The following is a very interesting guest post from Jumping On The Path To Prosperity. I'm sure many of you reading this will have some quite strong comments about what he's suggesting. ;-)
This is a fascinating question with a far more complex analysis required than appears on the surface. Right up front you need to know that I am talking about your personal residence – not an investment property. An investment property needs to be tied to the needs of your potential renter and the common mistake made by investors is to buy a place that fits the investor's style. That is another blog.
Let's say you need a 4 bedroom / 3 bath home in the burbs. Let's say the home that would fit your needs totally can be purchased for $300,000.00. At the same time, let's say you can qualify and handle the payment on a $400,000.00 home.
The Dave Ramsey's of the world would probably tell you to rent and definitely not tell you to buy the $400,000.00 home. My feelings would send you into the $400,000.00 home for a ton of reasons.
First reason is lifestyle. I am going to guess you will be a lot more comfortable in the $400,000.00 home than the $300,000.00 home. If you live in the home the typical 5-7 years, that is a big chunk of your life. Why not enjoy it?
Economics and Financial Planning make the reason even more compelling. That $300,000.00 home is likely to appreciate over $100,000.00 in five years (based on historical averages). The $400,000.00 home is likely to appreciate over $135,000 during the same period. The difference is $35,000.00 if you ignore all of the tax and lifestyle benefits.
Assuming you put the national average of less than 10% down – say 8% - and you had the seller pay the closing costs, you would have an additional cash outlay of $8,000.00. That gives you a cash on cash return on investment of $35,000.00 over five years on an $8,000.00 investment! That is a simple return of well over 400% in five years on an incredibly safe investment. Further, I have not taken into account the tax benefits and the lifestyle benefits.
What other investment could you possible make that is safe and secure that would predictably yield that kind of cash on cash return on investment in five years. Because of compounding, the numbers are actually more attractive and more predictable as you go down the road.
I am not suggesting that you get crazy. I am not suggesting that you employ this strategy if you intend to die in the property and do not intend to use a refinance strategy. I am suggesting that if you are like most families and are going to be in the property 5-7 years, pushing yourself a little bit will likely yield enormous returns.