Rules for a Trade-Up House

I’ll admit I have houses on my mind these days.

After seeing my friend Alan’s new home – complete with its four-car garage and Hugh Hefner grotto – my wife is bugging me to upgrade. And while I’m not crazy about taking on a major new expense, she makes valid points. Our two boys are the proverbial bulls in a China shop, and they’ve pretty well trashed our existing place. So even if I don’t buy a new house, I’m probably looking at tens of thousands of dollars in repairs and remodeling. And a little extra square footage wouldn’t be a bad thing.

We’ll see. If the right house comes along at the right price, I’ll likely join the millions of my predecessors that got suckered in the trade-up game. Or, I might resist the urge and continue on in my broken-down hovel for another couple years.

This brings up some questions on when and how to trade up. Last week, I really drove home the point that your house is not an asset. It’s an expense and should be viewed as such.

So, today we’re going to continue this conversation. We’ll call it “The Rich Investor’s rules for upgrading your house.”

Rule #1: Retire with a Paid-Off House

I consider this rule the single most important to your financial wellbeing. You do not want to start your retirement with the responsibility of a mortgage.

Once you’re retired, your income stops. You no longer have the ability to work overtime or earn that year-end bonus that helps you wipe the credit card balance clean. You have to live off of Social Security and off of whatever dividends and income your portfolio throws off.

Your expenses in retirement will be higher than you planned. It’s inevitable. And if you let your expenses get out of control early in retirement, you risk depleting your assets and then being forced to move in with your kids later. So, do whatever you need to do to ensure your mortgage is paid off before you retire. That potentially frees up several thousand dollars per month and gives you more flexibility.

So, if you’re thinking of upgrading, do the math. If you’re 45 and planning to retire at 65, will you be able to pay off your trade-up home in 20 years?

If that’s not realistic, then don’t upgrade or do so with a cheaper house. That beautiful home with the perfectly manicured lawn might be a trophy at 45, but at 65 it will be an albatross around your neck.

Rule #2: The Three-Year Rule

This rule is a bit more extreme, but I like it. I have a colleague in Houston that runs a large wealth management practice, and his rule for a trade-up home is simple: If you can’t pay it off in three years, don’t buy it.

The Three-Year Rule is obviously unrealistic for the young couple struggling to save for a down payment on their starter house. But that’s just it. We’re not talking about your starter house. We’re talking about an optional upgrade that you might want but that you certainly don’t need.

It’s important to note that you don’t necessarily have to pay off the house in three years. You just need to be able to pay it off in three. If you choose to keep the mortgage and invest your cash somewhere more profitable or stash it in a 401(k) or IRA, that’s perfectly fine. The Three-Year Rule is more about setting a practical spending limit than on keeping a specific timeline.

Rule #3: Watch Out For Taxes and Expenses

Let’s say you’re disciplined and get your mortgage paid off. Good for you! That’s a major financial milestone.

But your homeowner expenses don’t stop with the mortgage. You also have to pay property taxes, insurance, maintenance and possibly more frivolous things like HOA dues and landscaping.

So, consider your neighborhood closely. If your kids are already out of high school, paying the property-tax premium for a house in a good school district might not be necessary.

Likewise, some houses are far more expensive to insure than others due to their proximity to flood zones. And some neighborhoods have outrageously high HOA dues that are used to pay for services you might not want or need.

You might be able to skimp a little on maintenance, cleaning and landscaping. But once you’re moved in, you’re stuck paying taxes, insurance and HOA dues for as long as you own the property. So, be sure to take those numbers into consideration before you buy.

There’s nothing wrong with splurging on your dream home. It’s your money, and you only live once. But if you bite off more than you can chew, that dream home is going to end up being a financial nightmare for you.