If you are considering building a home, your two major options are to pay in cash or to obtain a construction loan. If you can swing the first option, there are many benefits that await you. But, before you lay down your life savings, here are some things to consider about building a house with cash, Dave Ramsey style.
Is It Legal to Pay for a Custom Built Home in Cash?
Absolutely! There is nothing illegal about purchasing a custom built home with cash. While we typically don’t imagine people walking around with suitcases full of money, you can certainly buy a home with cash, whether you are paying for the house outright or to build it. Also, paying with “cash” doesn’t usually equal cash, but instead a cashier’s check, wire transfer, or other, more secure form of transferring payment.
When Does It Make Sense to Pay Cash for a New Build Home?
There might be times when it is a particularly good time to pay cash for a new build home. Some benefits of paying cash include:
Financial Freedom & Cash Savings
Paying cash for your new build can give you a great sense of financial peace of mind and freedom. Housing in the United States becomes more expensive with each passing year.
There has been an average inflation rate of 4.14% year-over-year. A house that cost $100,000 in 1967 would now cost $895,528.58 in 2021.
Housing inflation has been higher than the average inflation rate for other expenses. While the median home price in 1953 was just over $18,000, it was nearly $301,000 in 2020. Since it is likely inevitable that housing expenses will only increase with time, locking in a lower price today can mean more opportunity to save money in the future.
Buying a home with cash can also be a great personal finance move. After you have completed your debt snowball, you can concentrate on making it possible to have housing without a mortgage payment. The financial freedom that comes with this is undeniable.
No Mortgage or Variable Interest Rates
When you think about it, the interest rate is just the amount you pay for not having the money to pay for something now. This holds true for anything you purchase on a credit card, a car note, or a mortgage. If you take out a 30-year mortgage on a $200,000 home and pay 4% fixed interest rate, you will pay $143,739.01 in interest over the term of the loan. If you use a 15-year mortgage instead, you would pay $66,287.65 in interest. Either way, that’s a big chunk of change. Change that you can save if you can skip a loan altogether.
Construction loans sometimes have higher interest rates, so you may have even more money you can potentially save by skipping them. Also, construction loans may use variable interest rates, which sometimes appear attractive at first but become cumbersome when the rate increases.
You might be able to skip some of the closing costs and other associated costs by paying cash. Many closing costs are tied to such items as loan origination fees, appraisals, and similar line items.
While it often takes months to clear the purchase of a property with a mortgage, buying a house with cash may take only a few weeks. You do not have to worry about loan officers, extensive paperwork, and other administrative headaches and delays.
Cash is king in many businesses. If you can pay for everything with cash for your new home build, you may stand to enjoy discounts across the board. General contractors may be more willing to offer you a discount if you pay in cash or pay in advance. Home builders may do the same. Real estate agents or brokers may also be willing to give you a discount since it will be easier for you to close a deal with a cash offer.
Difficulty Obtaining a Construction Loan
In some instances, it may be difficult for you to obtain a construction loan. The bank may perceive you or the property as too risky. The bank may not have the benefit of having instant security in a home that is not yet built. Paying cash for the build may help you skip these aggravations.
When Does It Make Sense to Use a Construction Loan?
There may be other times when it makes more sense to use a construction loan than to buy a home with cash. Situations that may influence you toward the construction loan include:
Staying in an Existing Home
Many people do not want to live in a construction zone. This may mean that they wind up staying in their existing home while taking a home loan out for a new build.
If you have other debt, it may make sense to take out a construction loan for your new build while you focus on a debt snowball to address the other debt with a higher interest rate. You might then consider refinancing your mortgage debt if more favorable terms are available or you can afford a lump-sum amount to pay off the mortgage. With mortgage rates at historic lows, locking in a mortgage at a favorable interest rate may free up cash to pay off other debt.
Emergency Fund & Cash Savings
A major drawback of buying a house with cash is that the cash is no longer available for other purposes. If a sudden emergency occurs, you may not have the funds available to pay for it, or you may wind up having to borrow funds at a less attractive rate. This can be worrisome as you face the prospect of unforeseen circumstances surrounding the build, such as environmental issues, sudden increases in material or labor costs, or other factors outside your control.
Illiquidity and Market Volatility
A danger of putting all of your money into your home with a cash offer is that you can’t get the money back out of your home very easily. Down the line, you might be able to get a home equity line of credit, but that won’t help while you are in the build stage. You may also begin your build only to discover that the market has changed drastically by the time you finish your build.
Many people receive tax breaks by paying interest on a mortgage. This can help reduce a person’s overall tax liability, which may be an important consideration for buyers in higher tax brackets.
The Actual Cost of Building A House
The actual and perceived cost of building a house are often very different. Construction always seems to take longer and cost more than ever initially anticipated. Unexpected expenses, upgrades to materials, and add-ons to the scope of work can make the overall cost of building a house balloon.
Whether you choose to build a house with a loan or cash, it is important that you have a good understanding of what you can expect to pay when you build your house. We also have tons of tips to help you learn how to buy a house without a mortgage, how to pay off your mortgage early, and how to use our calculators to help you get accurate estimates.
Also, check out our video on building a house with cash by Dave Ramsey.