We are wondering whether it is better to pay cash or to borrow money to buy a small second home. Here is some info about our current financial situation. My wife and I work at two different cities, each in a different state far from each other. We bought our first house where my wife works, and paid cash for it more than a year ago; the (small) second home that we are thinking about buying in a different city is for me to live where I work. The value of our first house represents less than one tenth of our total assets, which include the house itself, cash in money market funds, investments in mutual funds, and money we put in our retirement funds (401k, IRA, etc.). Roughly the value of our retirement funds represents about 90% of our total assets. The cash we have in money market funds (outside our retirement funds) represents about 40% of our assets outside of our retirement funds. This cash portion, about twice the value of our current first house, is more than enough to pay cash for a second house equivalent to our first house. If we bought a second home by paying cash, the total value of both properties would be about 20% to 25% of our total assets (including our retirement savings).
Our question for you would be whether we should pay cash or borrow money to buy this second home. If we borrow, we will have to pay 3% to 6% of the home value for the closing cost, in addition to paying the loan interest over time. The argument to borrow money to buy a home is that one can benefit from tax reduction on the loan interest, and can invest the cash "saved" in stocks to get higher returns than the loan interest. Paying cash for a home would avoid the loan interest and closing cost, but we cannot invest the cash we used to pay for the home. There are some risks in stock investment of course (it is only an expection that stock investment returns would be 8% a year, and would thus be higher than the loan interest rate; when selling a home, there is also a 6% of the home value for realtor commission). I plan to live in the second home for many years (even though things could change).
We enjoy your column, and are looking forward to your advice.
