Buying a Home? When to Think Small


Recent reports from the housing industry show that sales of homes priced at more than $750,000 are sinking, while the market for less expensive homes is getting better. This two-faced market is a lesson in the perils of buying too much home.

In fact, one can get richer faster by keeping the home purchase as modest as possible and investing the savings elsewhere. High-end homes are suffering because it’s harder and more expensive for borrowers to get “jumbo” loans, or those exceeding $417,000 to $729,750, depending on the location.

The average 30-year fixed-rate “conforming” mortgage charges 5.364%, according to the survey, but jumbo rates tend to be higher.

Wells Fargo (Stock Quote: WFC), for example, offers a conforming 30-year fixed loan for 5.25%, but charges 6.25% for a jumbo loan. Jumbo borrowers are often asked to make larger down payments as well. Use the shopping tool to find the best deal.

Sales of cheaper homes have been spurred by the $8,000 federal tax credit for first-time buyers. Also, the flood of foreclosures has hit the low end of the market harder, creating a lot of bargains that have spurred sales.

Another likely factor: The low end of the market has more potential buyers, since wealthier buyers can cut their spending limits. At the high end there aren’t as many people to begin with, and there’s not a large pool of people who are even wealthier that can step down.

Finally, conspicuous consumption seems to be a bit passé, at least for now. People feel less need to own homes with multiple guest rooms or formal living and dining rooms that are rarely used.

Whatever the reason, choosing a more modest home generally makes sense over the long term. Home values typically rise at about 1 percentage point above the inflation rate, while stocks tend to return 6 or 7 percentage points more than inflation. By opting for a more modest home, you can build a nest egg faster, or have extra money to spend on other things.

Look, for example, at the choice between one home for $500,000 and another for $350,000, each with 20% down.

At the Wells Fargo rates for 30-year loans, monthly payments would be $2,463 for the bigger loan, $1,546 on the smaller one.

A buyer who chooses the cheaper house and invests the $917-per-month difference at 7% a year would have about $158,000 after 10 years, according to the Savings, Taxes and Inflation Calculator. In addition, that buyer could invest the $30,000 saved by making a smaller down payment. It would increase to $59,000 over that period. Total gain from lower payments and down payment: $217,000.

If homes appreciated at 4 % a year, or 1 percentage point over the average inflation rate of 3%, the $500,000 home would be worth about $740,000 after a decade. Subtracting the $336,950 still owed on the mortgage, that’s a net gain of about $403,000.

After the same period, the $350,000 home would be worth about $518,000. With $229,455 still owed, that’s a net gain of $288,545. That plus the $217,000 investment gain produces a total 10-year gain of $505,545, about $100,000 more than if the more expensive home had been purchased.

In real life, the cheaper home would surely be even more profitable because taxes, insurance and maintenance costs would be lower as well. There might be a larger tax deduction for interest expense on the pricier home, but not enough to offset all the other advantages of the cheaper property.

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