Author Topic: Case Study - Is it smart to downsize our house now?  (Read 7267 times)

Shop_man

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Case Study - Is it smart to downsize our house now?
« on: March 12, 2014, 09:27:49 PM »
I make 62K a year.  Wife is in school, but will start part time work this fall.  We have 2 kids - 4 and 5.

Three years ago we bought our house for 168k and made 20% down payment.  House is 15 years old, 3 bedroom, 3 bath, and 2400 finished sq ft.  We have refinanced twice to shorter terms with better interest and now have a 15 year mortgage (165 payments remain) at 2.75%.  We have also spent 20K in home improvement projects, most notably a new deck and a large 2nd garage that I use for woodworking.  With the exception of the foundation of the garage I did it by myself, so lots of sweat equity. 

Other debts include 5K car loan at 2.49% and 7K on a 0% credit card.  With our 2014 tax return and savings we can pay off the credit card before we pay any interest charges.

However, there is another smaller 2000 sq ft 3 bedroom house for sale in our neighborhood for 135k.  It is similar in age, but fewer upgraded features (stuff we don't need) and smaller yard.  Has a large enough garage to use for a shop space.  It is no closer to my job (25 min/15 mile commute), but same schools that we moved here for.  In order to buy this house I would have to borrow 40K from my 401K as a down payment on a 15 year mortgage at 3.375%.  The new house will cost us $4900 less a year in payments and taxes. 

Current home would be converted to a bridge loan and interest only 4.25% until it sells.  After realtor fees of 6% we should net 57k from current house to pay back 401k.  We have input 81k in down payments, refinance fees, principal and interest, and improvements.  So it cost us 24k plus sweat equity to live here for 3 years. 

During the transition of paying on two properties we will spend $2250 a month on debt and interest.  That is more than 40% of my gross income, but the bank is OK with it.  As a result I will not pay off the credit card until after the sale of our current house. 

Should we proceed with purchasing this house?  As long as our current house sells in under 6 months we should be fine financially.  Based on our current local market conditions the sale should not be a problem.  My other alternative is to make an offer on the new house contingent on the sale of our current house, but I think I can negotiate a better price without that stipulation. 

Thanks

« Last Edit: March 15, 2014, 03:01:44 PM by Shop_man »

payitoff

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Re: Case Study - Is it smart to downsize our house now?
« Reply #1 on: March 12, 2014, 10:05:10 PM »
i think its a little risky. borrowing from your 401k for a downpayment is already dangerous, what happens if you cant sell the old house? then you will be stuck with 2 mortgages plus a 40k loan.

here's what i can see:
buying new house:
possible 2 mortgages at $2250/month
new $40k loan
maintenance costs
moving expenses
$7k credit card debt
$5k car loan


vs.

staying at old house:
$7k credit card debt - paid off
$5k car loan
401k in tact and growing

its conservative but you dont have to worry about listing your old house, pricing it right to sell quick, if not, find a tenant asap to hopefully cover mortgage and how to pay back 401k loan etc. etc. this will be stress that you can avoid. plus with wife working part time soon, this will end up going into new expenses.  you might want to revisit changing homes in about 5-7 years when equity is much higher then this might be a good option by then. you will still get the $4900/year savings in moving to a smaller home now that wife will be working part time, could be more! good luck.

MattC

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Re: Case Study - Is it smart to downsize our house now?
« Reply #2 on: March 12, 2014, 10:13:31 PM »
Yours is a tough case; I can see either way being justifiable.  At the end of the day, though, if I were you, I would wait some time before making this transition for a couple reasons:
1.  You don't have a lot of financial margin in case something went wrong. 
2.  Re-figure what your current mortgage payments would be if you had 180 payments outstanding (as for the new 15yr mortgage) instead of 165 in order to compare apples to apples.  I suspect that this difference is inflating your $4900 number.
3.  If housing values in your area increase, you'll see greater increase in equity with your more valuable house.  For the 3% average that is being forecast nationwide, the difference would be ballpark 1k/year in favor of your current home.
4.  Also think of how much equity is going to be destroyed in the housing transition (realtor fees, mortgage origination fees, lawyer, loss of earnings from 401k, etc.).  These will take at least a few years of savings to pay off.   

The numbers might work out slightly in favor of moving, however the risk/reward seems kind of high at this point, but I suspect risk/reward for making this switch will get better for you in the future.   

Thegoblinchief

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Re: Case Study - Is it smart to downsize our house now?
« Reply #3 on: March 13, 2014, 06:18:53 AM »
I would only do it as a contingent offer unless your current house would cash flow as a rental (I'm assuming no, since you didn't mention it). Too much risk for not enough reward otherwise.

Mister Fancypants

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Re: Case Study - Is it smart to downsize our house now?
« Reply #4 on: March 13, 2014, 09:27:34 AM »
I make 62K a year.  Wife is in school, but will start part time work this fall.  We have 2 kids - 4 and 5.

Three years ago we bought our house for 168k and made 20% down payment.  House is 15 years old, 3 bedroom, 3 bath, and 2400 finished sq ft.  We have refinanced twice to shorter terms with better interest and now have a 15 year mortgage (165 payments remain) at 2.75%.  We have also spent 20K in home improvement projects, most notably a new deck and a large 2nd garage that I use for woodworking.  With the exception of the foundation of the garage I did it by myself, so lots of sweat equity. 

Other debts include 5K car loan at 2.49% and 7K on a 0% credit card.  With our 2014 tax return and savings we can pay off the credit card before we pay any interest charges.

However, there is another smaller 2000 sq ft 3 bedroom house for sale in our neighborhood for 135k.  It is similar in age, but fewer upgraded features (stuff we don't need) and smaller yard.  Has a large enough garage to use for a shop space.  It is no closer to my job (25 min/15 mile commute), but same schools that we moved here for.  In order to buy this house I would have to borrow 40K from my 401K as a down payment on a 15 year mortgage at 3.375%.  The new house will cost us $4900 less a year in payments and taxes. 

Current home would be converted to a bridge loan and interest only 4.25% until it sells.  After realtor fees of 6% we should net 57k from current house to pay back 401k.  We have input 81k in down payments, refinance fees, principal and interest, and improvements.  So it cost us 24k plus sweat equity to live here for 3 years. 

During the transition of paying on two properties we will spend $2250 a month on debt and interest.  That is more than 40% of my gross income, but the bank is OK with it.  As a result I will not pay off the credit card until after the sale of our current house. 

Should we proceed with purchasing this house?  As long as our current house sells in under 6 months we should be fine financially.  Based on our current local market conditions the sale should not be a problem.  My other alternative is to make an offer on the new house contingent on the sale of our current house, but I think I can negotiate a better price without that stipulation. 

Thanks

Huge mistake, you have a current mortgage with a balance that is well under asking price of the new house, you have already paid to refinance twice which if you sell those become sunk costs. If you sell you are adding realtor fees, taxes title etc. etc. additional sunk cost.

During the transition you will pay a bridge loan with an interest rate of 4.25% for as long as it takes to sell, you are going to borrow from your 401(k), all very risky and unneeded expenses.

And you are doing all of this to downsize into a house with a higher interest rate for 15 months longer than your current mortgage? You haven't stated you monthly payment, so there is no way to determine your breakeven, but since you only have 165 months left on your current mortgage and your new mortgage will be 180 months to make this work financially the difference in monthly payments divided by 15 has to cover the all of the cost, the 401(k) borrowing cost an additional 15 months of mortgage payments.

Since the interest rate is going to be higher and the new house is price so close to the old house it is extremely unlikely that the new mortgage payment is going to be that much smaller than your current payment to allow you to recoup your costs.

So this would be an extremely costly move, you will spend a lot of capital up front, have a longer loan, a 401(k) loan, put off paying back your 0% credit card and have a smaller house... I am looking for the incentive to move? If you think the better cash flow on a smaller mortgage payment is it, you are not looking all wrong.

You have not provided enough numbers to provide a true analysis, so this is really just back of the napkin math, but I can't see how this would work out even with all the numbers... Me I would just stay put.

-Mister FancyPants

Shop_man

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Re: Case Study - Is it smart to downsize our house now?
« Reply #5 on: March 13, 2014, 09:45:24 AM »
Thanks for the insight, you bring up valid points.
 
MattC do you mean what would my current house pay off look like as a new 15 year mortgage at current rates?  I owe 121k on the house, so if I refinanced today that would change the payment to 858 principal and interest.  Currently I pay 882.  New house would be 602 a month if purchased for 125k and 40k down.  So in my current payment it would save me $280 a month plus $1400 in property taxes.  The $4900 was calculated wrong to begin with, it is $4760.  But I still want to understand your apples to apples comparison, can you clarify?

Tonight my homework is to make a spreadsheet to calculate my monthly cost of ownership so far including property taxes which I neglected earlier.  Then forecast that cost of ownership into the future as we pay down the mortgage and the house appreciates.

2wakefulFlea 2250/month includes payment back to 401K, but otherwise you are right.

ShortInSeattle

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Re: Case Study - Is it smart to downsize our house now?
« Reply #6 on: March 13, 2014, 09:50:38 AM »
Why do you want the other house? Seems risky to float both when you've got a nice setup already and you've remodeled it already to suit your preferences.

I guess I don't see the appeal of the move.

Numbers Man

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Re: Case Study - Is it smart to downsize our house now?
« Reply #7 on: March 13, 2014, 10:02:52 AM »
I once borrowed from my 401(k) to buy another home before I listed my home for sale. But that was in a seller's market where I was able to sell my home in 2 weeks. I don't really see why you need to move and incur those soul sucking real estate commissions.

Argyle

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Re: Case Study - Is it smart to downsize our house now?
« Reply #8 on: March 13, 2014, 10:07:58 AM »
Also moving itself is expensive.  Not to mention the disruption and hassle. 

With the two refinances, and now this idea, you keep going through commotions in pursuit of some financial advantage.  Do you get bored or anxious if things are just ticking along? 

I think the most effective thing to do is all the less dramatic, more everyday frugalities — the saving, shopping, eating frugalities.  I bet what got you into the position of buying a car on loan and having $7000 worth of credit card debt is not the expense of your mortgage, but your everyday spending patterns.  Turn those around and you've done the most important thing.  Conversely, you can go through all the expense and hassle of moving to the cheaper house, but if you continue your daily spending as you have done, you'll soon have credit card debt again.  So I vote for turning your attention on the other aspects of spending.

kite

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Re: Case Study - Is it smart to downsize our house now?
« Reply #9 on: March 13, 2014, 10:43:53 AM »
In hindsight,  it is possible to see the exact boneheaded financial move that someone made which unraveled everything.   You're on the verge of one. You can't afford to buy a new home if you need to withdraw 2/3 of your annual household income from your 401k AND simultaneously have a bridge loan.   Don't confuse bank approval with good idea. 

The upside is modest and the downside is gigantic.   

SunshineGirl

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Re: Case Study - Is it smart to downsize our house now?
« Reply #10 on: March 13, 2014, 11:31:42 AM »
Plus, you mentioned the house needs to be updated -- so if you spend another 20K to do that, that's 4+ years of the amount you hope to save each year by moving.

A 15-year mortgage is a great thing - trust you're making good headway on the house you're in, and skip the new house.

MattC

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Re: Case Study - Is it smart to downsize our house now?
« Reply #11 on: March 13, 2014, 10:43:08 PM »
re: comparing a 15-year refi of your current home to the 15-year financing term for the potential new house.

I guess what I was getting at is that you'll have your current house paid off in 165 payments, whereas if you move, you've got 180 payments left.  Making or not making those last 15 payments should have some weight in your decision.  For comparing the two alternatives, I would suggest instead of $882 you use $821 as your current housing payment (for 2.75% interest, 882x165 payments = $821x180 payments).  That reduces the benefit of your move by $730 a year. 

lackofstache

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Re: Case Study - Is it smart to downsize our house now?
« Reply #12 on: March 14, 2014, 07:55:10 AM »
I agree w/ the others that have said stay put. If you're paying back the 401(K) loan + the new mortgage, the difference in monthly expenses will be negligible for the short term. Since it also means you can't pay back other debts and would take longer to pay off the home, I don't see the upside. Couple all those factors in with the fact you're taking on a huge risk w/ the bridge loan, I just don't think downsizing makes much sense in this case.

2527

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Re: Case Study - Is it smart to downsize our house now?
« Reply #13 on: March 14, 2014, 09:44:46 AM »
You have a once-in-a-lifetime mortgage interest rate with the house you are in.  The house you've got right now is not crazy big or unaffordable to you or in a bad neighborhood or in a bad school district.  The house you are contemplating is not a significant improvement on what you have.  Stay where you are and put your mental energy and time into something else.

Shop_man

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Re: Case Study - Is it smart to downsize our house now?
« Reply #14 on: March 15, 2014, 03:42:40 PM »
Thanks for the thoughtful responses.

To be honest 4K of the credit card debt was wasteful unnecessary spending for a family vacation.  The remainder was household expenses that I was letting the CC company float me an interest free loan for.
I only financed the used car to bail out a family member who could no longer afford it due to illness. 

Now that I have confessed.  I'm actually surprised that not one person thought I should go forward with this purchase.  I get it - borrowing from my 401K and shelling out the cash for two properties at the same time is RISKY!  New development in this scenario is that we have some interest in our house by word of mouth alone and might be able to get it sold on our own.  Additionally, after a 2nd look at the new house and some more comparisons it is overpriced.  We would only buy it at 120K or less.  So with these new factors is it a buy, even though we will pay for a longer time?  FSBO should gets us 66K in hand for down payment.  54K loan at 3.375%, 383 a month for 15 years is 69K vs. 147K to stay in our current house. 

Someone asked why we don't want to stay where we are at, since we put money and sweat equity into it.  After living here it is just more space than we need, we have a giant family room in the basement that no one ever uses.  Also this has useless "upgrades" that dazzled us when we bought it.  Cathedral ceilings (empty space to heat) and an unused two person jacuzzi tub (needs at least 120 gal of hot water to fill) that are inefficient.  The other is house is more basic that will meet the needs of our family and to me was ideally mustachian. 

Mister Fancypants

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Re: Case Study - Is it smart to downsize our house now?
« Reply #15 on: March 16, 2014, 11:36:11 AM »
Thanks for the thoughtful responses.

To be honest 4K of the credit card debt was wasteful unnecessary spending for a family vacation.  The remainder was household expenses that I was letting the CC company float me an interest free loan for.
I only financed the used car to bail out a family member who could no longer afford it due to illness. 

Now that I have confessed.  I'm actually surprised that not one person thought I should go forward with this purchase.  I get it - borrowing from my 401K and shelling out the cash for two properties at the same time is RISKY!  New development in this scenario is that we have some interest in our house by word of mouth alone and might be able to get it sold on our own.  Additionally, after a 2nd look at the new house and some more comparisons it is overpriced.  We would only buy it at 120K or less.  So with these new factors is it a buy, even though we will pay for a longer time?  FSBO should gets us 66K in hand for down payment.  54K loan at 3.375%, 383 a month for 15 years is 69K vs. 147K to stay in our current house. 

Someone asked why we don't want to stay where we are at, since we put money and sweat equity into it.  After living here it is just more space than we need, we have a giant family room in the basement that no one ever uses.  Also this has useless "upgrades" that dazzled us when we bought it.  Cathedral ceilings (empty space to heat) and an unused two person jacuzzi tub (needs at least 120 gal of hot water to fill) that are inefficient.  The other is house is more basic that will meet the needs of our family and to me was ideally mustachian. 

If you can sell your current house first and than use the proceeds to first pay off any interest bearing debt regardless of it was helping a family member or not (CC debt is CC debt).

Then with a down payment buying the cheaper house is practical. You then have a smaller principal balance so even though the rate is higher and term is longer the total amount due will be less. You will have no other debts especially no new  401(k) loan. So if the new house is more accommodating to your needs than this is the way to go.

As to being surprised no one thought your previous idea was Mustachian, go back and read all the comments.... You had planned on taking on huge amounts of risky debt with no financial upside simply for something you wanted but didn't need... Regardless of the fact that the want was a smaller house and you thought that was Musthachian, wanting the unattainable was the problem and trying to hack it and rationalize a way to make it work. It's no different the buying an SUV on credit hoping next years bonus will pay it off.

-Mister FancyPants

capital

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Re: Case Study - Is it smart to downsize our house now?
« Reply #16 on: March 16, 2014, 03:05:58 PM »
The move you're thinking about is a good idea overall, it's just incredibly risky right now due to the sum of your circumstances, with your family having a single income and no savings. Sometimes simple living is about managing risk, rather than selling things you don't need off.

What happens your employer gets bought out or the local economy slows down, and you have a house that won't sell, a layoff notice, and the 401k loan called in? The worst case scenario for your plan is pretty bad, for a relatively modest upside that seems like it'll still be available a couple years from now.

Is there any reason you won't be able to make the same move in a couple years, when you have two incomes and a lot more savings?

Or, if you want to make the move now, can you sell your current house and find a short-term rental if necessary while shopping for a better house?

iris lily

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Re: Case Study - Is it smart to downsize our house now?
« Reply #17 on: March 16, 2014, 03:18:24 PM »
...
Someone asked why we don't want to stay where we are at, since we put money and sweat equity into it.  After living here it is just more space than we need, we have a giant family room in the basement...Cathedral ceilings... jacuzzi tub ...

Ok so you have more house than you need. That's fine, cut off those unused space. Don't fill the damned Jacuzzi tub. Live as though you are in less square footage.

I will say that is seems to me that psychologically NOW would be a better time to downsize given the age of your children than later, when they are teens. If you do it now they will be accustomed to more family togetherness in a smaller space when they are at those difficult ages.

But that's just one factor. The overwhelming evidence has been presented upthread that now is a bad time for you to make this move, a bad time financially. Don't do it.