A reader Terri, who is enjoying reading about the process of buying our new vacation home had a few questions surrounding the decision to pay cash:
I’d like to know why you chose to make an all cash purchase as opposed to financing. I suspect the decision was easier since you plan to hold on to the property for the long term. But, was your decision entirely about skipping the financing costs and interest obligation? What about the risks of locking up that much of your cash at the outset when buying property? I get mixed messages about the value of paying cash versus financing when investing in real estate. What’s your opinion?
I’m glad you asked Terri, because I’m sure you’re not the only one who wants to know!
Cash Trend on Vacation Homes
While we were in the process of buying, there was a helpful CNN article that FMF [1] sent to me about vacation home prices falling [2] and the popularity of buying distressed properties. The part that caught my eye was how common cash deals are becoming:
One factor depressing sales was the difficulty in getting mortgages due to tight credit markets. Buyers often did an end-around this problem by paying cash. Nearly 40% of vacation home sales were cash deals.
Cash Offer in Negotiation
When we made an offer on our vacation home [3], our main goal was to pick up the property for a cheap price. Here were some of the impacts that went into our decision to buy with cash:
Quick closing. We knew in advance that the bank wanted a quick closing. And the fastest way for us to facilitate this was to avoid financing which would have dragged the closing out for weeks.
Lower purchase price without a financing contingency. I’ve frequently read that it makes no difference to the seller whether or not the buyer is obtaining financing. However, when we sold our condo to an all cash buyer, I can guarantee you that we were more inclined to take their offer at a lower price because it eliminated the contingencies, which also eliminates a lot of risk for the seller in this market. I’m sure many of you will disagree with me, but we did lower our maximum price we were willing to pay by about $3000 when we made the decision to offer all cash.
Skip the closing costs. We didn’t have to pay any points, fees, or closing costs that banks require, including an appraisal. For a property under $100,000, eliminating closing costs meant a lot of savings percentage wise.
High interest rates. Because we will rent out the vacation home that we purchased when we aren’t using it, it doesn’t qualify for the traditional second home financing with attractive interest rates. However, since we won’t be exclusively renting it either, it doesn’t qualify for standard commercial financing either. It fell somewhere in between; the best rate we found was a 3/1 ARM rate at 5.75%. Not exactly what I consider an attractive interest rate right now.
Dealing with banks. Finally, let’s be honest, I’m not exactly golden in the eyes of banks. At the time of purchase, I had about $180,000 in dirt cheap balance transfer money [4] on credit cards. In the past I’ve successfully shown our local banks the assets to offset the balances, but sometimes dealing with underwriting at an unfamiliar bank isn’t worth the time and effort…. especially, when they suggest that I should pay off some of it so their computer program will work better!
Leveraging Assets
While it made sense to make an all cash offer to obtain the property, long time readers know it’s very out of character for me to make a cash purchase without using leverage to potentially increase the rate of return.
And don’t worry, I still firmly believe in leverage [5] and cheap financing [6]! In this particular case, I just didn’t believe a traditional bank mortgage was the right place to get the money.
That’s where my newest credit card extravaganza comes into play. It’s pretty hard for me to willingly accept a 5.75% 3/1 ARM from a bank when I can easily beat that rate with credit card balance transfers.
Credit Card Financing
Here are some of the other offers I used to pull it all together:
Penfed Life of Balance Offer. To get started, just as we were finalizing our purchase, Pentagon Federal Credit Cards [7] rolled out the 4.99% for the life of the balance transfer with no fees. So we already had the bank offer beat. (They’re offering it until June 30, 2011 if you are interested in using it for something).
Life of the balance transfers are attractive, since it eliminates the risk of having to roll it over to a new card (especially since it gets harder and harder to get new offers once we cross the $250,000 mark in unsecured outstanding credit). However, my goal was to finance the entire property at an average interest rate of 4%. So I also wanted to combine the Penfed offer with others that would offer lower rates when factoring in the length of the balance transfer and the fees [8].
Citi 21 month balance transfer. Citi Platinum Select MasterCard [9]: 0% balance transfer for 21 months with a 3% balance transfer fee.
Discover 18 month balance transfer. Discover More Card [10]: 0% balance transfer for 18 months with a 4% balance transfer fee.
Bank of America Mail Offer. I read about a trick at FatWallet in the Bank of America system right now to get a 0% balance transfer with 0 fees. If you got the 4.99% offer in the mail on one of your BOA cards, you can log in and elect a $100 balance transfer. Log out, and log back in and the offer changes to a 0% with 0 fee offer. Not only did it work like a charm, but Bank of America called to offer to make it one big balance transfer at 0%.
Alternative Financing
So Terri, I hope that explains my reasoning for what looked like a cash offer on the surface. I still feel that leverage is a profitable way to increasing wealth. And even though I avoided traditional bank financing, I have been working hard to put together a less expensive route to financing the property. Obviously, my route is risky and not for everyone, but I feel that the savings will outweigh the risk in the long term.