Several of my friends and family are currently looking to buy a house, or have recently bought a house. Some rented before buying their first home, others have upgraded to a larger house. Even though I am rather rational, emotion does sometimes get a hold of me. Especially when looking at real estate.
Because who doesn’t like a nice house to live in? But is living in a larger house on a bigger piece of land worth the investment? And what exactly is the impact of buying a larger home on reaching financial freedom? Let’s find out in a real-life situation.
Our current home
A few years ago we bought a nice 4-bedroom, 1,500 square feet home (3 floors) on about 2,150 square feet of land, in the center of The Netherlands. It was part of a development project, so it was a newly built house. We financed 100% of the house with a mortgage of €260,000.
Financing 100% of a property is not something I would advise anyone to do, but in The Netherlands it is very common. Since I worked in the consulting industry with relatively high yearly salary increases, I did not feel the need to make a large down payment. We also did not take out the highest mortgage we could possibly get, so we had a margin of safety.
Our current monthly mortgage payment is around €750:
• Interest: €260,000 @ 4.3% = €11,180 gross. Net around: €450 on a monthly basis.
• Repayment: €260.000 with 50% payment obligation over 30 years via a mortgage savings account generating 4.3% a year (tax free) = Around €300 per month.
Compared to when we first took out the loan, things have changed. We deposited more money in our mortgage savings account than was required. As a result, the time needed to reach €130,000 (50% of €260,000) at a 4.3% return, decreased from 30 years to around 21 years. But for the sake of simplicity I will leave this out of the equation.
Our potential new home
Looking for potential new homes is something Mrs. Chipmunk enjoys doing. We have been thinking about buying a piece of land and have a construction company build the home. This way we can really add our personal touch to our new home.
Land will cost around €275,000
A piece of land in an in-demand location in the center of the Netherlands costs about €50 per square feet. To have some privacy we would need at least 5,500 square feet of land.
Building a house will cost around €300,000
If we build a home to our personal preferences, we don’t want to be cheap and after a few years regret it. But with the housing market skyrocketing and construction companies trying to squeeze out every penny, building a house is expensive.
The example in the picture will cost around €300,000 including basic finishing on the inside. That’s a lot of money for just some walls and a roof!
Finishing the house will cost around €75,000
If we have a nice house with a lot of room, we will not settle for Ikea or some other large furniture store. We want some nice stuff! But nice stuff comes at a price:
- Painting walls, woodwork, etc. €2,500
- Flooring (ceramic parquet) €10,000
- Kitchen Island €15,000
- Bathroom €12,500
- Fireplace €5,000
- Veranda/garden €20,000
- Furniture €10,000
Price of our potential new home €650,000
- Land €275,000
- House €300,000
- Finishing €75,000
Ouch. That’s a lot! Even though it would be a lot bigger and nicer than our current home.
Financing our potential new home
Let’s make some back-of-the-envelope calculations on what the impact would be if we decide to make this new home a reality.
With interest rates at very low levels, it makes sense to make use of the possibility to pay off our current mortgage in full and take out a new mortgage on our new home.
Even though our current mortgage requires only a 50% repayment over 30 years, this is a huge difference. If I make the comparison easier and apply the same 100% repayment requirement for our current mortgage, the net monthly expenses are about €1,100. Still a difference of €730 each month.
This does not even include the huge opportunity costs of the €75,000 for a kitchen, bathroom, flooring, garden, etc.
Let’s say, instead of buying this new home, I invest the €75,000 and the monthly difference of €730 in an index fund of the S&P 500. The S&P 500 averaged 7% historically after inflation. After 25 years the value of my investments is almost €1 million. €978,678 to be precise.
As you can see, the impact of upgrading to a nicer and bigger home comes at a price. A price that is much, much higher than the price you pay for your new home.
Of course, real estate tends to appreciate over time as well. But a big part of this appreciation will be offset by an increase in property taxes, maintenance expenses, etc. A bigger house means bigger expenses.
Obviously, a new home can give a lot of joy and comfort that cannot be expressed in Euro’s. But is it really worth missing out on (early) freedom? Is it worth not being able to quit your job because you have big mortgage to pay? For me, the answer is a big NO.
- Upgrading to a bigger, nicer home comes at a price. Far beyond the purchase price of your new home.
- If you want to reach financial freedom, you need smart financial decisions. Buying a bigger house often isn’t.
- With housing expenses being the biggest expense of the average American family, it’s a quick-win to buy a home below your means.
Do you have any plans on buying a new house? Maybe even down sizing to reach financial freedom earlier?