Should I remodel or buy a bigger house?

Question

My husband and I have two children under 2 years old and have outgrown our current 1400 square foot home. My husband and I both work from home, and we have a day nanny who comes and helps with the kids. All five of us our falling over each other all day. We would like to acquire more space and more storage.

Background details: Our current home is worth $285K, and we owe $185K on the mortgage. Our interest rate is 3.14%, with a biweekly payment of $420. We have a savings/investment target of $3,500/month (kids' college funds, emergency funds, and retirement), which we can barely afford now, given our other normal expenses (car payment, groceries, etc.). Our largest expense is our nanny at $2,500/month, which will go away in about 3 years when our youngest heads off to school.

We've considered two options: remodeling our current home, or buying a large home. Each has their own set of pros and cons.

Option 1: Remodel

We have an unfinished basement which we do not use very efficiently. We could gain about 700 square feet of usable space if we refinished it. A real estate agent estimates that it would cost us around $15K to finish the basement (the average in the neighborhood for our size of basement), and that we could expect to get almost all of that back on resell. We would also need to remodel the kitchen to add more storage space and functionality. Kitchens are expensive and we'd have to do a lot, so I'd estimate about $10K for this task. We would able to pay cash for such a renovation.

Pros:

• Cheaper than Option 2 (below) because we can stay in a lower mortgage after the renovation
• With more free cash, we can more consistently hit our savings and investments targets each month
• Less risk. If one of us loses our jobs or an unexpected expense comes along, we have a little wiggle room, since we're not locked into a higher mortgage

Cons:

• Would be very disruptive to renovate, with two small children, the nanny, myself, and my husband who are all home all day
• It won't be a 100% satisfactory solution, because a lot of the space we gain will be in the basement, which is somewhat inconvenient for a kids' playroom (up and down and up and down the stairs we go!). A better solution would be a main-level kids playroom, close the kitchen and/or living room.
• We don't want to price ourselves out of the street. Being the most expensive home on the street is bad for resell, real estate agents say.

Option 2: Buy a larger home

The idea here is to sell our home and buy the "next level" of home: somewhere in the $500K-$600K range. The larger home would have the more space and more storage that we seek. There are plenty of such homes in our neighborhood, which means we can keep the same school district, amenities, friends, etc. With current mortgage rates (in Ontario, currently around 3% fixed for five years) and a 5% down payment, this would give us an estimated monthly payment of $2000 - $2500.

Pros:

• Won't have to live through a renovation
• It's a 100% solution: we can can get exactly what we want, or at least very close. Having more space will make day-to-day living much more enjoyable

Cons:

• Will lose money on closing costs (real estate agent's fees, etc.), about $15K total
• Will have to pack boxes and move them, which is disruptive.
• Will have to sell our current place, which always carries some risk of how long it will take. To sell our current place, we'd have to do some minor repairs and painting, totaling perhaps $4K.
• Will increase the amount of monthly expenses (higher mortgage, utilities, property taxes) we bear, meaning we can save/invest much less that we'd like to. (However, in three years when the nanny leaves, we will have an extra $2,500 freed up for savings/investments.)
• More risk. If one of us loses our jobs, we're screwed until we find a new one. (Our emergency savings as of right now unfortunately isn't high enough to carry us very long in the case of a lost job.)

My Question

Given the above two options, does any one have any advice? Any pros or cons that I missed?

Answer 1

After a 6% commission to sell, you have $80K in equity. 20% down on a $400K house. 5% down will likely cost you PMI, and I don't know that you'll ever see a 3.14% rate.

The realtor may very well have knowledge of the cost to finish a basement, but I don't ask my doctor for tax advice, and I'd not ask a realtor for construction advice. My basement flooring was $20/sqft for a gym quality rubber tile. You can also get $2/sqft carpet. I'd take the $15K number with a grain of salt until I got real bids. What's there now? Poured cement? Is there clearance to put in a proper subfloor and still have adequate ceiling height? There are a lot of details that you need to research to do it right.

That said, the move to a bigger house impacts your ability to save to the extent that you are taking too large a risk. The basement finish, even if $20K, is just a bit more than the commission on your home. I like the idea of sticking it out. Once the nanny is gone, enjoy the extra income, and use the money to boost your savings and emergency funds.

As I read your question again, I suggest you cut the college funding in favor of the emergency fund. What good is a funded college account if you have no funds to sustain you through a period of unemployment?

There's a lot to be gained in holding tight for these 3 years. It seems that what's too small for 5 would be spacious once the nanny is gone and the basement added. The cost of a too-big house is enormous over the long run. It's going to rise in value with inflation, but no more, and has all the added costs that you've mentioned. On a personal note, I'm in a large house, with a dining room that's used 2 or 3 times a year, and a living room (different from family room) that is my dog's refuge, but we never go in there. In hindsight, a house 2/3 the size would have been ideal.

Finishing the basement doesn't just buy you time, it eliminates the need for the larger house.

Answer 2

I am quite sure you can set up an office in your basement for a lot less than $15,000. Don't build any walls, install any flooring, or upgrade the ceiling. Just install more lights and plugs. Set up your desks, bookshelves and what not in whatever corner is furthest from noises like the laundry room or the furnace. The kids and the nanny get the main floor - just let the whole living room be a giant playroom, for example. This gives you the separation you need to work at home, but you can hear if something really needs your attention.

When the kids go off to school, you can refinish the basement into a playroom for kids who don't always need supervision, using the money you are no longer spending on the nanny to install carpeting, real walls, a drop ceiling and so on. Your office stuff can move up to the main floor or to a spare room upstairs if you had one but it wasn't usable during the baby years when upstairs generally has to be quiet. As the kids get older the basement can get tailored to what preteens and teens like.

This is essentially what we did, and our square footages and child counts match yours almost precisely. We did eventually convert our garage to carpeted and finished space, and it spent time as an office with staff coming in each day, then some time as a teen playroom (think video games and loud music) after the business rented office space outside the house, but if you don't intend to hire staff for your business you don't need to do this part. We did the majority of the basement wiring ourselves and got an electrician to hook it into the panel and check our work. The budget would probably be less than 10% of the guess from your real estate agent.