Saving Up for a House Upgrade

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cal91
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Saving Up for a House Upgrade

Post by cal91 »

My wife and I are currently saving up for a house upgrade. Our Current house is worth ~$260,000, and we owe $226,000 on it. We went in with 3% down on an FHA loan right out of college. We want to upgrade to a house that's around $400,000, and are saving about 15% of our income in an account dedicated for the down payment. We will have enough for a 20% down payment in about 4 years.

I am wondering if it would be wise to sell my current house and to rent until we can afford the larger house. My thoughts are that, right now, we want to preserve our principal, and if the housing market were to loose 40% of it's value, we'd be underwater and would not be able to afford the house upgrade for a longer time. On the flip side, if the housing market were to continue increasing we would benefit, but the magnitude of the possible benefit from increasing value in the next couple years is not nearly the same as the magnitude of the possible loss from losing value.

It just feels like our plans to buy in the next couple years are very vulnerable to the housing market right now, where if we rented we would have much less risk of loss while only losing small potential gains.

Any thoughts?
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Pajamas
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Re: Saving Up for a House Upgrade

Post by Pajamas »

If your current house lost value, the one you would want to upgrade to would probably lose value, too. You could think of it as already owning 260/400 or 65% of the house you want to buy. If housing prices go down 20%, it would then be 208/320 or still 65%. You might be better off though, as you currently need $140k to upgrade and if prices go down 20% you would only need $112k to upgrade. If housing prices go up, the additional cost would go up instead, and you would need to save more to offset it. Depending on the market, the more expensive house might lose even more value than a more moderately-priced house and you might come out ahead if prices go down.

If you sell and rent instead and housing prices go down, you might be in a better position to buy later. On the other hand, if they go up, you could find yourself worse off.

You need a place to live, though, it is not primarily an investment or financial issue. If renting is less expensive than owning and an acceptable alternative, why not sell your house and rent and not plan to buy another one? Probably because you want to own a house.

So I think you should start by thinking about what you want in a dwelling and then see how to best manage your finances to achieve that rather than letting the finances be the primary consideration.

Besides, you can't predict the housing market with certainty. Even during the last financial crisis in which housing was greatly affected, prices didn't really change much in some markets and the recovery varied between different areas, too. Housing markets are very local.
Topic Author
cal91
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Re: Saving Up for a House Upgrade

Post by cal91 »

@Pajamas

Thanks for the reply. It's kind of hard to ignore my house as a financial issue when the value of my house maxes up 90% of my net worth!

Here's why I am thinking this way. When someone is close to retirement they want to preserve their principal and are not too worried about losing potential gains. For this reason they have more bonds and less stocks.

I am close to buying a house. There's four options of what will happen in the next 4 years.

1. I keep my current house and the market doesn't crash. I have enough money after selling my house to pay off the remaining loan and buy the bigger house.

2. I keep my current house and the market crashes. I'm upside down in my house, and don't have enough money to pay off my loan after selling my house, and then buy the bigger house. This is very unfortunate because the bigger house is at a low price.

3. I sell my current house and the market doesn't crash. Not ideal but with my taxable savings I can afford a down payment on the bigger house.

4. I sell my current house and the market later crashes. Excellent! I sold high and can now buy low!

Looking at these options, I have much to lose if I keep my house (#2) and little to gain. If I sell, I have much to gain (#4) and little to lose (#3).

Is this thinking incorrect?
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WoodSpinner
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Re: Saving Up for a House Upgrade

Post by WoodSpinner »

OP,

I think your thinking is correct except for one problem ...

Which of the scenarios is going to happen?

So here is a question for you ...

What is driving the need to Upgrade the House?

If its a purely financial question, than I would ask you to consider another alternative....
  • Keep the house and use the extra money to invest -- Live Below Your Means
If there are other factors at play (e.g. Out of Room for the family, Bad location, Poor Schools etc.) than it may not be a decision that will be driven by Financial Analysis.

Thoughts?
WoodSpinner
aristotelian
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Re: Saving Up for a House Upgrade

Post by aristotelian »

cal91 wrote:@Pajamas

Thanks for the reply. It's kind of hard to ignore my house as a financial issue when the value of my house maxes up 90% of my net worth!

Here's why I am thinking this way. When someone is close to retirement they want to preserve their principal and are not too worried about losing potential gains. For this reason they have more bonds and less stocks.
Are you saying that 90% of your net worth is in your house, you are near retirement, and you are considering upgrading your house? Are you sure about that? Do you have a pension that you expect to cover 100% of your expenses in retirement?
Topic Author
cal91
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Re: Saving Up for a House Upgrade

Post by cal91 »

Haha! I forgot to finish that train of thought. I guess my mind is close to retirement :)

So I am not close to retirement. But, like someone close to retirement, I am going to be drawing upon my assets in the near future. So my risk allocation should be similar, no? It seems risky to hold onto a house that my family is about to out grow, when the market is high, and I plan on buying a larger house in a couple of years once I have enough savings.

That is what I mean by 90% of net worth is in my house. The fluctuation of the housing market plays a huge impact on how much I'll have when I sell the house.
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Pajamas
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Re: Saving Up for a House Upgrade

Post by Pajamas »

If there is a crash and you are upside on your current house, the bigger house would have crashed, too. The larger asset would lose a larger dollar amount at the same percentage rate of loss and would cost you less to buy, net of your old house. So I really don't understand the logic behind #2. I draw the opposite conclusion from the scenario, that you would benefit from a crash if you want to upgrade.
cal91 wrote: That is what I mean by 90% of net worth is in my house. The fluctuation of the housing market plays a huge impact on how much I'll have when I sell the house.
You would have less value in your current house after a crash but a larger house would cost proportionately less, too, and would have lost a greater dollar amount than your current house.

Example: Your current house is worth $500k and you have a $200k mortgage balance and a $300k of net value. The house you want to buy costs 1,000k. The difference is $700k.

If there is a 50% drop in the market, you now have a house worth $250k with a $200k mortgage or $50k of net value. The house you want to buy now costs $500k. The difference is $450k.

It will now only cost you $450k rather than $700k extra to buy the bigger house.

So if you want to buy a bigger house, you should be hoping for a crash.
aristotelian
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Re: Saving Up for a House Upgrade

Post by aristotelian »

cal91 wrote:Haha! I forgot to finish that train of thought. I guess my mind is close to retirement :)

So I am not close to retirement. But, like someone close to retirement, I am going to be drawing upon my assets in the near future. So my risk allocation should be similar, no? It seems risky to hold onto a house that my family is about to out grow, when the market is high, and I plan on buying a larger house in a couple of years once I have enough savings.

That is what I mean by 90% of net worth is in my house. The fluctuation of the housing market plays a huge impact on how much I'll have when I sell the house.
I would still have issues with the premise. 90% of your net worth in a single asset is problematic for the same reasons that you are asking these questions. Real estate is risky, especially when you are talking about a single property. Consider concentrating on building up a diversified portfolio of stocks and bonds along with real estate. When you have a large enough portfolio that you can risk additional concentration in real estate, that would be the time to purchase a more expensive house.
Topic Author
cal91
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Re: Saving Up for a House Upgrade

Post by cal91 »

Pajamas wrote:
Example: Your current house is worth $500k and you have a $200k mortgage balance and a $300k of net value. The house you want to buy costs 1,000k. The difference is $700k.

If there is a 50% drop in the market, you now have a house worth $250k with a $200k mortgage or $50k of net value. The house you want to buy now costs $500k. The difference is $450k.

It will now only cost you $450k rather than $700k extra to buy the bigger house.

So if you want to buy a bigger house, you should be hoping for a crash.

Right, except I have little equity. My house is worth $260k and I have a $226k balance, a $34k net value. House I want to buy is $400k, difference is $366k.

If there is a 50% drop in the market, I now have a house worth $130k with a $226k mortgage or -$96k of net value. The house you want to buy now costs $200k. The difference is $296k. - BUT i have negative equity in my first home, and would not be able to come up with a 20% down payment. Whereas if my first home was sold before the crash, I would not have that problem.

That is the essence of my question, I guess. Should I sell my house now while I can, to eliminate the risk of having negative equity in the future? If I was in a house that I would be staying in the long run I would definitely not sell, however, my family is growing out of our current house and I am hoping to upgrade soon.

I am pretty young and just trying to learn all I can from those with more experience than me. Thanks for your responses and patience!
am
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Re: Saving Up for a House Upgrade

Post by am »

Is there any way to make your current house work? Changing houses is expensive. Houses are poor investments. There are many costs in addition to mortgage and some unknowns.
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Pajamas
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Re: Saving Up for a House Upgrade

Post by Pajamas »

Okay, I see that you would still be better off in that scenario in terms of absolute dollars but you wouldn't have cash for a down payment so it would be irrelevant.

If all the scenarios go as you say, I guess you might be better off hedging your bets by selling your house now, especially if renting is cheaper than than staying in your house and would allow you to save more money faster. But things have a way of taking unexpected turns and you could also find yourself priced out of the market indefinitely or have the expense of renting escalate. I don't know anything about your local housing market. Maybe there are lots of houses and room to build new ones and you can get a nice apartment for $650 a month including utilities.

It seems to me that you could barely afford your current house and could only put 3% down on it and so you have little equity after several years. As others have pointed out, you are already house poor and would only make that worse by buying a larger house and tying even more of your net worth up in it.

I also think that the underlying problem is trying to time the market and basically use your dwelling as a speculative tool. If you would simply stay put in your current house and focus on improving your overall financial situation with savings and investments you would be better off in the long run than in trying to time the buying and selling of your primary dwelling.

I know people who made money speculating on single family houses in the boom but then they got stuck in the crash and were worse off than they would have been had they done nothing. A house is not an ideal vehicle for buying and selling in response to market moves because of the huge transaction costs, the time it takes to complete the transaction, and an imperfect market. If you absolutely must speculate, do it with currencies or commodities or stocks or options or anything else with good market pricing information and fast and cheap transactions, not with your house.
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