Did You Know Paying Cash Can Have Big Financial Consequences Later?

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When most people hear that someone is paying cash for a property, it seems like they are in the lucky minority.  Paying cash would appear to be the simplest option on the surface, but did you know that it can have some major financial consequences later on?

Some people pay cash for a property with the idea that they will later put a home-equity line or second mortgage on the home.  About 9% of people paid cash for their properties in 2010, and 2011 is showing that the percentage will be even higher.

When Is Paying Cash a Potential Pitfall?

So what is the problem with paying cash if you plan to take out financing later?  The main issue is that you may eliminate any chance you have of deducting the major portion of your interest on the mortgage.  How does this happen?

Let's take an example such as this one: Let's say that you purchase a home for $300,000.  Your plan is to take out a $200,000 mortgage later.  Currently, you can deduct interest on $1 million of acquisition debt.  Acquisition debt simply means the amount of debt you have taken on as a result of acquiring the property.

If you opt to pay cash and take out a mortgage after the fact, this establishes your acquisition debt at zero.  Later, if you decide to take out a home equity line or second mortgage, your debt will be limited to $100,000 over your acquisition debt.  In this case, the acquisition debt was zero which means that it's limited to $100,000.

As you can see, there is quite a difference in being able to deduct the interest on $1 million worth of debt rather than $100,000. If you don't know this in advance, it can be quite a nasty surprise later on. Of course, it's very important to speak with your accountant about the situation before it happens.  They can advise you on the best course of action for your specific situation.  You can also refer to IRS publication 936 for more details.

Although paying cash seems like the simplest option and would probably put you at in a better situation when it comes to negotiations, there can be consequences later.  As a Residential Finance Consultant, part of my job is to point out when you need to speak with your accountant or when you might be making a negative financial decision.  Sometimes, you can do more harm than good even when you think you are making the best decision.

For more information or to chat more about paying cash for a home, contact me today.  I would love to discuss your unique situation so that I can give you the benefit of my experience in the real estate industry.