The Opportunity Cost of Buying a House that is Just Too Big
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This article was written for my 3 children to hopefully read someday when they are starting down their road to financial independence. It is also for anyone out there that may be thinking of buying their first home.
I am of the opinion that there are plenty of benefits of owning your home … as opposed to renting. The math certainly doesn’t make any sense and buying a house is almost never a good investment … but there is something to be said about owning your own place. Especially when you are raising young children.
My wife and I have been raising our family in the same home for the past 10 years … paying our mortgage every month, along with insurance, taxes, utilities, and the list goes on.
And despite all those expenses (mortgage, insurance, taxes, etc.), we have made some wonderful memories with our family living in a house that we will never forget.
Buying a House that is Too Big
We prefer to own instead of rent … but that doesn’t mean we made the best financial decision when we decided to purchase our house over a decade ago.
If we could go back … we wouldn’t have bought such a large home.
My goal is not to steer you away from ever buying a home. I couldn’t imagine raising a family in anything other than a house you can call home.
But what I want you to really understand is that buying a home that is too big can be a horrible financial decision.
Take for example the two scenarios I have provided below. The first scenario is an example of buying a home that is bigger than what you need. This is actually the house we bought. The second scenario describes a hypothetical home that is smaller and cheaper … but still can provide for the needs of our family.
Scenario #1 – The Larger Home
In the first scenario, let’s look at buying a house that is too large … or the house that my wife and I purchased 10 years ago.
Here are a few details on house #1 –
- Total Square Feet – 3,362
- Purchase Price – $280,500
- Price per Square Foot – $84
We bought this house with a 20% down payment of $56,100 and mortgaged the remaining $224,400 for 30 years at 4.375%.
Our monthly mortgage payment on this home is approximately $1,120. This payment covers principal and interest only … as we decided to manage our own escrow for the home.
Scenario #2 – The Smaller Home
After living in our home for almost a decade, I have come to realize the house is about 1,000 sq. feet too large … with over 650 sq. feet that hardly ever gets used. There are two rooms that make up that 650 square footage that we rarely use and a lot of extra space in other rooms that is underutilized.
Looking back, we could have easily purchased a house for our family of 5 (two adults and three children) that was 2,500 square foot and still lived very comfortably. Honestly, a 2,000 square foot home probably would have done just fine too.
For scenario #2, aka the “smaller home” … let’s assume we could have purchased a 2,500 square foot home … which is about 862 sq. feet smaller than the larger home. Again, I probably could have figured even smaller, but then we would be talking about living in a different neighborhood and the pricing may not be equivalent.
At the time we purchased our new home in our neighborhood, brand new houses were selling for $85 to $90 a square foot. We actually got a pretty good deal negotiating down to $84 a square foot at the time.
Here is what a hypothetical smaller home would have looked like –
- Total Square Feet – 2,500
- Purchase Price – $225,000
- Price per Square Foot – $90
Note – I like to figure high in these back of the envelope types of calculations, so I went with $90 a square foot on the smaller home.
Let’s assume we bought this house with a 20% down payment of $45,000 and mortgaged the remaining $180,000 for 30 years at 4.375%.
This would have made our monthly mortgage payment $899, which would cover principal and interest.
That is about $220 less per month for the smaller home … which may not seem all that significant … but over 30 years it is huge!
Opportunity Cost of Buying the Larger Home
Saving $220 every month on a mortgage over the course of 30 years … is a really big deal. Buying a slightly smaller home that covers the same needs as a larger home would have been a game changer.
The opportunity cost comparing both scenarios above turns out to be a ton of money over the life of a 30 year mortgage. If we opted to buy the smaller home, our down payment would have been smaller by $11,100. That is a big savings of cash right there.
Let’s assume we invested that $11,100 in an index fund instead of putting it towards a home. And then there is that extra $221 each month that we would be saving that could also be automatically invested in that same index fund.
Over the length of the 30 year mortgage, we could have invested the savings and ended up with $422,985.17 instead of buying a larger home … of which we don’t really need.
Here is a look at the details –
- Starting Amount – $11,100 (down payment)
- Length – 30 years
- Average Return Rate – 8%
- Monthly Contributions – $221
This is just some back of the envelope math … but the significance of buying a slightly smaller home over 30 years is huge! We are using an 8% average return each year as an estimate (probably could be higher).
Total Profits After 30 Years – $422,985.17
Heck, if we would have bought a 2,000 square foot home at $100 / square foot, our mortgage would have been $799 a month. With that type of savings compared to our larger home, we would have an extra $615,000 invested.
We Still Like Our Home
I don’t want to say that we are stuck in our home. We could certainly put it on the market tomorrow and sell it for more than our purchase price. But that doesn’t mean it was a good investment or we would make any money from it.
If I were to add up all the costs of owning our home (including mortgage payments) … we would have spent more money on it than what we would get back from the sale.
But that doesn’t mean owning a home (for us) was a bad thing. My wife and I love owning a home a raising our family in it. The thought of renting a place to raise our family just doesn’t work for us … but it might for some.
The one thing we do regret however is buying a house that was just too big. We could have theoretically bought a slightly smaller home and invested the difference. This small little step could have pushed our total net worth up by almost $500,000 over the course of a 30 year mortgage.
So my lesson today … when buying a house … please consider buying one that is below your means.