By Patrick Barta
Special to RealEstateJournal.com
Question: Our current house, which is almost 30 years old, has about 1,600 square feet of space, and is good enough for our family of three. However, we would like a newer and bigger home, and we're tempted to move up now, mainly because interest rates are so low, and we think a bigger house would be a good investment. Our current home is worth $160,000, and we have $48,000 left in our mortgage, so with the equity that we have, we think we can afford a $250,000 house. But is buying a bigger home a smart financial move? We'd have a bigger mortgage payment, moving costs, higher homeowner-insurance bills, and higher property-tax and utility payments. Should we stay put or move on?
-- Julie, Grand Rapids, Mich.
Julie: Most financial planners agree that if you can afford it, and if you don't mind carrying some extra debt, owning a bigger house is a good financial move. But those are big ifs, and it's important to put a lot of thought into your decision before moving forward.
For starters, it's dangerous to load up on unnecessary debt, a fact that's more evident than usual these days. Mortgage foreclosures are running at record levels, in part because too many families have been lured into buying bigger homes than they can afford in a distressed economy. If you're worried about taking on too much debt, a helpful rule of thumb is that you should avoid entering a mortgage whose monthly payment -- including taxes and insurance -- totals more than one-third of your gross pre-tax monthly income. (Don't expect lenders to tell you this: Many lenders will encourage home buyers to take on far more debt, in some cases twice as much.)
Even if you can afford more debt, there's also a question of whether you really want it. With just $48,000 left on your old mortgage, you could be free and clear of housing payments in only a few years. That would allow you to shift hundreds of dollars each month to other spending, or better yet, to investments for your retirement. Indeed, if your top goal is to build a nest egg, there are probably better ways to go about it than socking your money away in real estate. Even the stock market -- despite the dismal results of recent years -- pays a higher return over the long haul.
That said, if you still feel like you're ready to move up, there are lots of upsides to buying a larger, more expensive home. The most obvious is the intangible, emotional upside that comes with owning a nicer home: It can greatly improve your quality of life.
More important from a financial point of view is that if home prices continue to appreciate, you'll get a bigger bang for your borrowed dollar from a larger, more expensive home. For example, say home prices grow 5% over the next year. If you hold on to your $160,000 home, you'd wind up with $8,000 more in equity. But if you owned a $250,000 home, that same rate of appreciation would give you $12,500 in new equity.
Today's low interest rates -- and the fact that you already have lots of equity built up -- should help improve the odds you'll do well. If you sell your $160,000 home, you'll wind up with about $100,000 in equity once you pay off your old loan and pay a realtor's commission. If you apply all that money to a new $250,000 house, you'll wind up with a mortgage that only totals $150,000, which will likely cost you a little more than $800 a month at today's interest rates That's probably close to or even less than what you're paying now!
Linda Lubitz, a certified financial planner at The Lubitz Financial Group in Miami, recommends that families who are moving up take out mortgages whose monthly payments are equal to -- but not greater than -- the old home loans they're replacing. Her reasoning: Borrowers should aim for the highest amount of leverage they can afford, in order to get the best return on their borrowed capital, so there's little sense in paying less each month than you pay now (unless you just want more cash in your pocket). Paying more, of course, is always possible, but it also means you might have to trim back spending in other areas.
Ms. Lubitz offers another tip: With interest rates so low, it's possible you can get the same monthly payment you had before without using up all your equity for the down-payment on your new home. If that's the case, you could use some of that money to invest elsewhere, making the move-up even more attractive.
All of this, of course, assumes that the house you buy will continue to appreciate in value -- an outcome that is never 100% certain. And to increase the likelihood your home will appreciate, you might want to consider some compromises on the kind of home you choose.
For example, Lou Barnes, a mortgage banker in Boulder, Colo., argues that borrowers are better off avoiding the big, new houses that are sprouting up all over the country's suburbs; such houses, while possibly more attractive than what you own now, could appreciate less over time as builders add more, similar homes. A smarter move, he says, would be to "move up" to an older and possibly smaller home in a highly desirable neighborhood that's close to large employment centers and respected schools. Even though these homes may not have all the bells and whistles you're looking for in your move-up, they're more likely to gain value over the long haul.
