# How does 'upgrading' from one house to another work?

Consider this scenario.

For a given neighborhood, a small house is \$100K. A big house is \$150K.

For simplicity, assume that you purchase the small house with all cash. 5 years later, it is now worth \$300K. So you sell it and make a \$200K profit. "Great, I can buy the big house now!" Not so fast. The big house also tripled in value, just like the small house. So the big house is now \$450K. You only have \$300K. In fact, you are even further behind what you need to buy the big house for all cash. You were originally \$50K behind, but now you are \$150K behind.

Upgrading seems like it works only when the market of the house that you are selling behaves significantly differently than the market of the house that you want to upgrade to.

• You don't hear people talking about it because most people are not that bright, they focus on the big new house and forget all the middle steps. If you talk with someone in finance, they will go over how upgrading can be both advantageous and risky. No one wants to talk about loosing \$5,000 in Vegas, but people love to talk about winning \$50 in Vegas. Commented May 5, 2016 at 17:34
• There's a story (maybe Mark Twain?) about a man in a mining camp who started a rumour about a big gold strike in Hell. Pretty soon everyone in town had left for the new diggings, so he figured there must be some truth to the rumour, and went too. Commented May 5, 2016 at 17:35
• You don't have to upgrade within the same neighborhood (or town), and just because a house is larger doesn't mean that it's proportionately more expensive - maybe it's older or in worse condition, maybe it has a smaller yard or is right next to a busy road. There are way too many factors to consider in an "upgrade" to boil it down to a simple equation. Commented May 5, 2016 at 19:59
• Your example has enough unrealistic assumptions to make it not especially useful. The biggest problem is the houses tripling in value in 5 years. Even in the hottest markets at the height of the bubble I don't think they grew that fast. Over five years you can basically ignore inflation and/or the time value of money; however over the time frames it would take a house to triple, those factors make a large enough difference that they can't be ignored. Commented May 5, 2016 at 22:10
• Your example Chris, is completely correct. Most people are "totally silly" about Real Estate. Essentially what you're observing is that price growth doesn't "get you anything" (unless you're moving away to a totally new cheap areas). (note - this is precisely why people move away to totally new cheap areas when they retire.) Basically you're right. Note that you have not considered the leverage aspect, explained well in an answer. Tax is also critical in every real estate consideration. Commented May 6, 2016 at 16:18

What you are missing is "leverage", which is the typical case for real estate purchases. Buyers usually only put a percentage of the cash down, not the whole amount. So instead you have something like this:

Year 0: Buy \$100,000 house for 10,000 down. \$10,000 equity, \$90,000 debt.

Year 5: Sell house for \$300,000. Even if the debt was not payed down and ignoring fees/expenses, that means you have \$210,000 in cash at sale. 300,000 sale - 90,000 debt = \$210,000, so 200,000 profit out of your starting 10k in cash.

So, let's say the \$150,000 house also tripled to \$450,000. When you first bought you could only obtain a \$90,000 loan with your \$10k cash, but at the same 90% loan-to-value ratio \$210,000 could now secure you a house costing \$2.1 million. That's leverage in action. You could also put all the cash down on the expensive house and it is now available to you with a ~50% loan, whereas previously it could not be purchased at all.

Note that the "upgrade" still increases your debt and overwhelms your equity, so you go from being up 200k after the sale to being in debt by millions after the purchase, and it also increases your expenses. This is why this is a dangerous game. If your plan was to "upgrade" again at year 10, or at least cash out and enjoy being a millionaire, what if house prices fell, flat-lined, only grew very slowly - and something happened to your income and you couldn't keep up those huge debt payments?

If things go as planned, though, leverage is what delivers the theoretically big upgrade. House prices grow by a percentage of their value - regardless of the percentage of the value you have in equity at the beginning, and regardless of how big the theoretical loan is. If housing prices increase faster than the yearly interest (which is certainly not guaranteed!) you pay on the loan, every year is a paper profit and your buying power increases.

In fast-growing housing areas, this was what created the "property ladder". You bought a house, and in a few years it was worth vastly more - and your income was probably higher now, because the economy was booming. So you bought a bigger, fancier house and in a few more years sold that too (or just refinanced) and bought another. 20-30 years of regular living produced millions in profits once it was time to sell the great big house, downsize, and enjoy your retirement. This has lots of assumptions - from higher income to fast growing housing markets, to employment stability, ease of selling or refinancing, etc. Don't assume what works on paper necessarily will work in practice!

• +1 for helpful and insightful. The sentence "wipes out your equity position" is a bit off. The percent drops, but the equity isn't lost save for a bit of expenses. Commented May 5, 2016 at 15:36
• I'm confused, so sorry if this comment seems obvious, but on the purchase of the \$100k house, shouldn't it be \$10k equity and \$90k debt? why is the \$10k down gone? Commented May 5, 2016 at 15:39
• Ok, so just for fun I ran the numbers... assuming Zillow's overly optimistic numbers are correct, I took our net equity, kept the payment the same (which is optimistic since property taxes and insurance would go up on a bigger house), calculated how much of a loan we could afford, added the equity, and... we could get house costing 1.5% more than ours is currently worth. Despite having over 5x the initial equity due to appreciation!
– user12515
Commented May 5, 2016 at 18:00
• @user1477388 300% appreciation is the hypothetical posed by the original question. It is not intended to be a realistic scenario, but to illustrate a general concept. Also your "\$10k to \$300k" should read "\$100k to \$300k". \$10k was the down payment; 300% appreciation multiplies the original value by 3 not 30 nor 300. Commented May 6, 2016 at 18:47
• @user1477388 300% isn't that high over a longer period of time, so to make it more commonly realistic we'd probably need 10-20 year time frame. However, if the local market experienced high appreciation (a big housing development came in, a big company announced huge expansions and new high paying jobs nearby, etc), then the short time period isn't quite so unusual - especially during boom times. It's helpful to remember real estate is a local market, and national averages don't mean much. I've seen real estate double in value over 3 years, then fall to less than it was originally within 2. Commented May 6, 2016 at 23:09

there are a lot of factors involved in your scenario, but basically you are right: the only way to "upgrade" your house, is to spend more money.

more specifically, your scenario strongly reflects the interaction between 2 principles: inflation and debt. inflation drives up the nominal prices of everything. so most house prices go up, and most salaries go up too. debt on the other hand tends to go down over time (assuming you make payments on time, and don't refinance). so, over time, you will build up equity in your home (equity equals house value minus debt). you can use this equity as a down payment on a new larger home. this larger home will come with a larger monthly mortgage payment, reflecting both inflation and the cost of "upgrade", but hopefully your salary has increased at least as fast as inflation. also, most people's salary outpaces inflation until they reach 30-40yrs old.

side note: urban property does tend to increase in price faster than rural property. so in theory, you could ride the development wave by buying houses on the edge of the city. that would however be a very speculative investment, so i would recommend against it.

• Note that increasing property values are not just a function of inflation. Normally, real estate actually appreciates in real terms over time, since the number of people demanding land is increasing, but the amount of land available is not. If the population in an area starts decreasing over time, the opposite will likely happen (that is, real value of the property will probable decrease) for the same reason. Commented May 5, 2016 at 19:05
• @reirab i share your intuition, but have been unable to support it with empirical evidence. while median US home prices have gone up slightly in real terms over the last few decades, that trend disappears once you adjust for square footage. adjust for energy efficiency too and it can go negative. but then, adjusting for inflation is a perhaps the least scientific branch of a field of questionable scientific rigour (economics). in any case, it is moot to the question at hand if you assume all house prices in an area move proportionally. Commented May 5, 2016 at 19:19

I think you're missing the focus on "monthly payment" that most people have to some degree, aside from the fact that virtually no one will pay \$100K in cash for a house...

Take this more plausible scenario... A family buys a house for \$165k, and puts 10% down. Their monthly payment on a 15yr mortgage is \$1100. They pay on the house for 6 years, and their principle balance is now \$100k.

The house is now worth \$300k, so they have \$200k for a down payment on a new house. Careers have progressed, and they decide they can afford a mortgage of \$1800/month. They can buy 450k house with a loan amount of 250k and their monthly payment will be \$1800. Without that large down payment (upgrade), they would only be able to get a house in the \$270-\$280 range for the same monthly cost. They just got a huge upgrade for a slightly larger payment.

This of course simplifies the added expense of taxes and insurance on a larger house, but the fact remains that your increasing equity allows you to get a bigger house for your monthly payment as you "upgrade" over time... as long as home prices don't go down...

I find this to be one of the mysteries of buying houses.

Let me say that I find buying a house a poor choice for investment. That's just my opinion though and many will disagree. Just want to make that clear so you can pick out the bias.

First you buy your 100k house and lets say you got "no down payment". Next you pay off the debt down to 50k. Now the house's value at sale is 300k. So you now have a fat bank account worth 250k, and no debt. Your "upgrade" is now worth 450k, but hey you have 250k to make a down payment.

That's the general logic. The problem is exactly what you state, when you buy the 450k house, your actual value drops* to -200k. And you have 200k in debt. You have gained, in theory 250k in equity in your new home, but you also have a larger debt. 200k v.s. your old 100k or 50k.

Obviously this pattern lets you buy a larger house, but it also puts you in more debt, and gives your fewer liquid assets (payments on 200k are going to be more then on 100k). In many cases it creates a "I want it now" illusion where your trading your long term security for an extra large living room.

All that said, it's the increase in buying power and equity that you focus on. That's what growing. Your actual worth, is not growing in this scenario. After a time you will have more "worth" because you have paid off the debt, but your worth will not increase from day 0 to "house upgrade" until after your debt is below 100k on the new house.

When it is a good thing

Usually, when someone did this historically it's because their family situation changed, and they needed more room. These days we have a tendency to this "just because". This is a good path to go down if you actually need the extra room/space/whatever. However there are usually better alternatives. Can you expand your current home for less then 200k? What about remodeling?

This is also a decent way to build equity and credit. Your 90k loan, once payed off only shows that you can pay a 90k loan. A 450k Loan payed off looks better. Your 90k house has a max equity of 150k, 450k is larger then 150k.

Big things to remember

This is a terrible thing to do, if your trying to make money. A lot of people seem to think that this is great way to make money and they will just keep flipping houses till there selling McMansions. Those people file for bankruptcy more often then not.

The housing market goes up and down. Just cause you bought at 450k doesn't mean it's going to stay there. Land (not houses) goes up in value over time because we can't make more of it. But it's a long game plan. Decades or centuries. A 5 year spike is nothing. There are also HUGE other factors like neighborhoods going bad, or land forming sinkholes or such that makes it unlivable.

• I have no idea what work to use here but essentially, the idea is you still owe 200k in debt and have 0 in liquid assets, with 250k in the house as equity. You don't gain any real money, just debt.
• You are not using net worth correctly. Your net worth should be 250k, with 200k of debt and 450k of assets. Commented May 5, 2016 at 22:02
• I tried to clarify, the point is that you had 250k in "value" before the upgrade and now you have 250k in "value" + and additional 200k in debt. Commented May 5, 2016 at 22:44
• No, you had 250K in "value" before the deal, and 250K in "value" after the deal. The 200K in debt is offset by the 450K value of the asset, which nets out to 250K. Commented May 7, 2016 at 12:22

This falls under your "when the market of the house that you are selling behaves significantly differently than the market of the house that you want to upgrade to" criteria.

You forgot to consider another major effect you can see in action across the US: urban(suburban) sprawl. If you were fortunate enough to own a home that tripled in value, you are probably now living in a dense area close to the city. So what now? Hop on the freeway, head about two exits out of town, follow the lineup of homebuilder signs, and all of a sudden what you sell your house for can buy you three times the square footage! All you have to do is trade house size/amenities for location.