Liquidity is King

August 25, 2011 · 47 comments

Dave Ramsey often repeats the popular phrase “Cash is king.” While I wont necessarily disagree with Dave, I’d be much more on-board if he said “Liquidity is King.” Two similar statements, but they mean a world of difference. Let’s look at an example…

Say Girl Ninja and I have been diligent little savers and we have $200,000 cash money sitting in our bank account. Then say we find a property that we want to buy valued at $180,000. Dave has always said he prefers people buy a house with cash (although he does tolerate 15 year fixed mortgages). Following Dave’s advice, you’d write a $180,000 check for the house and have $20,000 left in your bank account.

I don’t know about you, but there is no way in h-e-double-hockey-sticks I’d ever put 90% of my liquidity into an illiquid object like a house. That’s just as crazy as going to Vegas and putting $180,000 down on red. Don’t do it. EVER!

I will gladly pay a 4.25% fee (estimated mortgage interest) to keep the majority of my cash as, well, cash. It’s no different than when I had my student loan. At one point I had a $14,000 loan balance, but $16,000 in my savings account. I could have paid Sallie Mae off with the click of a few buttons. But I didn’t. What if I lost my job? What if my car was stolen? What if I had health issues? A paid off student loan isn’t going to put food on the table in the event I became unemployed. Money in the bank, however, allows me to pay my student loan payment, put gas in my car, food in my fridge, etc.

Instead of pay my loan in full, I mitigated my risk by paying bigger payments over a six month time frame. I’d throw a couple thousand at the loan each month, significantly reducing the balance, while still giving me time to replenish my savings. The peace of mind this strategy provided was well worth the $300ish dollars I paid in interest over those six months.

For this Ninja, liquidity is king. A house is only worth as much as someone is willing to pay for it (subjective), but a $100 dollar bill is worth one hundred dollars (objective). If you had $200,000 in the bank and you wanted to buy a $180,000 house, would you pay cash for it? Why or why not?

{ 47 comments }

1 StackingCash

Agreed. We would put 20% and try to pay it off in 15 years. That requires a very affordable house. I do not want my home to be a big factor in our networth. A homes primary purpose is to provide shelter, which most of us need. It is easy to go overboard in wants when it comes to home shopping. That can lead to paying for a house you can barely afford. Thankfully lenders are more stringent on qualifying for a loan these days.

Going through the horrendous housing bubble explosion here in Las Vegas, I know better than to lock up all my cash in an expensive house. I know of a few who put down huge down payments only to walk away once the value of the home dropped more than 100k. The value of a house can change in an instant. Look in Japan, how do you think the real estate market changed after that terrible tsunami and nuclear fallout?

2 Ryan

I disagree. How much cash do you really need on hand at any given time?

If you’re saying you have $200K in cash that’s NOT designated for any plans (medical bills, vacations, vehicles), that would be the equivalent of a 5-6 year emergency fund, which I think is overkill. I might not pay the ENTIRE house in one sitting, because my one-year EF with no debt would be about $25K, but it would be a serious consideration.

3 slug | sunkcostsareirrelevant.com

Fuck no. Liquidity buys peace of mind. You don’t even mention that your true cost of capital is lessened further by mortgage interest deduction. At today’s rates, that peace of mind has never been more affordable.

4 Mary M

Tough question. I could be tempted to write the big check, or most of it. I would have peace of mind that I could get a home equity loan if I needed it and save the 4.25% as long as I could.

5 Executioner

Buy the house with the $180K cash. Instead of paying a mortgage, take the amount you would have paid into the mortgage each month and add it back to your liquidity fund. It will only be $20K for one month. Each month afterward, it will grow. By the end of one year you could reasonably be at $32K or higher.

If you can’t get by on a $20K emergency fund for a month or two, you have some serious spending issues to deal with.

6 Beef

Just to keep it in perspective. If you put 20% down, and agreed to a 15-year fixed mortgage at 4.25%, you would pay $50,990.56 over that 15 years. I get what you’re saying, and I wouldn’t put it all down, but I would put a major dent in it. Who would want to pay $230,990.56 for a $180,000 house if they didn’t have to? All in the name of liquidity?

How much money could you funnel away if you only had taxes, insurance, and utilities on your home? I would be killing it…

I think there is a balance to be struck here…

7 Larry

Do not listen to Dave Ramsey. Do not listen to Dave Ramsey. Do not listen to Dave Ramsey.

IMHO, if you are thinking of buying a house:
– Yes, save up 20% to put down.
– Don’t buy something larger/more expensive than you need.
– Buy in the next couple of years while interest rates are still historically low and the Fed has pledged not to raise them.
– Do not be a hero and take out a 15-year loan. Take a 30-year loan and pay more towards the principal when you can. That way you have more freedom with your cash flow, while at the same time you have the flexibility to accelerate the loan at your own pace. Best of both worlds. Besides, the longer the term of the loan, the cheaper your payments become over time due to inflation (which means that in inflation-adjusted dollars, the difference between a 15- and a 30-year loan is less than may appear).

“a $100 dollar bill is always going to be worth one hundred dollars”
$100 in 1900 would be equivalent to $2600 today. $100 in 1950 would be equivalent to $900 today. Inflation.

8 Tom

This!

Why get a 15 loan when you can do 30 and make extra payments? I don’t see why people trap themselves like they do. Also, I’m totally counting on the inflation thing.

9 Ninja

I stand by my statement a one hundred dollar bill will always be worth $100. I have a $20 bill dated in the 70′s, that is still just worth $20. Purchasing power changes over time, but the assigned value remains unchanged.

10 Larry

You have to distinguish nominal value from purchasing power then. If your $20 would have gotten you 4 pounds of filet mignon in 1970 and 1 pound today, then is your $20 worth the same?

11 Matt

Larry,

Thank you for the sound advice. I agree with you and I appreciate your insight.

12 Larry

Much as I appreciate the appreciation, Matt, please do not take just my word for this and do your own thorough research before embarking on such a major expense.

13 Jen

I would not tie up all of my liquidity – regardless of whether it was in a house or in paying down other debt.

Right now I have twice as much cash as I need to pay down my car loan, but since it is a fixed rate 0% loan, I will be holding on to that cash and paying just the minimum every month.

Same for student loans – I’ve got more than enough in my retirement account to pay off my smaller student loan, but then I wouldn’t have that money accessible (albeit minus early-withdrawal penalties) in case of a mega emergency that wipes out my regular emergency fund.

Liquidity helps me sleep at night. I feel a lot more secure with a few cash stashes and some manageable debt than I would with no debt but no cash.

14 Oskar

Don’t tie up al your liquidity but at the same time don’t pay any more interest than you need, in this case above I would pay somewere between 100-130 KUSD in cash and borrow the rest for the house paying the rest of as soon as possible (should be possible in 1-2 years with 2 incomes). Yes 4.25 interest does not seem much but over a lifetime it is and were do you get that sort of stable and secure return…stockmarket? Bank acount? NO!!

15 graduate.living

Is there a middle ground here? Could you put $100,000 toward the house, leaving $100,000 in the bank and making your mortgage only $80,000? On a 15-year mortgage, payments would be less than $1,000/month, with reasonable property taxes and homeowners insurance. And you could potentially accelerate your payments, if you have the resources to do that AND build your savings account again.

16 Mo D.

GL, this is the exact route Hubby and I will take when we sell our condo next year and buy a townhouse; we’ll plop down probably 50% of the sale price of the new digs as a down payment, leaving the other 50%liquid for stuff like moving expensive, new furniture for the larger home, build up a nice EF, etc… best of both worlds, IMO.

17 Beef

I’m personally a fan of the 15 year mortgage in my scenario. Our interest rate was lower than that we would have received with a 30-year. Most people are well-intentioned when it comes to talking about paying down their mortgage faster, but I would love to see statistics on how diligent the majority are when it comes to actually writing that larger check every month.

I’m not commanding a ridiculous salary, and still manage to pay for our home, utilities, groceries, insurance, taxes, cars, my wife’s grad school, 5k a piece in roth contributions, 15% to my 401k, and set a little aside with my 15-year. I realize no one has a financial situation exactly like another, but I am still a fan of the 15 year.

18 Beef

As for your view on a $100 bill always being a $100 bill. I bet our government wishes everyone thought like you. We can just print cash until the end of time…

19 Kevin @ Thousandaire.com

I agree with your general statement here, but I do take issue with “A house is only worth as much as someone is willing to pay for it (subjective), but a $100 dollar bill is always going to be worth one hundred dollars (objective).”

A house is always worth something because it is a valuable thing. $100 will always be worth $100, but today $100 might buy 100 McChickens and tomorrow it might only buy one.

20 Larry

Exactly.

21 Emily

If I knew I was going to stay in the house the rest of my life, I’d definitely pay for the house in cash. If I knew it was temporary and planned to move to a bigger/better house, I’d get a mortgage. Currently, my PITI mortgage is $1200 a month ($800 actual mortgage) that I would most certainly like to use on something other than a mortgage payment (such as woodwork, tiling, rewiring, paving, saving for world cruise).
Some food for thought: The FDIC/NCUA only insure so much in financial institutions. If you are ever named in a civil suit they’ll go after the liquidity. $20 today will only be worth $20 tomorrow but today I can buy a 1 lb steak while tomorrow I may only be able to buy a 1/2 lb steak (stupid inflation). The lower the interest rate on a mortgage, the sooner you lose the interest deduction on your taxes (refinancing a 5.625/7.5 to a 4.8 cut six years off my interest deduction).

22 In Debt

I guess I just don’t understand. If you could live in your home mortgage free by paying cash and not have a $1,300 mortgage payment and were able to instead invest that monthly payment into your various retirement accounts where the gains are higher, why wouldn’t you?

23 Anita

I would put pay 50% of the house and the rest 50% I would pay it off in a max 10% mortgage.

24 Ryan

Question for everyone reading this: how would your answer to this question change if you had $2 million in the bank? How about if you had $1,000,000 in the bank and were looking at a $700K house?

25 Beef

I would feel differently b/c it would take me personally, much longer to replenish that amount of cash in comparison to the 180k.

Just to be clear, the original topic was about liquidity, not investment related funds. This expenditure theoretically would not touch your retirement funds directly.

26 CnC

I would absolutely pay the full 100%. Lets look at this scenario, what if you did only put 50% down and then you lost your job, sure you’ve got 50% of the money to fall back on but what if that money ran out? You’d still have a mortgage to pay with no income to pay it. Sure if you paid off your mortgage you’d only have $20k in the bank but I like the suggestion of taking what would have been your mortgage payment and putting it back in the fund until you could get it up to a comfortable level. That seems like the best scenario to me; no mortgage and money still in the bank not to mention saving tens of thousands of dollars on interest. Perhaps it may be because my mortgage is significantly more than $180,000 (and paying 100% would be a crazy dream) thus my payments are MUCH higher than what these payments would be so having no money to make mortgage payments is very scary to me.

27 IPunchedDebtInTheFaceToo

I’d pay the $180,000 cash to save the $50,000 in interest and would be ok with $20,000 in the bank while I built my EF back up. If I lost my job… I wouldn’t have a mortgage payment!

28 Jessie's Money

I really liked how you explained that – makes sense to have liquid cash at all times :D

29 krantcents

As I get close to retirement, I do not want a mortgage. So if I sold my house and bought another, it would be without a morgage.

30 Melissa

I would absolutely NOT buy the house in cash. I’d figure out what a reasonable, say, 10-year mortgage payment would be and do that, using whatever of the $200k as a downpayment. I’d probably use at least half of it on the house, but definitely not all of it. No way.

I’m totally with you that a zero balance on a mortgage or a credit card will NOT put food on the table. I think it’s always important to have some cash set aside for the unexpected.

31 ShoeGal

I never would. Plus it doesn’t make sense as an investment. You would be better off putting that money into a mutual fund and come out on top as long at the interest rate is higher than what you would be paying on the mortgage.

Plus what if something does happen. The bank wont care that you bought your house with cash when the reposes it.

32 CnC

If you don’t have a mortgage the bank can’t repossess it…

33 Jim

But the city could, if you can’t pay your taxes…

34 This Guy

the most i would ever dump into a house at one time is 50%. do the rest on a 15/20/30 year mortgage and have the flexibility to make small payments some months (and in need situation) and big payments on a normal basis. i wish i have $200,000 at my disposal though…

35 Cassie

I see your stick figures are filling out a little ;)

36 StackingCash

After reading through these great comments, I am begining to like paying the house off in full. For me and those who do not believe in the stock market, a paid off house is a viable investment option. First, you would hopefully have a low housing cost just taxes, insurance, and utilities. This would free up a great deal of cash flow each month which to me is mega sweet. Second, to get more liquidity you can get a HELOC, usually 50% of the value of the house. I do fear extreme cases of home values going down to zero still.

37 cashflowmantra

I would not pay cash for the house. I would maintain as much liquidity as possible. You never know when you might need it.

38 KevinMzansi

This is definitely not a “black or white” question, for me. It definitely depends on the big picture.

I am a fan of liquidity myself, so agree with you that I would not put my 180K in the house. I would probably put around 50%, depending on how my expenses and job situation looks at the time.

As others have mentioned, “a dollar is not always a dollar”. Here in South Africa our inflation runs around 6%, so a fresh 100 over here would buy you only half the stuff in 12 years time. With all the money being printed in the US right now, I would not be surprised if inflation soon inches up and becomes a factor really soon.

Something else to think about is that: “inflation is the friend of the borrower and the enemy of the lender”. If you sign up for a 15 year mortgage, for instance, your $1,000 payment in 13 years time (= 2 weeks of groceries, for instance) would be much cheaper than the $1,000 you are paying now (=4 weeks of groceries). So, it may benefit you in the long run to not put the majority of the money up front.

39 Jim

There is no money being “printed” in the U.S., at least not in the way people seem to think. The Fed’s “Quantative Easing” is the swapping of one asset for another – no new spending power in the economy, thus no inflationary pressure. (If anything, actually, QE is deflationary – since it removes the interet income that the private sector owners of the debt were getting from the economy. It’s kind of like a 80 billions dollar tax increase taht way. Overall, it’s a stupid, ineffective program created by people who don’ understand the monetary system, but it’s not going to cause hyperinflation the way some people seem to think…)

All government spending, at all times, is “money printing”, of course, since government spends by crediting banks accounts with new money (and destroys it by taxing it back). But if there is spare capacity in the economy (as there is with almost 20% un- and under-emoplyment), there is no inflationary effect of that “printing”. What we and the world need desperately right now is more “printing” – the deficit needs to be far, far higher in order to supply the savings the private sector is trying to accumulate…

40 Jason

I’d be more inclined to paying cash for the entire house outright. As one of the previous commenters mentioned, you can take the amount that you would be paying for a mortgage and put that back into your savings. If you were to lose your job, you wouldn’t have to worry about being foreclosed on, and plus, saying you own your home outright has got to be a pretty amazing feeling (I wouldn’t know, I just bought my house with 3.5% down, yieks!)

41 Claire

We own our house outright. (my husband didn’t buy it with cash though, did the mortgage and paid it off) It gives you the most incredible freedom. My husband has been a house dad for 6 years and we have lived off a single – not very big – income. Freedom from debt gives us so many choices. If things got bad, we wouldn’t have to worry about mortgage repayments – we just have to put our heads down and cut back on things. And it is easier to build up an EF if you don’t have a fixed repayment to deal with every month. Even if you only have a little bit of money you can stop buying new clothes, or plant a vegie garden, barter services with friends, but if you have a debt it must be paid.

I understand what people are saying about liquidity and I wouldn’t tie up all my cash to buy a house, but if the result is that I had $20k left over, which is not an insignifcant amount of money if used wisely , I would think very seriously in paying cash, or paying a significant percentage of the purchase price in cash. I agree with Jason, not having to worry about being foreclosed on in times of crisis is a lovely worry to be without in times of crisis.

42 B Kelly @ MoneyMasteryAcademy

I would definitely not buy it cash and be left with only $20k in the bank. For me, i’ll go with a 50% loan spread over the next 10 years or so and this allows me to have a reasonably smaller monthly mortgage repayment whilst i focus the rest of the money on some other investment vehicles…

43 Kevin@RothIRA

Completely agree on the importance of liquidity. A fixed rate mortgage of up to 80% of a homes value is perfectly reasonable, especially with rates below 5%. Mortgages are patient debt–you have 15-30 years to pay it off in level increments. But having most of your cash free will help you to avoid debts, make investments and get the best deals.

It would be better to diversify the cash by putting a big chunk of it in something other than a house, which is only a single investment itself. Having it in retirement plans will also enable it to grow tax free.

44 Roger

Hmmm. If, for some reason, I was really this concerned about remaining liquid, I think I’d be inclined to:

Pay cash on the house, then get a $100K (or whatever) line of credit secured against the house.

That sorta gives us the best of both worlds.

45 south County Girl

If I had the option of paying cash for a home and it made me SAVE a significant portion (like cash 99,000 or loan 150,000) i’d pay cash…

but most likely i’d get a loan with no pre payment penalties, makes sure I was secure for a bit, then go ahead and pay off the sucker. As Roger put it… You can always get a HELOC

46 Jim

Actually, you can’t. In fact, the times you are most likely to need the money (lost job, for instance) is when the banks are least likely to allow you to open a new HELOC, and most likely to cut you off from the one you already have open.

47 Kristin

First of all, I thing it would be tough to go all or nothing; I’d be more interested in doing a percentage in the middle. Which end of that spectrum would probably depend somewhat on my life situation. If I was buying a starter home that I planned to live in for a defined but still substantial period of time, I think it would make sense to leave more money liquid, because substantial costs are incurred in the process of moving and there’s more uncertainty. If I knew that under most circumstances, I would be staying in the house for the rest of my life, I’d be more inclined to put more money down. However, I don’t believe that most first time home buyers of my generation (as this situation seems to allude to) can say with that kind of certainty they would want to stay in a particular house for the rest of their lives.

I will say that not having a mortgage or a rent payment would reduce the amount of money that you need in your emergency fund by a substantial amount, if you want to go by “have X months of expenses”. So you might find that you’re comfortable having less liquidity in that sense, because your needed cash flow level is lower. That’s not to say that you still wouldn’t need to pay taxes, insurance, and repairs, which by nature tend to come in lump sums at particular times, in which case you’d be better off with more liquidity if something happened to you.

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