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Reader Question: Should I Buy a Smaller or Bigger House?
By JLP | January 14, 2010
I was going through my inbox and found this email that came to me the week I was gone for Thanksgiving. I apologize for my tardiness but the question was interesting enough that I decided to go ahead and post about it. Here is the email:
JLP –
I just found you site so forgive me if this question has been asked and answered already.
One thing I found on your site was a comparison of 15 and 30 year mortgage. The timing is perfect as I’m debating that question now. But one other question I’ve considered is this…..does it make more sense to buy a more expensive house rather than a less expensive one? My “thinking” is that the growth in pure dollars of the more expensive house will certainly be more (e.g. 3% of &500,000 is more than 3% of $250,000), but payments will be less on the the less expensive house. So, after all is said and done (e.g. after the home is paid off), which home produced the highest net worth.
I was wondering your thoughts on this – I’d welcome another perspective.
Thanks!
Gene
Interesting question. Here are a couple of things off the top of my head:
1. Purchasing a $500,000 home is going to require a Jumbo mortgage. Interest rates for jumbo loans are higher than interest rates for smaller loans. How much more? According to Bankrate, I found them to be 6.396% for a $500,000 30-year fixed mortgage and 5.134% for a $250,000 30-year fixed mortgage. Based on those numbers, the payments on the $500k mortgage would be $1,746 MORE PER MONTH (Over $20,000 more per year).
2. It will most likely be more difficult to sell a higher-priced home than a lower-priced one. Definitely something to think about if you anticipate having to move.
3. Property taxes (almost a form of rent) on the more expensive home will most assuredly be higher than on the cheaper home. In some cases they can be A LOT higher. Definitely something to think about. Our home is worth around $200,000 (maybe a little less) and our property taxes are around $3,200 per year. Houses nearby that are worth $500,000 are paying property taxes of $12,000 per year.
3. As far as your logic goes that a more expensive home will grow “more” than a lower-priced home…
You have to look at the big picture. Assuming you can afford either house purchase, then you have to assume that you have other options too. For instance, you could purchase the cheaper home and invest your other money elsewhere. Or you could buy the bigger house. I think the more important thing is to look at your needs. Do you need a larger home? Is the larger home in a nicer area? Better schools?
Unless there were significant advantages to the larger hosue, I think I would go cheaper and invest the difference.
Thoughts?
Topics: Miscellaneous | 15 Comments »
January 14th, 2010 at 3:42 pm
Or he could go cheaper and put a significant amount down instead of investing the difference. How much interest would an extra 20k on top of the required 20% save him in interest?
January 14th, 2010 at 3:53 pm
I don’t think the possible ‘net worth’ should affect the decision at all. Find the home that meets your needs for the lowest price. Why pay more unnecesarily?
January 14th, 2010 at 3:59 pm
@Katharine
A bigger down payment makes a lot of sense if it will allow him to avoid a jumbo loan or avoid Private Mortgage Insurance (PMI) but after those the return is the same as the interest rate of the mortgage.
Since mortgage rates are really low right now, investing in something else makes more sense. It’s also nice to have some more liquid investments.
Two more arguments against a bigger house:
#1 Utility costs will likely be more for a larger house unless the smaller house is really energy inefficient.
#2 It’s harder to accumulate wealth if you live in a more expensive home: see http://www.thomasjstanley.com/blog-articles/61/Avoiding_The_Money_Pit.html
-Rick Francis
January 14th, 2010 at 4:16 pm
I agree with JLP. One thing that Gene says that strikes me wrong in so many ways is:
‘…My “thinking” is that the growth in pure dollars of the more expensive house will certainly be more (e.g. 3% of &500,000 is more than 3% of $250,000)….’
It sounds like Gene needs to do some more studying. First of all 3% growth is 3% growth — what she is saying is similar to “What is heavier, a pound of lead, or a pound of feathers?”.
Second, even if the average appreciation rate for homes is 3%, that doesn’t mean that a cheaper house is growing at the exact same rate that an expensive house is growing. It could be that cheaper houses are appreciating 6%, and expensive ones 1% (or vice versa).
Thirdly, I’d ignore home appreciation assumptions altogether. It is just as likely that homes will fall in value for the next 10 years (or stay flat).
When you buy a house, the purpose is to live in it, not make it your retirement nest egg. If you can comfortably live in a $250k house, then do it. If you can comfortably live in a $80k house, _then_do_that_instead_. I am really blown away by people who think an expensive house is a good thing.
Shelter is one of the basic necessities of human life, why would you want it to cost more than necessary? When you shop for groceries, do you intentionally look for the most expensive food items to buy — are you importing your sandwich bread directly from France?
Dang, now I’m ranting…
January 14th, 2010 at 5:03 pm
It is almost certainly not a wise thing to buy more house than you need. By doing this you are effectively speculating on housing prices, and we all know how that can work out. Like others have said, buy what you need. If you want to invest money in something, do it somewhere else.
Furthermore, I’d like to propose that people stop looking at housing as an investment. A house is a liability that serves a purpose, as a shelter. Houses cost money in the form of realtor fees, interest on your mortgage, school and property taxes, and maintenance and upkeep. Yes, you usually can sell it for a nominal profit after many years, but few take into account all the money the was dumped into the house while it was being held. Add up everything and this “investment” doesn’t look so great.
You wouldn’t go out and buy 2,000 metrics tons of copper, hoping to make a profit on it, if you didn’t know anything about copper prices, would you? So don’t do it for housing if you don’t know the first thing about real estate. For some reason people see houses differently and think they can assume they will always get a return on their purchase.
January 14th, 2010 at 5:07 pm
A house is shelter, not an investment.
January 14th, 2010 at 5:30 pm
Just found this article
It’s tangentially related but really gives you a better idea of how much further there is to go in housing depreciation. The best advice, don’t buy a house now. Wait until the tax credit ends and interest rates go up. The reason? As interest rates go up, housing prices go down which is great, especially if you already have the cash.
January 14th, 2010 at 7:29 pm
I think Gene has a lot of investment fundamentals mixed up. This could be quite dangerous.
Firstly, if you are buying the house to stay, then don’t think of it as an investment (ie. assume appreciation will be zero). The main consideration should be what is your debt servicing ability – or the ability to pay mortgage. Rule of thumb here is that total debt should be below 30% of your net income.
Second, whether a house will appreciate will depend on just one thing: location! A smaller house in a good neighborhood will appreciate faster than a bigger house in the suburb, for example.
Third, networth doesn’t depend on the size of the house. It depends on how much of the house you will eventually own. If you are so in debt from buying the big house, then your networth will turn out lesser.
Anyway, as for buying a home (not for investment), I suggest getting the biggest one that you can comfortably afford if you have children staying with you, or plan to have them. If you do not have children, or they are grown up, then just get one that fits a couple’s lifestyle.
January 14th, 2010 at 8:54 pm
I think there is some over-reaction here to the current real estate environment. Housing has been a worthwhile investment for much of our history, and it will be again at some point. (Feel free to argue exactly when that is). I know it’s a dirty word right now, but the argument FOR a bigger house is leverage. I’m not saying it’s a sure thing but just to offer an alternative viewpoint. Also minor FYI the jumbo loan limit varies quite a bit depending on where you live.
January 14th, 2010 at 10:51 pm
there are a few exceptions to all of this. First, it depends on the real estate market you are living in. I’m in one where expensive houses are the norm and will continue to be so. Two, in high cost areas, $500k mortgage does not necessarily require a jumbo loan. there is no data yet on new housing construction demand, which will really dictate what the market is going to bear in terms of house size, composition, etc. this will have an impact on what people are willing to buy in the future. a 3-4 br house for a family is still going to be attractive regardless. now whether that 3-4 br is 2200sq ft or 4000sq ft is anyone’s guess.
we are house hunting right now, and i will say that mid-cost houses for the area are hard to find, whereas houses on the low end and high end are abundant. the low end are old and small and require significant upgrading, which many people don’t want to do…at least, we don’t. i think if the cheaper houses were newer construction, we wouldn’t have any issues.
i don’t think the question can be couched and answered so easily. i’m willing to pay more for a house because the existing homes reflect it, whereas the older, cheaper homes will require significant investment to upgrade. something buillt in the 50s is going to need upgrading in order to continue, and in our area they are justing being torn down and rebuilt bigger. so the question is the cost of rebuilding/renovating versus paying up front for what has already been constructed or renovated.
last, more expensive does not mean it is bigger, so the blanket statement of utilities etc doesn’t necessarily apply. now a house assessed as more is going to cost more in terms of taxes, but again go back to the number crunching of what you are going to have to pay into a cheaper house to upgrade versus a more expensive one that does not.
January 14th, 2010 at 11:01 pm
All good comments…
Tim, have you considered buying a couple of the smaller houses and renting one? Seems like there might be an opportunity there.
January 14th, 2010 at 11:04 pm
You know, something I failed to mention is that in some markets I have read that prices for more expensive homes have fallen much further (in percentage terms) than lower-priced homes. So, there might be more bargains in the higher-priced arena. Still, there are risks involved.
January 15th, 2010 at 12:29 am
Skimmed the comments but I am the poster child of having a larger home and the accompanying increased expenses. And yes, it is harder to save now. But I wouldn’t trade it. As long as our 3 boys are at home, I love (almost!) everything, esp our setting in the woods. The best is having HUGE parties (100 people for the 4th) and being able to have enough room for all to be comfortable. Yes, we’re the one footing the bill, but giving pleasure to others is something that gives us great joy. Friends and family are where it’s at.
Do I wish my taxes were lower? Show me someone in the Chicago area who doesn’t. Our state’s finances are a joke and it won’t be getting better. But home is home.
When our boys are gone, it’ll kill me to leave, but by then I’ll be ready for smaller digs in warmer climes.
January 15th, 2010 at 9:59 pm
@JLP: that’s the crux of the problem, the area isn’t really a renter’s area. if we bought two cheaper, we would still need to renovate at least one. plus, i’m not so sure we are really landlord people.
in our area, it really depends on the neighborhood. it is clear that the bubble happened in the areas farther in the sub-suburbs b/c the houses closer into the center were already very expensive. the problem is that the high priced houses closer in have been listed for a long time, but the prices aren’t moving. unfortunately, this is the area we are looking to buy for many reasons (schools, closeness to work, living, etc).
January 17th, 2010 at 7:53 am
I’m thinking a bigger house costs more to heat, cool, and otherwise maintain. Additionally, I don’t really consider my house an investment. It’s a place to live and it costs me lots of money. That’s fine if it is truly what you want, but you can get 3% return on your investment without all the expenses.