Owning a home is a tricky thing.
It’s likely the most expensive purchase you’ll ever make. It comes with a lot of upkeep. Oh, and buying it and selling it is a major pain that involves agents, paperwork, credit checks, and appraisals.
It’s natural that people want rules of thumb to make sure they aren’t doing anything stupid when it comes to buying or selling a house. One of the basic questions that needs to be answered is how much equity should I have in my home before selling?
There’s no perfect way to answer this, but here are some things worth thinking about.
The More The Better
The more equity you have in your home, the more you will get when you sell it. And like in many other areas, more is better.
The biggest thing is that you have enough equity that you get something. It’s possible to be “upside down” on your mortgage. This happens when you have so little equity that the market value dips below the amount that you owe on your loan.
If you for some other reason you need to sell your house, you’ll end up losing money by selling your home. Which has never happened to me but I can’t imagine is any fun.
Anyway, the two things that will help you have more equity in your home are making a large down payment and living their for a long time.
The longer you live in your home, the more equity you will build through paying off the principal of your mortgage.
When you put down a large down payment, you are less likely to get caught upside-down if you need to sell the property in the next few years. That’s actually one of the big arguments in favor of making a large down payment.
The Closing Costs Double Whammy
When you buy a house, you pay closing costs. When you sell a house, you pay closing costs. This double whammy gets pretty expensive if you’re constantly buying and selling houses.
If you’ve ever seen the advice that you shouldn’t buy a house unless you think you can live there for five years, this is where it comes from. There’s nothing magical about five years, but think of it like this: incurring closing costs every year would be a disaster. Incurring them once every five years isn’t so bad.
Closing costs are one of the “phantom costs” of owning a home. People tend to ignore them and just focus on how much they will be paying every month for their mortgage. But closing costs are real and they add up quickly. The best way to minimize them is to incur them infrequently.
Where Are You Going to Live?
One of the big problems with selling your house is that you’re homeless unless you buy another one or revert back to renting.
Both of these are fine options if you need to move, but not so great if you were selling your house to cash in on the price appreciation.
Some people think “Housing prices have doubled, I’m an investment genius! I’ll take this house that I bought for $400k and sell it for $800k and make out like a bandit.”
Yeah, except that $800k isn’t going to go very far in a market when everything costs twice as much as it did before. And oh, buy the way, you’ll incur closing costs on both the sale and your new purchase like we just talked about.
The truth is that it’s tough to make money by using your own home as an investment. But you can pull it off in a few circumstances:
- Moving to a cheaper area
- House Hacking
If you can pull it off, house hacking is the best way to treat your house like an investment. Real investing in real estate means buying rental properties and house hacking is basically the in-between step where you use your house as your first rental property.
- Make sure you have enough equity that you aren’t upside-down on your mortgage
- Figure out how much it will cost you to close (both to sell and to buy)
- Will you have enough money to close (20% down payment + closing costs) on a new home?
That third bullet is optional if you’re making the switch from owning to renting.
Of course, the five year rule of thumb still applies. If you can live in your current residence for at least five years before selling, it helps keep closing costs from becoming too frequent.
Selling a house can be stressful. Buying a house can be stressful. If you have a good reason or are highly motivated, go for it. But if not, it’s always worth asking if staying put is a viable option. The fact is that you’ll get used to where you live wherever that happens to be.
There’s no way to pursue contentment by having what you want. You can only do it by wanting what you have.