The advantage of using other peoples' money

Dear Ms. Mortgage Maven: I want to buy a condominium in Dupont Circle to use as a pied-a-terre during the workweek and to attend cultural events on the weekend. My wife wants to take out a mortgage to buy the property. I want to be debt free as we go into retirement. What do you think we should do?

Thanks for your advice.

Herbert S.

Dear Herbert:

Let's just get my bias out of the way up front: I am a mortgage lender. If people paid all cash for their home purchases, I would have to find a new line of work.

There is a general rule of thumb that applies to financing all sorts of transactions, the use of "OPM" or "Other Peoples' Money" instead of your own.

This certainly applies to you. You did not say how much you intend to spend on your condominium purchase, so let's say that it is $300,000 for this example. On one hand, you can pay cash by taking $300,000 out of your savings and/or investments and "invest" it instead in the condo.

Is paying cash for the condo a good investment strategy, compared to the savings and investments your money is currently in?

Housing generally appreciates about 3-6% each year. Currently we are in the midst of a market slow down, and the condo market in DC is has been hit harder than the market for single family homes. Since I do not have a crystal ball, I do not want to forecast what the appreciation rate will be in the immediate future for this property.

While I do believe that real estate is a good investment, it is important to realize that it will take time and money for you to realize any financial gain from it. Real estate is a "non-liquid" asset. If you paid cash and later need the money that is tied up in that property, it could take you several months and cost you a good chunk of change to get your money back through the sale of the property (6% realtor commission and a 1.4% transfer tax, for example). As you approach retirement, the non-liquidity of your $300,000 is important for you to consider. You and your wife may be hit with unexpected medical or other bills, and if your money is in real estate you will not be able to call your stockbroker and have him or her transfer the money into your checking account.

On the other hand, you can go the conventional financing route by getting a mortgage (using "OPM"). A representative interest rate over the last several weeks for a thirty-year fixed mortgage is about 6.25%. You can put 20% down on the property ($60,000) and get a mortgage for $240,000 at 6.25%, for a monthly principal and interest payment of $1,477.72 (not including condo fee, taxes or insurance). And, because mortgage interest is deductible from your federal taxes, it has the effect of lowering the interest rate for the borrowed money into the vicinity of 4%. What a bargain! (Not to mention that the $240,000 is still yours to invest in something other than real property.)

There are other reasons not to pay cash for a condominium purchase. The condominium complex could have inadequate reserves and hit all owners with a hefty special assessment; your upstairs or next door neighbors could be particularly noisy; the complex could have a disproportionate number of renters, contributing to a general lack of upkeep and possibly making the complex unable to qualify for conventional financing (ultimately limiting the number of prospective buyers when you or your heirs ultimately decide to sell the condominium).

My advice to you is to obtain a mortgage for at least eighty percent of the purchase price. After a couple of years, once you feel you have really gotten a feel for the condominium board of directors, management, maintenance, and other occupants, if you still want to pay off the mortgage, you certainly can. Meanwhile, you are not tying up your cash in an unknown, non-liquid investment.

Enjoy the excitement that downtown has to offer! Sincerely,

Jessica White, also known as "Ms. Mortgage Maven," is a mortgage consultant with Tenacity Mortgage, a division of Tenacity Group, the Capital region's leading financing, real estate advisory and tenant condominium-conversion company. Call or email her to discuss your home purchase or refinancing needs. She can be reached at 202-607-4449 or Jessica@msmortgagemaven.com. You can also apply online at www.msmortgagemaven.com.