The Opportunity Cost of Paying Cash
WHAT IS THE COST OF PAYING CASH?
When you pay cash for a property, you miss out on the opportunity to earn a rate of return on that cash. That's called an "opportunity cost." How much money could you earn on that cash if you kept it invested in an outside investment such as stocks, bonds, or another real estate property? To calculate your opportunity cost, multiply your likely rate of return by the amount of cash you'd have available to invest. For example, if you could earn 8% on your cash by keeping it invested, here's how much money you'd lose by NOT keeping your cash invested:
- $100,000 cash not invested @ 8% rate of return = $8,000 annual opportunity cost
- $500,000 cash not invested @ 8% rate of return = $40,000 annual opportunity cost
- $1,000,000 cash not invested @ 8% rate of return = $80,000 annual opportunity cost
WHAT IS THE COST OF USING A MORTGAGE?
If you use a mortgage to finance the purchase of a property, you would pay mortgage interest. To calculate the cost of using a mortgage, multiply the mortgage rate by the amount of the mortgage. For example, if your mortgage rate/APR would be 7%, here's how much interest you'd pay by using a mortgage:
- $100,000 mortgage @ 7% interest rate = $7,000 annual interest cost
- $500,000 mortgage @ 7% interest rate = $35,000 annual interest cost
- $1,000,000 mortgage @ 7% interest rate = $70,000 annual interest cost
WHICH OPTION HAS THE LOWEST COST?
If your rate of return on investments is greater than the interest rate on a mortgage, it may make more sense for you to use a mortgage and keep your funds invested. Also, keep in mind that mortgage interest may be tax-deductible, which could lower the after-tax cost of your mortgage even further. Please see a tax advisor for more details on that.