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Option 1:

Buy a smaller house/condo now and later down the road (5-10 years) sell it to buy a bigger place.


Option 2:

Wait, rent (for 5-10 years), and save to buy a bigger place.


Background Details:

Location: San Diego, CA (or nearby)

"Smaller Place"

Price: $100,000 (guesstimate)

Down-payment: $20,000 (guesstimate)

Size: 1-2 BDR

"Bigger Place"

Price: $300,000 (guesstimate)

Down-payment: $60,000 (guesstimate)

Size: 3-4+ BDR (for kids eventually)


Question:

I would guess that it would be better to do option 1. Reason being... when you rent, you don't really see that money ever again, but when you buy are place you are making payments towards an asset that you own. Of course there is potential to lose money in home maintenance/repair, the selling of one place to buy another, etc, but you are at least still investing in your own asset.

Is option 1 really the better long-term financial choice? What might I be overlooking?

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  • Can you provide any estimates here, such as: how long you think you'd own the smaller home for (or rent) before buying the bigger home; what you expect the annual house price appreciation to be in your neighborhood; and so on? Such numbers - even guesstimates - would really help in answering your question. – Scott Mitchell Dec 30 '10 at 3:21
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Option 1, but for a different reason. Buying the smaller home may let you see that you really don't need the big home you're considering now. It's easy to see a larger house and think it looks great, but, do you really need the extra bedroom, or can a guest sleep in the kid's room and come into yours on the blowup mattress? The dining room? We pay to have it 24/7 yet use it maybe 4 times a year. Get the small house, and after saving aggressively for retirement, use the extra money to pay the mortgage down faster, you won't regret it. If after 10 years, you still 'need' the big house, go for it.

Edit - I'd like to add this thought. 80% mortgage gives you a choice of $240K or $80K (for the choice of $300K or $100K home), as the mortgage balance. At 5%, the $240K loan has a payment of $1288. But - if you take the smaller house and lower mortgage, that $80K loan can be paid in 6 years by making the same $1288/mo payment. You've now lived in the house for 6 years, have no mortgage and if you wish to move up, you can increase the size by 60-70% (let's assume some appreciation, both to your house and the next one) and keep the payment pretty much the same (and pay that off in 6 years as well.)

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    +1 - having a bigger house is (to me) more trouble than it is worth. More to clean, fix and heat or cool. – MrChrister Dec 29 '10 at 16:35
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    Don't forget maintenance. All the money you have to put into maintenance (on top of your mortgage, don't forget) is money that you are not going to get back (unless you can sell your house for more...) – GUI Junkie Dec 30 '10 at 16:41
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    I find that more rooms = more "stuff" accumulating; if I have a smaller living space I am more conscious of the things I buy and where I need to store them, and keep clutter down to a more manageable level. – Ether Dec 30 '10 at 18:54
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    It isa good point that a physically bigger house can have disadvantages. One of the reasons I would consider it over a smaller place would be for kids. – Andy Fleming Dec 31 '10 at 1:43
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Try the NYT Rent or Buy calculator or a similar rent or buy calculator. Insert the rental numbers and house numbers you'll be using. See how long it takes that smaller house to recoup all costs and be a better financial investment than renting.

Of course the calculator can't magically predict the housing market. If it could, we'd all know what to do with housing. At the same time it tries to give you a full picture of the costs of buying (closing costs on the purchasing and selling end, property tax, all sorts of things most people forget about when buying). That calculator won't take into account HOA/condo fees and maintenance. Maintenance may end up being 1-2% of purchase price yearly over the time you own the home. In my area some condos have higher association fees than my monthly rent.

At the same time, at some point it does make sense to buy in most parts of the US today and in many other parts of the world. Buying gives you all the benefits the Realtors tell you that it does. It just comes with its own costs that they don't tell you about too.

So run the numbers for yourself and see.

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One advantage of buying the smaller house now is that it will help to insulate you against general movements in the housing market - suppose simplistically that the smaller house always costs exactly half the price of the bigger house. By getting the smaller house now, you're only exposed to half the price swings while you save up to upgrade.

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  • A good point. Alternatively, one could put some money into a real estate ETF, and sell just before buying a house. – Daniel Lubarov Dec 9 '13 at 6:17
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OPTION 1:

Initial investment, whatever is the price going on in the market. Then on top of it maintaining the asset in a proper fashion, so as to get maximum returns on selling it. Returns on selling depends on how the housing market fares during the time when you are saving to buy a bigger house. Supposedly the housing market booms, the price of your house goes up, so does the price of the bigger house you are looking to buy. And vice versa too. You have to take into count how much appreciation/depreciation of your current asset and the target asset occurs.

OPTION 2:

Yes you pay rent, but you should see that your initial investment is still with you and you can still earn returns from it if invested in a proper manner. You save on the maintenance and repairs of your house. Supposedly the housing market booms/busts you can decide when to buy, which is a highly valuable option. You will surely try to buy when the prices are lower i.e the housing market has gone bust. Now supposedly you were following option 1, your initial investement has depreciated in value, but you can get a cheaper house, so you take a mortage.

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  • So which is your recommendation? – Andy Fleming Dec 29 '10 at 23:41
  • I would prefer Option2, because I can wait. I am not aware about your situation ? I have lived in California for quite some time, and I can say house prices in California are always going to be higher and immune to a larger extent to the vagaries of the economy, because of the demand. – DumbCoder Dec 30 '10 at 8:25
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Housing is a cyclical market, and houses and mortgages are cheap now, so buying the smaller house is probably a good idea.

The real answer to the question depends on you. Are you likely to want to stay in San Diego? Is your income variable? Can you afford the additional costs (maintenance, taxes, etc)?

Another great thing for a buyer in this awful market is that you have the freedom to choose. When I was house hunting in 2006, even in backwater Albany, NY demand was high and you literally had to be willing to put an offer down within hours of seeing a house.

So look at lots of houses, figure out what you actually want, and buy something that you're happy with. If you like old houses, remember that they will need somewhat more maintenance. If you are choosing between a house in a good vs. not-so-good school district, pick the good one, even if you don't have kids.

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