For most people, getting a mortgage to buy a house is essential because paying cash for a home isn’t feasible. But for rich people with millions of dollars in the bank, covering the costs of a property out of pocket would likely be within reach.
Despite the fact that many wealthy people could afford to buy a home outright, they often get mortgage loans anyway. Here’s why they make this choice.
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Wealthy people may see benefits to getting a mortgage
There’s a simple reason why many rich people opt to get a mortgage even though they don’t have to. They see this type of debt as being financially advantageous.
See, mortgage loans tend to come with very low interest rates — especially for well-qualified borrowers. If you can borrow at a 3% interest rate and use the bank’s funds to pay for your home while keeping your money free to invest in assets that produce a higher rate of return, it may make sense to do so. After all, why tie up hundreds of thousands — or even millions — of dollars in a property when you could borrow at a very low rate and use your money elsewhere, like putting it in a brokerage account.
Many wealthy people also itemize on their tax returns. This means they claim specific tax deductions, rather than the standard deduction. And if you itemize, it’s possible to deduct mortgage interest on loans up to $750,000 (the IRS limit as of the time of this writing).
When you can claim a tax deduction for your mortgage interest costs, the government subsidizes some of your loan amount so the loan doesn’t cost you as much. And wealthy people get an even bigger benefit from this because they tend to be in a higher tax bracket and pay taxes at a higher rate.
Say you can claim a mortgage interest deduction and reduce your taxable income by $10,000, for example, because you pay that much in annual mortgage interest. In that case, you can avoid paying taxes on that $10,000.
If you make a lot of money and are in the 37% tax bracket, that $10,000 deduction could save you $3,700 on your tax bill — not counting any state tax savings you’re eligible for. The government, in other words, is basically covering $3,700 of the mortgage interest costs incurred for the year.
Considering that interest is already really low — often barely above the rate of inflation — the fact that the government lowers the cost further helps make mortgage debt even cheaper for the wealthy. And that tilts the balance that much more in favor of borrowing for a home to keep cash free for other things.
Of course, this doesn’t mean that every rich person opts for a mortgage. But for many wealthy Americans, it just makes sense to optimize the use of their funds and invest their money while taking advantage of cheap debt that comes with generous tax breaks.
Of course, this doesn’t just apply to wealthy people. Although many lower and middle-income Americans don’t itemize on their tax returns, they can still get the benefit of borrowing at an affordable rate while using their money for other purposes. As a result, paying down a mortgage early — or making a very large down payment on a home — simply may not be the right choice.
View more information: https://www.fool.com/the-ascent/mortgages/articles/why-dont-rich-people-pay-cash-for-homes/