Bajtelsmit Column: Buy a House Now or Later?

Note to Reporters: Vickie Bajtelsmit is a finance professor in the Colorado State University College of Business and the author of three personal finance books.

With unemployment still high and the economy thus far insufficiently stimulated by the federal stimulus, home sales are not where they have been in years past. However, real estate professionals in Fort Collins have seen some glimmers of hope with spring and early summer sales. Sellers have reduced asking prices and buyers have benefited from mortgage rates that are quite low by historical standards.

One of the principles of investing is that you should ideally “Buy low and sell high”.

Unfortunately, we are in what’s called a “buyers market” and many home sellers may be in the position of having to do the reverse. If you don’t have to sell, this certainly isn’t the time to be doing so.

I am happy to have recently found a buyer for the house I own with my ex-husband and, like most sellers, we thought it sold for less than it was worth. But I’m hoping to make up some of my “loss” by getting a bargain price on the purchase of a new one.

So now the big decision is what to buy. My quandary is whether to buy for now or for later. I could live in something older and smaller for a few years, save my money, waiting to buy a nicer home later. Or I could try to buy the future home now. This decision is similar to that of a couple planning to have children, or a family with young children anticipating the need for more space for teenagers.

This decision requires some serious cost benefit analysis. In the absence of a real estate market downturn, the benefits are primarily about lifestyle—having a better home sooner. With a depressed housing market, you may also benefit from getting the more expensive home at a discounted price relative to what it might be when you actually need it.

On the other side of the scale, you need to estimate the incremental costs of the more expensive home, the amount in excess of what you would be paying for the smaller one. That should include additional after-tax mortgage interest, property tax, insurance, and maintenance costs as well as the opportunity cost on any additional down payment you must come up with. If you borrow more than $417,000, you’ll also have to pay a jumbo loan mortgage rate which is about 1 percentage point higher than conventional mortgages.

As a simple example, suppose you anticipate needing the “family home” in five years but are fine with living in a small townhome now. Assume the total incremental cost of buying the larger home sooner rather than later is $5,000 per year after tax, or $25,000 over five years. At a compound growth rate of 5 percent per year, a $250,000 house will appreciate about $27,000 more than a $150,000 residence will over the five years. And, as an added bonus, you’ve gotten to live in the nicer house all that time!

Of course, a prerequisite for this decision is that you be able to afford the larger home now. We all know the consequences of people getting in over their heads in real estate. Add to that the uncertainty of the real estate market and the economy in general and you may conclude its better just to be a renter. If so, I hear my landlord may have a nice house for rent pretty soon.