Why You Should Buy the Least Expensive House You Can Afford

February 4, 2014

less expensive houseThe housing market has changed a lot in just the past few years. The old philosophy of buying the most expensive house you can afford has become obsolete. There are far more advantages to buying the least expensive house you can afford.

Consider some of the following . . . .

Lower Down Payment and a Lower Monthly Payment

Every expense and cash outlay that you have in connection with a house rises and falls with the price that you pay to purchase it. That includes your down payment. For example, if you purchase a $300,000 house, and need a 20% down payment, you’ll need to have $60,000 upfront. But if you opt instead for a less expensive house, say $200,000, your 20% down payment will be only $40,000.

That will leave you with $20,000 extra after closing on the home. This is more important than it seems on the surface too. The down payment that you make on a house can be thought of as trapped equity. That means it is capital sitting in the property, but unavailable for other purposes.

The same is true with expenses. A higher-priced home will result in higher property taxes and insurance, and if the house is also larger, you’ll have commensurately higher utility and maintenance costs.

One of the fundamental problems with both the down payment and the monthly expenses in regard to higher-priced homes, is that you essentially locked them in at the time you purchased the home. There will be no opportunity to lower those expenses after the fact.

More Money for Living Life – Avoid Being ‘House Poor’

The more money that you have tied up in the house – whether in the form of a down payment or a high monthly payment – the less you will have available for everything else in your life. At the extreme, a high-priced home could lead you to be house poor – owning a nice home, but having little room in your budget or your bank account for anything else.

That can be a tough way to live, especially if it develops into a permanent arrangement. The best way to prevent it from happening is to buy on the lower end of your range of affordability.

More Money for Savings and Investments

Many homeowners and would-be homeowners confuse a house as an investment. While a house certainly does have certain qualities of an investment, or at least it did up until about 2006, it’s more of a place to live than anything else. The investment angle has largely been used by the real estate community – and by overzealous home buyers – to convince themselves to shoot for the works and buy the most expensive house they can. After all, if it is an investment, why not just load up on it and make a bigger “profit?”

The primary issue with this kind of thinking is that it violates one of the first rules of investing: always diversify. While owning a house can be a good investment, you should never pour most (and certainly not all) of your money into it. If you do, you’ll have little left over for more traditional investments.

Keep your investment in your home at a reasonable level, and be sure that you will have enough cash and extra income after the purchase to also invest in stocks, fixed income securities, and other investments. Keeping everything in your house is not a very good investment strategy.

A Mortgage That Can Be Paid Off Quicker

The less expensive that your home is, the lower your mortgage will be as well. This is important because the objective with a mortgage should always be to pay it off as soon as possible.

In recent decades, homeowners have overemphasized price appreciation as the primary investment return on their homes. But mortgage amortization and an early payoff can provide even bigger returns, especially in a flat or declining real estate market.

Whatever price level you are buying at, you should always have a credible plan to pay off your mortgage ahead of schedule. There is a strategic component to this plan as well. As we now know that real estate prices can fall, paying your mortgage ahead of schedule is more important than ever. Generally speaking, it’s not falling house prices that hurt homeowners nearly as much as declining equity. The best way to avoid that trap – in fact, the only way you have any control over it– is to accelerate paying off your mortgage.

That will be much easier to do on a lower-priced home, one that is beneath your maximum financial ability.

You’ll Take Less of a Hit if Property Values Fall

Let’s spend a little bit more time on this issue of declining house prices. By example, Homebuyer A buys a house for $300,000; Homebuyer B buys a house for $200,000 in the same community. In the next three years, property values in their community decline by 10%. Which homeowner will suffer the greater loss in both property value and equity?

Answer: Homebuyer A. The 10% decline in the value of his house resulted in a $30,000 loss in equity ($300,000 x 10%). Homebuyer B suffered only a $20,000 loss in equity ($200,000 x 10%).

Some would argue the inverse – that Homeowner A wins in the event that values rise by 10%. He gets a $30,000 gain in property value and equity, while Homeowner B gets only $20,000.

But in the event property value rise, both homeowners come out ahead – it’s a win-win. Losses, on the other hand, tend to be felt more acutely, especially when home equity is thin to begin with.

And if Homeowner B bought a less expensive house than he could afford, he’ll better be able to weather whatever financial consequences result from the decline in property values. Remember that just a few years ago a lot of homeowners were in a crisis situation because their homes were “underwater” – the property was worth less than the outstanding mortgage balance. That’s a situation that you should want to avoid at all costs, and the best way to do it is to buy the least expensive house you can afford.

Can you see any logic in buying the least expensive house you can afford? Leave a comment!

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Kevin

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Kevin
Kevin Mercadante is professional personal finance blogger, and the owner of his own personal finance blog, OutOfYourRut.com. He has backgrounds in both accounting and the mortgage industry. He lives in Atlanta with his wife and two teenage kids and can be followed on Twitter at @OutOfYourRut.

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4 Responses to Why You Should Buy the Least Expensive House You Can Afford

  • Tim Mobley

    Great points! It is important to remember that while real estate is indeed an investment, it is a highly illiquid one and most homeowners are reluctant to liquidate due to emotional attachment to the home.

    • Kevin Mercadante

      Yes Tim, the “ATM” that houses had become in the 90s and early 2000s with home equity lines, made real estate seem more liquid than it actually was. It’s a long term investment and has to be owned and managed with that in mind.

  • Mortgage Free Mike

    When people ask me how I paid off my mortgage in 2 years, the first thing I tell them is that I made the decision not to be “house poor” from the start. Sure, I could have spent 3 times what I did, but I saw the bigger picture. I still live in a great building in a desirable neighborhood. When shopping for a home, my Realtor pushed me to get prequalified for the maximum amount. I pushed back. In fact, I waited until I found my dream home to get prequalified to avoid the temptation of spending too much.

    • Kevin Mercadante

      Hi Mike – You did it right. You took control of the deal, rather than getting caught up in the excitement and letting the agent take over.

      Real estate really is an excellent investment IF you buy smart. Many people don’t and end up getting burned. That explains why so many people got hit during the 07 – 09 meltdown. They either paid too much for the property, took an NIV loan and didn’t really have the income, or used the house as an ATM.

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