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My wife and I are first-time home buyers. We both have fairly stable jobs and have no trouble getting a mortgage on any price house in our town.

We are trying to decide which is smarter financially:

  1. Buy a starter home well within our means, pay it off within 4-5 years with extra payments of $1000 per month in addition to the $400 minimum, then sell and switch to a “forever home” having 1/3 of the money towards that purchase from the sale.

  2. Directly go for our long-term goal, a.k.a. some home we would want to stay with, which is three times the price, but making minimum monthly payments on it for 30 years.

Both homes meet our long-term needs (same size, same number of bedrooms), but the “forever home” is simply newer, beautiful, with a view, possibly has luxuries like a swimming pool or additional bathroom, and is in a great neighborhood. Payments would be $1200 for 30 years.

My wife and I both prefer the first option, as it involves less stress, and the short time needed to pay it off rapidly would be stronger motivation for us to make those extra payments. But, from a financial stand-point, is it much smarter financially to just start payments on the long-term goal directly?

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    Is a "newer, beautiful, with a view, possibly has luxuries like a swimming pool or additional bathroom, and is in a great neighborhood" home that is "three times the price" still less that 30% of your combined gross income? And don't forget increased property taxes, increased maintenance & replacement costs, HOA fees, you'll need nicer furniture, appliances, in a nicer home in a nicer neighborhood, and a car that suits the neighborhood. (While not strictly "keeping up with the Joneses", you'll want to look like you belong there.) – RonJohn Jan 5 '20 at 16:43
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    Are you planning for kids? If so, what's the school district like? And what are the schools like for the starter home? – mkennedy Jan 5 '20 at 20:11
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    You are missing an option here: you can rent. – gerrit Jan 6 '20 at 12:40
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    A starter home for $400/month? Did you forget to calculate taxes and insurance? A less than desirable starter home is usually wrought with issues that will continually cost you every month to get fixed; that monthly $1000 principal can quickly dry up. These issues will not be known until you actually move in; the home inspection does not reveal everything, just everything exposed and the previous owner is good at hiding stuff because they lived there. If you have kids then will both of you continue working? Do you want to be constrained or have a cushion? – MonkeyZeus Jan 6 '20 at 13:50
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    Have you considered keeping the starter home (as a rental/investment property) when you move into your long-term home? – John Wu Jan 6 '20 at 20:15
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I highly suggest you read other posts that discuss the math of home buying. There's a lot of information and shared experiences of the total cost of ownership.

I'd recommend buying the smallest home in an area you are happy with. Then, by all means, if you wish to pay the mortgage down in 10-15 year, or even less, do it. You'll be far better off in the long run by first seeing the expenses of owning a home, and living in a tighter space for a time. Real estate is all local. In many areas, it's better to rent than to buy a home, in others it's flipped. I'd also suggest that you'll be better off in the small house until you know how big a family you will have. Buying a 4 bedroom house and planning on 3 kids is fine, until life has other plans and maybe blesses you with only one or two, and the empty bedrooms only remind you of this.

Edit: In response to a comment, I'll add a link to Is it true that real estate prices mainly go up? I can make a strong case for the math. Long term, the trend is to follow inflation (you can debate, yes, I probably mean 'wage inflation', which singe 1970's has been pretty much the same as 'inflation')

One buys a too large house, say $300K vs $200K. Sure, that extra $100K increases in value, with inflation, but at a cost. I live in a town with a property tax just shy of 2% of my home's value. Houses have an annual cost of ownership. Maintenance, repairs, utilities, etc. these numbers are far higher than another 1%. So, that extra $100K part of the home is costing more each year than its value is rising. Let's assume one is a supersaver, and used a high down payment. Instead, they buy the $200K home, and invest the $100K. The stock market does its thing, and 15 years later, it's worth $400K. The price different from the $200K home to the $300K home is now just over $150K (as inflation took these 2 homes to $312K and $467K).

This is, to me, the quick dirty math to make my case. It's easily knocked down with a counter-example of an area with a fast-rising home market, and a contrary flat stock market. However, it presents the 'median' of the infinite possibilities, the long term numbers for both markets.

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    and of course the bigger house may well cause you to decide you can't afford both the large house AND the children... – jwenting Jan 6 '20 at 10:21
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    @gerrit I am used to the UK housing market where houses are sold by number of bedrooms. In that situation, there will be a living room, a kitchen, a number of rooms that can't possibly be slept in (bathroom, utility room, etc), and then any other space more than a couple of square metres will be sold as a "bedroom". (A little above my price range, you do start to get houses with "family room", "study", and other non-bedroom rooms). – Martin Bonner supports Monica Jan 6 '20 at 12:31
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    @gerrit my grandmother used her n+4 bedrooms to store, as stated in the estate valuation, a “vast quantity of wool”. I don’t think owning a vast amount of wool is generally good financial sense, though. Especially when you need bedrooms to store it – Tim Jan 6 '20 at 13:24
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    @gerrit while true, it's as -- or more -- reasonable than "assuming the parents are getting in a fight and want each their own bedroom". Usually, the man gets sent to the couch. – RonJohn Jan 6 '20 at 15:32
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    @Patrick87 - the question, as asked, is one with no possible single answer. I could post an answer that starts to list the variables, first financial, then human. Too many assumptions would need to be addressed and even if one could quantify them all, we still have probabilities. My answer, whether detailed enough or not, is to go smaller. Larger creates a higher expense too soon, and tougher (more expensive) to get out of. – JTP - Apologise to Monica♦ Jan 6 '20 at 18:31
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Assuming that both homes will appreciate in value at the same rate, and the real inflation-adjusted appreciation is non-negative, you will almost surely save money by buying the more expensive home first.

Suppose all growth rates are 0%; prices are completely stagnant. Then, buying the starter house doubles the amount you pay in closing costs. This analysis is the same as long as the appreciation rate is equal to the rate of inflation.

Suppose property appreciates faster than inflation. Then by waiting to buy the more expensive home, the home will have become that much more expensive in terms of present value.

However - if you expect the homes to appreciate more slowly than inflation, then it could make sense to buy the starter home now, and then buy big home later on. For instance, assuming no appreciation and inflation of 2.5%, then by waiting 15 years to buy you can get the expensive home for 69% of its original present value, which almost surely more than covers the extra transaction costs.

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    +1, though there's also the risk of foreclosure to consider - especially if the mortgage on the big property is financially a stretch while the small one sits comfortably within their budget. – Lawrence Jan 5 '20 at 16:00
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    Isn't comparing appreciation against inflation ignoring (a) the interest on the loan, (b) property tax or other home expenses and/or (c) the possibility of investing the money elsewhere? – NotThatGuy Jan 6 '20 at 3:16
  • @NotThatGuy Yes. However, my intuition says that since interest, property tax and home expenses are roughly in proportion to the home value, they can be safely ignored as long as home values are considered. You do make a good point about market returns, however. I initially wrote an answer discussing that as well as income growth rate and percentage of income, and changed it to focus on inflation just for simplicity. You make a good point in (c) about opportunity costs. – Patrick87 Jan 6 '20 at 3:33
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    @MasonWheeler Is this scenario not contemplated by the last paragraph? Depreciation is appreciation slower than inflation. – Patrick87 Jan 6 '20 at 13:36
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    I do not think it's inflation you should be looking at. It's the interest on the mortage, and interest on extra money in savings that you should compare against property appreciation. – Taemyr Jan 6 '20 at 16:38
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"Where to live" has too much of an impact on your entire life to make this a decision based purely on maximizing the financial outcome, or similar.

If you truly expect you will be unsatisfied with your house in 5 years, consider whether the next 5 years will have lower quality of life if you instead buy a 'starter' home.

If your 'dream home' will put strain on your budget, consider how comfortably you will sleep at night if your work circumstances change, etc.

In my opinion, if you can afford it *, living in a home you truly expect to live in for much of the rest of your life is literally one of the best things that money can buy. If either of those bolded parts is less than accurate, don't overextend yourself on a home you may leave soon anyway.

*Note: I will add that 'if you can afford it' does not mean 'if you can currently make the monthly mortgage payments', it means 'if making these payments will not adversely impact your ability to achieve all future financial goals, including college for children, retirement quality of life, etc.

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It depends on your risk perspective and what you are trying to optimise. Are you optimising the expectation value of net lifetime savings / minimise life time expenses? Or are you optimising some value that takes risk into account; a value which will depend on your own subjective risk assessment?

If you are minimising the expectation value of lifetime expenses, then buying the larger home will be the smarter strategy. But if you want to minimise the risk of a drop in income within the next 30 years, you may rather choose to buy the smaller home first.

In The Netherlands, certain conservative Christians are strictly against taking on debt, and there are other religions with similar objections. A strategy for debt-free home-owning I have heard about is that after getting married, the couple (then still double income, no kids) will remain living with the parents, allowing them to save up money very quickly; so quickly, in fact, that they can probably buy a small home outright within five years or so. After moving in there debt free, they will again be able to have a very high saving rate compared to people paying rent or mortgage, thus able to upgrade to a larger house as they are getting (perhaps many) children.

Personally, I am quite risk-averse. I would not like to commit to any debt running over 30 years, because I have no clue if we will have a good income in 10 or 20 years, so I opt rather minimise risk than lifetime expenses. I'm renting until I can buy, I know I "lose" net lifetime income this way, but that is not something I worry much about. Most house-buyers will take on a large, long-running mortgage despite the risks. The strategy minimising lifetime expenses allows you to enjoy the more expensive home for longer and relocate less often (assuming you don't need to relocate for other reasons), which may be a major reason why this is for most people the preferred choice.

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  • Why the downvote? It would be instructional for me to know the motivation of criticism of this answer. – gerrit Jan 6 '20 at 15:21
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    Not the downvoter but I just left a comment on the other answer that may apply to yours too: this is good advice but doesn't seem to address the question asked. Now maybe this is the question OP should be asking, but OP's question is not about risk. – Patrick87 Jan 6 '20 at 15:48
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    @Patrick87 Isn't risk a factor in "smarter financially"? It's a financial risk we're talking about here, which (like other financial aspects) has ramifications for primary needs. – gerrit Jan 6 '20 at 15:51
  • That's a good point, on a second look it's not asking about cost specifically but about finances generally. Given that, risk seems like a good thing to discuss. – Patrick87 Jan 6 '20 at 15:53
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If you were entirely confident in your income stream and needs in the future, and also in your location stability, then the more expensive home first makes sense - you will avoid the transfer costs, which are several percent (in the US, usually around 7-10% of the total, between commission (6%) and other fees).

However, the reasons to go with the home that is appropriate for today are numerous.

  • The likelihood of your income stream changing - up or down - and causing your needs to change. One of you might lose your job, one of you might decide you don't like your career and want to change, one of you might get a major promotion, who knows - but if that income stream does change, you may not want that dream home anymore.
  • The likelihood of wanting/needing to change location in the future. What if one of you gets transferred out of state? What if you both decide you're tired of the [cold/heat/lack of seasons/etc] and want something different? What if you get tired of your commute, or want a better school for your kids, or want lower property taxes when you realize you're not having kids, or ... who knows?
  • The possibility your needs change. What if your dream home is a 3br4ba, because you're planning on one kid and a guest room, but thew you have triplets (1 girl 2 boys), and then an accidental fourth (girl) three years later? I'm guessing that 3br4ba doesn't sound so good now, right? Or your dream home is a 5br6ba, because you're going for a big family, but you end up with just one kid (or none) either because you realize you're happier that way or for some medical/etc. reason? Or once you have kids you and your wife realize you're not able to really keep up a large house, because you would rather spend time with your kids than on cleaning/maintenance/organizing?

So much is possible to change even in 4-5 years, that my general recommendation is to go small to start with. Get a house that works for now, and save up for that bigger house - and then when your situation is more well defined, then make that bigger purchase. Even though there're slightly higher transactional costs as a result if it ends up you buy your exact same dream home then, the odds are you'll end up in a better home for your needs, and probably at overall less costs, than if you guessed at your needs 5-10 years from now.

The other issue is that if you do buy the dream home now, you're going to feel stuck with it even if it's not perfect. Buying the smaller one now will let you learn so much more about what you want in a home, and about what kind of home owner you are.

I believed I'd be a handy home owner who was constantly doing gardening/fixing things myself/etc. when we bought our (current/first) home, but have learned that I'm much happier spending time with my kids - so the house we bought in one sense isn't ideal (as it's more fixer-upper than I seem to actually like) but in another sense is perfect (as it's quite small, so much less cleaning/maintenance burden). If we move to a larger home now, I know that I need to either do a townhome/condo (where I don't have to do any maintenance) or a much newer house (current one was built in the oughts - 1900, that is).

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    Upvoted for addressing flexibility and uncertainty. It is impossible to foresee all future requirements / desires. We bought a fairly large house to have room for kids, but remained childless. One with a large yard as we enjoyed gardening, but now that we are much older that has mostly turned into dreaded and physically taxing chores. My spouse was laid off within a year after we bought the house, luckily we were able to make the mortgage payments / refinance. – njuffa Jan 7 '20 at 1:15
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    @gerrit, "3br4ba" means 3 bedrooms and 4 bathrooms. – Ray Butterworth Jan 7 '20 at 15:05
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    @gerrit Yes, it means 3 bedrooms 4 bathrooms. Many new homes, in America at least, have more bathrooms than they have bedrooms, especially in the "Dream home" category. – Joe Jan 7 '20 at 15:17
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    @gerrit, more than 2 baths is not uncommon in the U.S., especially among the demographic that stackexchange attracts. – user4556274 Jan 7 '20 at 15:17
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    @gerrit Many homes in the US tend to have 2 to 3 bathrooms, though not always full bathrooms (e.g. half-baths lacking a shower or tub). If families expect to have lots of children or many/frequent guests, or even to host events in their home like parties, two bathrooms quickly can become "not enough" (especially considering many people prefer to reserve the master bathroom just for the parent(s) and not for kids/guests). But yes, it is definitely a luxury (on top of the luxury simply living in America provides) to be able to do this. – TylerH Jan 7 '20 at 20:50
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I'm going to take this on another track: What are your real goals? What's your motivation for getting one house over the other?

If the two houses you are looking at are the same size with the same amount of bedrooms, but simply in different neighborhoods and one looks better, then you need to figure out the real reason for one versus the other.

After Purchase Considerations

Forget initial cost for a moment. An older house, which is what I'm guessing the lower cost house is, will need a lot of maintenance. But guess what, so does the newer house. Even brand new houses have things that need fixed and adjusted to make it your home. A newer, more expensive home is going to have more expensive repairs. Granted, those repairs might not be as often as a older house, but it can add up quickly. You may end up spending more on upkeep of a new house than the old house. Pools and other luxuries can be extremely expensive and time consuming to maintain.

Do you really need the all the shiny new things in the newer house? It'll have energy efficient appliances: maybe a tankless water heater, possibly solar panels, better insulation, better windows, and maybe a host of other energy saving devices. Those are great reasons to have the new house, but the old house can be upgraded (in most cases) to have these as well, although the older house will still likely have energy problems you don't know about.

But the "new shiny" goes beyond the gadgets and energy savings, there's the new siding, new roof, new driveway, landscaping, and more. Is it just the "newness" you want? Is it the status symbol you're looking for? Do you want to gloat that you have an expensive house with a large mortgage, rather than a "run down shanty"? Sure, it's great to have nice, new things, but are you willing to spend a literal fortune to have it? With interest, insurance, taxes, closing costs, and more rolled into the mortgage, you're looking at paying a minimum of 150% of the asking price for the house, and that's if you have stellar credit ratings. The longer you hold onto the mortgage and the higher your interest, the more that house costs, maybe up to 200-250% (or more) of the asking price.

Income

When thinking about the mortgage and long term payments, you need to ask yourself just how reliable your work is. I'm not talking about your job (since they can fire you the day after you sign the papers for your house), I'm talking about the industry you and your spouse work in. If you get fired, how long before you can find another job?

Never take your job for granted as "I'm going to retire from here", unless you have less than a week for that retirement. Employers are too often ready to fire anyone for anything. Even if you have a contract, their lawyers can likely find a way to get rid of you, even if it means "promoting" you to a job you're going to absolutely hate and want to leave immediately.

With that in mind, how much money do you have saved up beyond your down payment? Is it enough to live on for 3-6 months if one of you does get fired? Is 3-6 months enough time to find a new job? Are you putting all of your savings into the down payment? That can work, but it's not recommended due to all kinds of unexpected expenses that can come up, especially when moving into a new house.

One thing that people often forget, and not just when buying a new house, is that you should plan to live below your means. This takes the "money arguments" mostly out of your life. You'd be surprised how many marriages and other relationships fail because of money. If you don't have to worry about where the money is coming from to pay the mortgage, you have a huge lead over many people. This includes people who make more than you but also have a massive debt load, which includes a house they only think they can afford.

Conclusion

So I challenge you to consider your actual reasons for wanting each house. Is it strictly a cost thing? Is it a social status thing? Is it environmental and social responsibility? As others mentioned, is it the school district for your future kids?

Just what exactly do you want out of this house and what are you willing to put into it?

We don't need to know the answers to any of the questions I've asked here, but you do.

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I would definitely recommend going with the starter home, especially if you can and will pay it off as quickly as you say. Heck, pay it off as fast as you can, then start shoveling all that extra money into investments. Not to mention you guys seem to prefer the idea of getting a starter home anyway, so you might regret choosing to go straight for the "forever home" when you begin to feel the reality of a large financial burden for 30 years. My wife and I have made a similar choice, and we're reaping the benefits of it. We have very little financial stress. Just make sure to get a good, full home inspection during the inspection period of the closing process. It'll cost several hundred, but it's well worth it. It's good to know more about what you're getting before you get it. Consider the following:

  • You will have total lower monthly liability. If something unexpected happens you can always stop the additional payments for however long you need to.
  • You will pay much less in total interest over time, especially if you continue the trend of paying additional payments on your second house's mortgage
  • Most people move well before they pay off their mortgages, so don't assume you'll be different if you decide to go straight for the "forever home". You might find you still have a mortgage 50 years from now.
  • In my opinion, smaller loans are always better. If you can break a larger purchase into multiple smaller loans, they're easier to pay off quicker (mow them down one at a time). By going with the starter home, this is essentially what you are doing.
  • To avoid transfer costs mentioned by others, you can decide not to sell your starter house, and instead rent it out once you move on.
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