Having all-cash on hand can give homebuyers serious advantages. Cash offers are 97% more likely to be successful, not to mention the potential savings you can capture, either by making a lower offer or by skipping the lender fees.
But all-cash isn’t always all it’s cracked up to be. In fact, there are a few reasons you might not want to pay cash for a home.
We know, we know — this probably goes against everything you’ve heard about buying real estate, where cash is most definitely king. But what if that cash could do a lot more for you if it’s not tied up in a home?
We tapped the expertise of top California-based real estate agent Jordan Clarke, who sells 13% more homes than the average agent in his area.
He walked us through the process for paying in cash, and he explained some unexpected pitfalls you might experience if you forgo financing all together. Here’s what you need to know.
How do you pay cash for a house?
First things first: how do you actually pay cash for a home? It’s pretty similar to any other home purchase, but minus the financing.
However, that “minus the financing” is a pretty big deal for sellers. Financing problems make up 37% of closing delays and 21% of purchase contracts that fall through entirely. Plus, cash is fast, allowing homebuyers to close in as little as one to two weeks.
Another difference between a cash purchase and a mortgage-backed purchase? With cash, there are way fewer contingencies to contend with. Contingencies are conditions that must be fulfilled for a real estate contract to be completed.
Two common mortgage-related contingencies are the financing contingency and the appraisal contingency.
The financing contingency basically states that the loan has to clear before the purchase contract can be fulfilled.
Meanwhile, under the appraisal contingency, the lender orders a neutral third-party appraiser to assess the value of the home and make sure they aren’t lending the buyer more than the home is worth. If the appraisal comes in lower than the purchase price, the buyer can back out of the deal or try to renegotiate with the seller, but the lender won’t be issuing the full loan amount.
As you can probably imagine, these contingencies can slow down the closing process, not to mention the fact that they present a risk to the seller: according to the latest data, 9% of contingent real estate contracts fall through.
That’s not to say there are zero contingencies with cash purchases (an inspection contingency is optional, but strongly encouraged for all buyers), but removing financing-related contingencies can make the deal a lot smoother.
The potential pitfalls of paying cash for a home
Okay, we know that cash is faster, easier, and more certain for sellers. But why would a buyer not want to pay cash? Let’s walk through some of the unexpected pitfalls of cash and how they can play out for homebuyers.
Buying a house you can’t grow into (or don’t love)
Most buyers will be somewhat limited in budget by paying in cash, especially if you aren’t extremely wealthy.
It’s not easy to save cash for a home purchase. The median home value in the U.S. sits at just around $313,000 as of Q2 2020, which is a hefty sum of money to save up. If you’ve saved even a portion of that amount, you should pat yourself on the back!
Still, using cash can limit your budget. Because, quite simply, your budget is limited by the amount of cash you have. With a loan, you may be able to leverage a larger budget and buy a home that’s better aligned with your longer-term goals than what you could afford with cash.
Of course, you could buy a lower budget home in cash, then fix it up and upgrade it as you go. That’s certainly one option.
But not every buyer is up for a rehab project, and a mortgage could put you closer to your dream home than you previously imagined — especially since you’ve already diligently saved up so much cash to put down.
Sinking all of your funds into one investment
Another disadvantage to paying cash? A whole lot of your money will be wrapped up in a single investment.
“You’re not leveraging your money,” Clarke shares. When mortgage rates are low, “mortgages are essentially really cheap for OPM — which is short for other people’s money.”
He explains that if you’re able to use other people’s money at a cheaper cost than you’re able to put your own money to work, then it’s worth reconsidering whether paying all-cash for a home is the best move for you.
When mortgage interest rates are low, “you really shouldn’t be paying cash for anything — even if you have the ability,” Clarke confides. “And that’s because you’ll be able to put your money to better use in many other ways.”
Not building equity while you’re saving
As we briefly mentioned, saving cash for a home is no easy feat, nor is it a quick one.
Recent data shows it takes the average American with median income 14 years to save up a 20% down payment for a median-priced home. In the most expensive cities in America, it’s more like 30 years. In Los Angeles, where the real estate market is hot and the median home value is $622,523, it would take around 43 years to save up just 20% on a home.
Needless to say, saving up 100% for a home could take a lot longer. And while you’re busy saving, home prices tend to go up by around 3.8% per year (though prices can increase up to 10% each year in America’s hottest cities).
And not only do home prices steadily rise year over year, but you’re also missing out on the benefits of gaining equity in a home — and thus building wealth — while you wait on the sidelines.
This is one of the top reasons buyers opt for financing. It gives you the opportunity to “get in the game” and start building equity now, rather than waiting until you’ve got a huge pile of cash saved.
Decreasing your liquidity
Sometimes life throws you curveballs, and having a bit of cash on hand can soften the blow.
“If you have more cash available, you’re going to be able to withstand storms if anything bad happens to the economy or anything else, because you’re going to have those liquid cash reserves in your bank account, and they’re not going to be in a non-liquid asset like a home,” Clarke explains.
Basically, if you put nearly all your money into your home, you could risk not having enough cash on hand if the unexpected happens.
Sudden job loss or illness can be devastating on your finances. Having some cash on hand gives you cushion in case of emergency.
Not leaving enough money for repairs or maintenance
Speaking of being low on cash for emergencies, you’ll want to have some cash reserves for repairs and maintenance on your new home. What if your roof starts leaking, or the electric system needs to be updated, or the foundation needs repairing?
It’s a good idea to have a cash emergency home repair budget set aside for any fixes that come up in your home. This is another reason a buyer might choose financing over cash: It leaves them with more cash reserves to actually maintain a new home.
Skipping an appraisal can come with risks
Skipping the appraisal sounds great in theory. Your purchase contract won’t have to be contingent on an appraiser’s opinion of your home’s value, which sellers love.
But what about from the buyer’s perspective? Sure, the appraisal is meant to protect your lender from making a risky investment and overpaying for the home. But the appraisal also protects you as a buyer. You probably don’t want to overpay for your new home, right?
Think long and hard about whether or not to waive the appraisal contingency, and definitely don’t take this step without first consulting a top real estate agent with time-tested market expertise who can make sure you don’t overpay for the home.
How can you avoid the pitfalls of paying cash?
Paying cash gives you a distinct advantage at the offering table, but it’s not without disadvantages. So how do you avoid the pitfalls of cash, while reaping the benefits of an all-cash offer?
Meet HomeLight Cash Offer, an innovative program that lets you make an all-cash offer (and close faster), yet still use a mortgage to enjoy the benefits of home financing.
It’s a win-win-win all around: The buyer gets more leverage with their offer, without losing the long-term benefits of financing. The seller gets quickness and certainty. The agents get a smooth transaction and speedy commission.
“From a buyer’s perspective the best thing about the HomeLight Cash Offer program is the ease that it provides,” Clarke shares.
“You’re doing a lot of other things while you’re in escrow. You’re going through inspection reports. You’re going through disclosures. You’re getting ready to move. You’re transferring utilities.”
It all adds up to a stressful situation. And when you tack on getting a mortgage loan on top of all that — with all the uncertainty that can come with home financing — the stress of homebuying can be overwhelming.
With Cash Offer, Clarke says, you get a lot more certainty upfront, thanks to HomeLight’s quick-yet-thorough approval process. When you’re ready to make an offer, you’ve got cash on your side — you can worry about the nitty gritty details of the financing later, after you’ve already secured the home.
“Beyond the negotiation benefits, Cash Offer just provides that certainty and that ease through escrow that makes the homebuying experience a lot more enjoyable,” Clarke adds.
Header Image Source: (Omid Armin / Unsplash)