In the budget series, we discussed housing as an item. Let’s revisit the housing discussion. It’s not clear a house is always better but this time we are assuming you have decided to buy a house. Let’s further assume you are a young couple (or individual). What kind of house should you buy? I’m going to make the argument that the old idea of a ‘starter home’ is something we should come back too. That’s a cheap, small, modest home that you can easily afford now, not what you can ‘stretch’ to afford or that includes things you might need down the road.
First, let’s look at some of your decision points.
- How big a house do you need?
- How big a yard do you need?
- What school district?
- What neighborhood?
These decisions will be influenced by other factors in you life, such as:
- Do I have or want children?
- What will the commute be?
- What lifestyle will I want?
People weigh some of these factors more than they probably should. For example, the job. You should think about the location with regards to more than your current job. The average employee is only with the same company 3-5 years, so your commute may change. Other factors such as access to amenities you and your family need or enjoy is probably more important. The school district basically doesn’t matter unless you already have children old enough to be attending school. If you don’t have kids yet, you have at least 5-6 years before the school matters, maybe more. And things may change in that time. Ditto for the yard – don’t necessarily place a high value on a large park or big backyard, unless you have kids old enough to be using a large space. A smaller one may do. I need to speak against a common argument here – some people will say that things like a good school, neighborhood, or similar increase the resale value. This is true. But it also increased your purchase price by the same amount, so it is always a wash. It shouldn’t tempt you to buy more than you need to or can afford.
The gist of this is that you should mostly base your decision on the house that supports what you need right now. This will save you from making trade-offs you didn’t need to make. You should then look for the cheapest house that meets your needs. Let’s consider a specific situation.
My wife and I do not have children, but want to have them. We work remotely, so the commute is not a problem, but we do want relatively easy access to groceries, amenities, and the outdoors. My wife is also an avid cook and wants a well-laid out kitchen. So what kind of house do we need? A typical answer might be to buy a 3-4 bedroom house with a yard, in a good school district, and not too far from the amenities of the city. A nice suburban house in other words. After all, we want kids, so why not plan ahead?
I would argue that this isn’t so clear cut. There are too many unknowns here. How long will it take us to have kids, assuming we can at all? How long for them to grow up enough to really take advantage of a large yard? How long before school? Will we decide to put them in the public school, or home school, or private school? Realistically, even if my wife gets pregnant tomorrow, it is at least a few years before the kids will start any kind of school or be running around the yard by themselves. It is at least that long until children will have a credible claim on needing separate bedrooms, especially if successive children are the same sex.
All of which means we only need a 2 bedroom, or at most 3 bedroom, house for the next 3-5 years. The yard might not be that important, and the school district certainly isn’t. So maybe this can be had for cheaper than the all-in suburban house. Let’s say that a house or condo that meets our needs right now can be got for $200,000, while the big suburban house is $350,000. We live in the Midwest, so adjust upward for your area, but the following points will stand regardless.
Going the route of a 3-5 year house will bring several advantages.
- First, the cash flow is greatly improved. Assuming we put down $50,000 on both, we will pay $1,000 vs $1,912 monthly for the 30-year mortgage. That means nearly an extra $1,000 every month that can be invested now, and getting money in an index fund <link> as early as possible is the most important thing in investing.
- Second, the amount of work we have to do now is reduced. It’s easier to clean and take care of a smaller place, and we’ll hopefully be dealing with young kids into the bargain. It’s also harder to fill a small space with useless crap, which may save us more money on the consumer front.
- It gives us time to better figure out what we will need next. We look at it as a 5-year hold-and-reevaluate plan. In five years, we may have a kid or two, and we’ll have a better idea of a lot of things. Would a yard make our lives better, or will a nearby park do? Are we having more children? How long until they need their own rooms? Will they go to public, private, or home school? All of these questions will be much better answered by experience rather than trying to buy our way into the perfect solution now.
So what happens if you get the smaller house, and you do need to upgrade in five years? Well, in that time you’ve added about $35,000 in equity to the smaller house. You could even have been paying slightly more, and still have had a better cash flow than paying for the big house originally. Which means if you move you can now make a bigger down payment on the more expensive house, and pay less in mortgage than you would have if you’d bought the biggest in the beginning with your $50,000 down payment.
In other words, if you want to own homes, I think embracing the idea that you will switch often and paying for only as much house as you need at the moment will help you financially. It will let you invest more in other areas earlier (remember the home itself is not an investment), and pay less in mortgage payments along the way. And if things go badly and you are forced to move in a downturn, having a higher percentage of equity in a cheaper house will be safer for you, because at least you will be less likely to go underwater.
I’m thinking of it like a ladder. I’m taking one step at a time when I need to, instead of charging straight up it as fast I can. I’m less likely to fall that way.