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I currently have a house worth about $450k. I'm thinking of upgrading. Upgrade is mostly for location and I can find a house in the location I want for around $450 to $500k.

What is a better option and why. Get another house for $500k or sell the current house and do a much bigger upgrade to $800k house.

But the fact that $800k will buy a much much better house (about the same location). If a mostly care about location and not necessarily a bigger/better house is it smarter to rent the current and buy a new one or sell current?

I would have to take about $300/month loss if I rent the current house now.

My thinking is if I rent the current and buy a new one the rental will help pay for the it. So in 30 years I'll have the house itself plus rental income.

I guess I'm looking for validation of my thoughts and maybe some math to back it up.

Thanks

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Consider selling the first house and buying a $500K house as your base option. Then, consider whether you want to invest in rental property (and all the pros/cons that go with it), or whether you want to spend that money on yourself (bigger house), or some other investment entirely. Those are really your three options. –  NickC Sep 6 '12 at 17:32
    
Don't forget to consider closing and selling costs in your math. The realtor commission on houses this expensive will be substantial. Also a factor: Property taxes. –  JohnFx Sep 8 '12 at 16:44
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3 Answers

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Having someone else paying you rent is always going to be the better deal financially. The question is, what does $450k buy in the neighborhood in which you want to live, vs $800k?

I'm going to assume you can afford either option (buying a $450k home and not selling, or an $800k home and selling your current one) whether someone's paying you rent or not.

Let's make up some numbers here; a $450k home, financed 80/20 (360k principal) at 4% for 30 years will cost you about $1720 in P&I payments per year (plus escrows such as RE taxes, PMI, and homeowners insurance where applicable).

An $800k home financed 80/20 (640k principal) at 4% for 30yr will give you payments of about $3,055/mo before taxes and insurance.

So, the worst case overall is that you buy a 450k home in the new neighborhood and are not, at any given time, collecting rent on the old property. That would (assuming the mortgage terms on both home loans were comparable) cost you $3440/mo and you'd be living in a $450k home in a neighborhood where 450k may not buy a home as nice as the one you moved out of.

The question as I stated above is this; assuming you had a reliable tenant in your home for the entire remaining life of the loan on your current home, which is more acceptable to you: buying $450k of home (which might be a downgrade in sqft or amenities) and paying $2020 in P&I, or paying about a grand more ($3055/mo) for a much nicer home in the new location?

Strictly from a money perspective, the renter is going to be the best option, IF you get reliable tenancy for the entire life of the mortgage on that house; you'll be paying $2020/mo for 30 years, which is $727,200, to end up with $950k of total home value (plus adjustments for actual home value appreciation/depreciation). That's the only way you'll come out ahead on any mortgage; have someone else pay most of it for you. If you don't rent, the $800k home will cost you $1,099,800, while two $450k homes will cost you $1,454,400. The percentage of home value over total payments for the 800k home would be 72% (you will have paid 137% of the value of the home), while you will have paid 153% of the value of two 450k homes.

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Forget the math's specifics for a moment: here's some principles.

Additional housing for a renter gives you returns in the form of money. Additional housing for yourself pays its returns in the form of "here is a nice house, live in it". Which do you need more of?

If you don't need the money, get a nicer house for yourself. If you need (or want) the money, get a modest house for yourself and either use the other house as a rental property, or invest the proceeds of its sale in the stock market. But under normal circumstances (++) don't expect that buying more house for yourself is a good way to increase how much money you have. It's not.


(++ the exception being during situations where land/housing value rises quickly, and when that rise is not part of a housing bubble which later collapses. Generally long-term housing values tend to be relatively stable; the real returns are from the rent, or what economists call imputed rent when you're occupying it yourself.)

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Because it appears you have in the neighborhood of 30 years remianing on your mortgage for the first house, If you can sell it you will likely be better off in the end. While renting has the potential for greater income it is a business. And like any business there are risks, expenses, and work required to make it successful. There will be times where you can not find a renter immediately and will be responsible for making both payments, maintaining both houses, the insurance(which for an owner is higher for a rental property than a domicile), and paying the applicable taxes.

You need to look at your best and worst case numbers. If your best case numbers leave you in the hole 300/month then that is not the sort of business you want to run. Your investment should build your savings and retirement funds not deplete them. Further you are more likely to fall between your best and worst case scenerios. So you need to be able to thrive at that level. If something in the middle is going to take you into bankruptcy then sell the property. If you are not willing to put the time into your business that it will need (My rental home took about 10-30 hours a month despite renters being responsible for basic upkeep and maintenance.

Finally your plan B: A home with 800k value will have higher costs and higer expenses and maintenance. If the 800k home is the home you and your family needs then by all means go for it. But if it can do just as well in the 450k Home then go there. Pay the home off early by making the payments you would be making for the 800k home. In this way you pay less in total cost of the home and set your self up for the greatest chance of success. Once that home is paid off the break even point for renting goes way down as well. So the rental option could be in the future. I would just aviod it now if possible.

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I'm not worried about finding renters. I'm in a pretty good area in Los Angeles so renters will be available. And the $300 loss per month is an estimate on a low end rental payments. I do like your point about paying off the house early and that's in the works but I have to move. The move is tied to better school area. –  Tigran Sep 7 '12 at 0:36
    
@Tigran - You are assuming that your renters will always pay and not sit there for the 6-8 months it takes(from the time they stop paying) to get an eviction in LA. Can you weather that type of storm? –  user4127 Sep 7 '12 at 13:57
    
I have hate to weather that type of storm but yes I can. –  Tigran Sep 12 '12 at 22:54
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