Hidden Burden of Overbuying: Housing Myths Part 6

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Would You Pay $250,000 for a Room?

The Housing Bubble: Historical Growth in Houses Square Feet per Person

4 Reasons People Overbuy Housing--and How To Avoid It

1. Expected Duration of Use: People who borrow, say, a lawnmower are not inclined to scour the city to borrow from the person who has a mower with all the exact, ideal features of the borrower's tastes. However, a decision to purchase often launches people on the slippery slope of pursued perfection to find a mower with the highest horspower and best cup-holder.
2. Timing of Use (Now V. Future): People who make small, instant-total-consumption purchases, such as buying lunch, are likely to buy just enough to do the job. That sizing job gets harder with longer time horizons and increasing risk or uncertainty of how much you will need years in the future. Imagine if you had to buy all your food for the next 30 years today.
3. Uncertainty and Insurance Premium: People tend to pay extra to overbuy as insurance against future unknowns, which is why long-term, fixed interest rates usually are higher than short-term adjustable interest rates over time (overpaying as insurance against future unknowns).
4. Infrequency and Information/Experience Deficit: People also tend to overpay when they do not buy an item frequently and therefore lack cost-benefit knowledge, so they overestimate both their needs and the value of the product, such as the case with choosing a college and buying a college degree.

House purchases are both infrequent and long-term (or at least many buyers treat them as such) and so people are prone to overbuy to compensate against future unknowns. Mission creep adds dens, offices, exercise rooms, decks, and saunas. House size doubles from 1,500 to 3,000 square feet—“just in case.”

Upsizing the house is like buying the $50k camper or boat that you use once every few years. People tend to imagine the temporary time of maximum needed space and then go into decades of debt for infrastructure that is rarely used.

Know Your Life-Cycle Needs

A newlywed couple might go 5 years with no children and even a baby does not require a new bedroom. It is not historically unusual for several children to share 1 bedroom (even boys and girls together). Teenagers tend to need more room but that is why they get drivers licenses and go away to work or college. Long life spans indicate decades of life as “empty nesters.” So, people tend to overbuy the largest purchase of their lifetime based on a brief 5-10 years of peak usage.

The Marginal Cost of an Extra Bedroom

The price difference between 1 house and another house with an extra bedroom might be $50-100k, which costs $100-250k for that 1 room after today's typical finance charges of a 30-year mortgage to pay for it (ballpark figures). If you only truly need the room for 10 years, you are paying maybe $10-25k per needed year for that 1 room (not counting the luxury use of the spare room before and after the peak).

Basic finance rules say that it might make sense to buy what you need daily for 50 years but to rent what you need briefly and occasionally. Another option is the pay-as-you-go method to add-on to a house as needed. Buying and selling houses is problematic both because of the high transaction costs and because of government regulations about public-school districts which can prevent families' smart housing choices.

Do Not Buy Too Early

Why borrow and pay interest for extra space over a decade before you need it? Why not save for over a decade and then pay cash for extra space exactly when the need arises? Do you borrow to finance an extra car when your baby is born because the baby will be driving age 16 years later?

The best financial choice is the opposite of what most people do.

The best financial choice for a lifetime house purchase would be a smaller house geared to the minimum points in the lifecycle (because you will have smaller needs many more years than you will have larger needs), with temporary conversions within the original house dimensions (no additions) to accommodate temporary needs for “increased” space. The Brady Bunch’s Greg Brady made an attic room for himself and today’s smaller families average only about 3 persons each (either 1 child or 1 parent) so that fleeting teenage bubble of demand for space will not require much change.

If you want to live in the “perfect”-size home at each stage in your lifecycle, renting might be the best choice for many of the years.

Your Choice Makes a Big Difference:

How much health insurance could you buy by not spending an extra quarter-million dollars for 1 extra room?

Next: Home Mortgage Tax Deduction Snake Oil: Housing Myths Part 7