The Real Estate Blog

Sometimes I encounter people with good credit—but very little wealth—who have recently come into a substantial cash windfall. More often than not, they are very eager to put every last penny of that windfall into a new home.

If you happen to find yourself in this situation, take a moment to consider the value of liquidity before investing everything into a new home.

It’s hard to know know when the need for cash will arise. The need could be anything: plastic surgery, a masters degree, starting a new business, everyday expenses after a lay-off, or an experimental treatment not covered by your health insurance. Who knows what the future holds?

One way of turning your home’s equity back into cash is putting the home up for sale. Aside from the obvious inconveniences of sale preparations, repairs, moving, and finding another place to live—there are also numerous expenses incurred when selling a home (i.e. closing fees, moving costs, rental storage, etc.).

Another popular way to turn equity into cash is the ubiquitous home equity line of credit that banks so eagerly push. A home equity loan is a variable-rate loan secured by the equity you have accumulated in your home. The primary advantage of a home equity loan is convenience: it saves you the time and trouble of selling your home to turn equity into cash. However, this convenience is not free—you will pay monthly interest at a relatively high, variable rate to borrow what is essentially your own money!

To avoid these stressful and costly scenarios, do not put your last dime into a down-payment. Try to keep enough cash in savings—or other liquid assets—to maintain your home and service its mortgage for six months to a year.

20% is the magic number for down-payments. At 20% down, buyers avoid PMI costs (Private Mortgage Insurance) which can add hundreds to the monthly payment. Paying more than 20% will reduce the monthly payment, but larger down-payments yield diminishing monthly savings beyond 20%. So, if you can afford to put more than 20% down, don’t. Put only 20% down to avoid the PMI cost. Put the rest of the cash in safe, liquid, interest-bearing investments that will keep up with inflation.

By preserving your cash with fixed-rate financing, and keeping some of that cash in more liquid investments that will help you keep up with inflation—like CDs, savings accounts, money market accounts, bonds, stocks, REITs, ETFs, and mutual funds—you can still buy a fine home while avoiding the expense and inconvenience of selling or re-financing your home when you need cash.

Under the current macroeconomic climate, inflation is the rule of the day. Every year, the average buying power of the dollar decreases two to four percent. That should be discouraging news for savers, but it’s music to the ears for any buyer who has just taken out a fixed-rate 30-year mortgage on the home of his dreams. Why?

As the value of the dollar decreases, businesses increase prices to make up for it. As prices go up, wages also have to go up so that workers can maintain their current standard of living. While prices keep going up for the same goods, and wages keep going up for the same services, the principal and interest payment (the bulk of the monthly payment) on a fixed-rate mortgage remains the same!

As a result, housing expenses as a percentage of monthly income will shrink over time for buyers who take advantage of traditional fixed-rate financing. A monthly payment of $700—which may be back-breaking today—could end up costing less than your monthly fuel and utilities in as little as five years time.

Just something to think about…