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Buying A Bigger House (Buying "Up" - In an Up or Down Market)

There are three different market scenarios that are possible when considering a larger home for your family. The market is either rising, it's falling, or it's stable, there is nothing tricky about that. You may add some variables as to what you believe the market will do next, but at any moment in time - relative to when you purchased the property -one of those three scenarios exist. We want to analyze now the effects on equity relative to those different scenarios, in the case of a sale and purchase of a larger property.

In the case where the market is stable, the situation is rather clear-cut. You have neither lost nor gained, and the values of other properties are the same relative to your home. If you move up in a stable market, it would be no different than had you bought the larger house in the first place, your equity in either home, your present or the new one will be exactly what you put in out of your pocket, plus the amount you've paid toward principle.

In the case of a rising market, unique opportunities exist. Let's look at a specific example of a purchase, 4 years ago at $ 180,000, 10% down payment at an 8% interest rate on the loan amount of $ 162,000. Let's say over the period, property values have gone up 25%, current valuation at $ 225,000… and this family needs a bigger home now. Their new loan balance after paying mortgage payments for 48 months is $ 155,874. Let's say that after selling costs (use 8% average including all costs), they net $ 207,000, and walk with a check from the sale in the amount of $ 51,126. Let's further assume that the new larger house is offered at $ 325,000, leaving a new loan balance of roughly $ 275,000. Yes the payments are larger each month, but the family has moved up nearly 50% in home value, which will be owned equity over time, on a 25% increase in the market value of properties with no additional monies out of pocket… 2:1 ratio. This is a "leveraged increase" in future equity value. They have also increased their downpayment from 10% on the former home originally to over 15%. If the right specific scenario is searched for, one might eliminate mortgage insurance through such a trade up if the situation yielded enough money to put up a 20% downpayment. In situations (like the current one at the time of this writing, January, 2001) where the interest rates have fallen and/or the market values have risen particularly fast, this scenario is even more exaggerated in favor of a move up.

In the case of a falling market, there are different opportunities for certain situations. In a recent purchase, there are no good scenarios to trade up, the money has simply been "lost" and more monies will be required to trade up typically. However, look at this scenario. Let's say we have a family who has been in their house for ten years, they now owe $ 100,000, value is $ 180,000, and at the peak of the market it was worth $ 200,000 say, six months ago. Some would say that if they had sold then, they would have $ 20,000 more in their pockets. In a trade up however they do better selling in the down market. Lets look more specifically:

At market peak:

$ 200,000 (less selling costs of 8%), net $ 184,000, equity is $ 84,000. Purchase home, price $ 300,000, New loan balance (assuming seller pays buyers costs) $ 216,000

After market decline: (10% decline to both properties)

$ 180,000 (less selling costs of 8%), net, $ 165,600, equity is $ 65,600 Purchase home, price $ 270,000, New loan balance (assuming seller pays buyers costs) $ 204,400

As you see, the trade up is effective during a down market for this situation. The client has bought the same property he could have six months prior and now owes substantially less than had he sold and bought at the peak.

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Now, there is always someone who will say regarding the comparisons, "Yeah, but what about all those monthly payments they made in those four years??" Well, there is some cost every month even if you don't own in paying rent, and we will assume that the combination of, 1) tax benefits, 2) "joy of homeownership" and 3) equity buildup over time… makes owning a home a better situation for most families. The actual "return on equity" calculations should be discussed with your financial/tax advisor, but I know this, rent money paid has no return!

There is no clear cut "rule" on when it is the right time to make the move up. These are specific examples, and not meant as a general discussion, written to prove the point that you can't rule out trading up under a certain market condition. Each situation must be looked at carefully. Interest rates, your current family income, etc. all play an important role. Check with your tax professional, then call us! We're here to help.