOC, paid off half, ran it back up again buying investments, and was able to deduct half the interest thereafter.

(this summary used to be right, but maybe they have changed the tax rules recently...I haven't followed the details there lately)

Jim

It's still right, though there are a bundle of complications. For any Canadians curious, see, e.g.,

https://www.canada.ca/en/revenue-agency/services/t...

I didn't say "cash-out refinance", I said "cash-out mortgage". Which corresponds to the original's statement of "... paying cash now does not preclude you from taking out a [new] mortgage later."

I am not following you with your terminology of a "cash-out mortgage".

My understanding is that taking out a mortgage later on a fully-owned home (not financed) is accomplished through a cash-out refinance.

I don't know what a "cash-out mortgage" is and how that would differ - care to enlighten?

Here's one site describing that process:

Cash-out refinance
If you want to take out a mortgage on a paid-off home, you can do so with a cash-out refinance. This option allows you to refinance the same way you would if you had a mortgage.

When refinancing a paid-off home, you'll decide how much you want to borrow, up to the loan limit your lender allows. Cash-out refinance loans can be a less expensive option than home equity loans because they have lower interest rates than home equity products. However, closing costs can be higher because the process of refinancing a paid off-home is similar to buying a house.

https://www.valuepenguin.com/mortgages/home-equity....

My understanding is that taking out a mortgage later on a fully-owned home (not financed) is accomplished through a cash-out refinance.

Just a side comment, as I know essentially nothing of US mortgage jargon on the ground:

In most commercial situations the term "refinance" is used solely in the context of replacing one debt with another, perhaps of different size/term/rate/conditions.
Though I don't argue with you, I for one would be deeply confused to hear the term "refinance" used in the context of obtaining a new loan secured against something already owned free and clear.

Jim

Though I don't argue with you, I for one would be deeply confused to hear the term "refinance" used in the context of obtaining a new loan secured against something already owned free and clear.

I fully agree on the terminology - it's not intuitive.

If there's another term someone is aware of for taking out a mortgage later on a fully paid off home, I'd love to hear it.

I see nothing on google on the phrase "cash-out mortgage" that another poster used, but I find many references to "cash-out refinance" referring to situations where the house is paid off and a new mortgage is taken out.

Just speculating, but perhaps since the vast majority of situations involving cash-out transactions are refinancing of existing debt, the same term has been adopted for this far less common but similar cash-out transaction?

My understanding is that taking out a mortgage later on a fully-owned home (not financed) is accomplished through a cash-out refinance.

I don't know what a "cash-out mortgage" is and how that would differ - care to enlighten?

It's shorthand phrases.
There is actually no such entity as a "refinance". What there is is getting a (new) mortgage and using the proceeds to simultaneously pay off the old mortgage.

Cash-out/cash-back is when the new mortgage is larger than the payoff balance of the old mortgage. The lenders assume (validly) that if the borrower walks out of the closing with cash in his hand, that there is a higher risk.
The lender views a refinance as one lender (the new one) just stepping into the shoes of another lender (the old one). The net risk in the transaction is the same, it's just moved from one lender to the other.

For a cash-back/cash-out mortgage on a house that doesn't have an existing mortgage, the risk is new. There is no "old" lender's risk that gets moved to the new lender. Hence the net risk is is higher.

In recent history, there manifestly was higher risk in mortgages where the borrower walked away with cash in his fist.

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