We often hear mortgage specialists and financial advisors recommending to home buyers that they should stay conservative and avoid overstretching their finances.
But to be honest, probably no one needs a financial expert to tell them that.
These “experts” are usually loan officers who are afraid that you might default with a higher monthly payment, or insurance agents who want you to spend your extra cash on their insurance policies rather than on the home loan.
Either case, being told not to over-leverage your finances is like being told to drink more water and have more rest when one has the flu.
It’s just such safe answers that one cannot claim that these advise to be bad advice.
It is no wonder why we keep hearing these statements on repeat all the time.
What they don’t tell you, or are too afraid to stick their heads out to say, is that if two houses have the same appreciation rate in a year, the bigger house would enable the property owner to bank in a higher increase in equity.
Saying this, how big a house your should buy with your down payment funds depend on a few big factors.
Every individual inevitably would have a different risk profile.
And this almost always boils down to how much cash or cash equivalents one has at any point in time.
The more you cash you have, the less risky you perceive your financial position to be, and the safer you feel.
This is why most home buyers prefer to buy houses with long term mortgage that require as small a monthly debt obligation as possible.
Having to put a huge portion of your personal income into the mortgage each monthly is going to be taxing on your lifestyle and can make you feel less secure about your personal finances.
But come to think of it, real estate is one of the least risky assets consumers can put their money into.
There’s a reason why almost every property would be able to find a bank who would be willing to finance it. And that is because real property is the safest asset to invest in.
Even though a bigger house will inevitably mean a larger debt commitment, the payments go towards home equity which belongs to the homeowner. And it can be accessed in future via home equity loans, lines of credit, reverse mortgages, and even from sales proceeds from selling the place.
So really. The idea that buying a larger house is riskier does not paint a picture as dark as many people paint it to be.
From a financial point of cash flow, it can be riskier. But that is a calculated risk that is buffered with the fact that accumulated equity still belongs to the homeowner.
In addition, when you consider that your personal income is more likely to rise than fall over, the monthly installments are only going to get easier to fulfill. Add in inflation which would decrease the value of the principal, and you are looking at a winning position to set yourself up for.
However if a bigger house is going to cause you sleepless nights, then it’s probably to big a pill for your to swallow.
Bigger house bigger appreciation
He has $20,000 in cash ready to be used as down payment for the house. This can be used to either pay down 10% of the first house or 4% of the second.
Either way, he is going to acquire full control of the house when he purchases it.
Assuming they both meet a market appreciation average of 10% in 3 years, at the end of 3 years, the first house would have a value of $220,000 and the second a value of $550,000.
This effectively means that he would have gained $20,000 on the first house, or $50,000 on the second.
If we look at return on investment based on the capital of $20,000 which is his down payment amount, then it would work out to 100% and 250% respectively.
You don’t need to be a genius to work out which return looks better?
This is why the term leverage is often used in real estate transactions.
When we include them into the equation, the returns on the bigger property is going to look even more attractive.
The numbers become even more staggering when a property is acquired with no money down schemes.
The gist of all these is that while a house is a place to stay, it is undoubtedly an investment instrument whether you like it or not.
This fact should be kept in mind when pondering whether to buy a smaller or bigger house. And if you can afford it, going big is usually a savvier choice than going small.
If there’s any material possessions in life that is worth putting your money in, it’s our homes.
There’s nothing wrong with allowing the place you call home to accumulate wealth for you while keeping a roof over your head.
If anything, you should at least leave this discussion with the following idea.
Buying a small house when you know that you would sell it in a just a few years is one of the worst financial decisions to make.
You minimize capital gains, pay a huge closing cost for the short stay, and forgo the opportunity gains (assuming appreciation) from a larger house.
So if you have a plan to eventually live in a larger house, go for it now if you can afford it.
Your balance sheet would thank you in years to come.