Risks of Trading up to Larger Home
Benefits of a soft market for homeowners

By Dian Hymer

December 03, 2007

Few homeowners cheer when home prices soften, but a soft market can actually benefit homeowners who have been waiting for a prime time to move up to a larger home or to a more expensive home in a better neighborhood.

Let's say home prices declined 10 percent in your area during the past year. This decline affected all price ranges equally. So, if you owned a house that was worth $600,000 last year, it would be worth only $540,000 today.

However, if the trade-up home you hoped to buy was out of reach financially at $1.5 million, you can now buy it at a discounted price of $1.35 million. Although you lost $60,000 in value on the home you want to sell, you'll pay $150,000 less on the home you want to buy. So your transaction costs will run $90,000 less than they would have a year ago.

This sounds great on paper. However, there are several variables to consider before forging ahead. In the first place, the depreciation rate may not be equal across all price ranges. In many areas the low end of the market has been disproportionately hurt by the recent subprime mortgage fallout.

Depending on where you live, you could find that your house has lost more than 10 percent in value, particularly if it's in a housing development with lots of unsold inventory and a high foreclosure rate. A trade-up home in the same area could have held its value better than your low-end house, making it more, not less, expensive to trade up this year.

Another factor is that the middle price ranges -- the prime move-up segment of the market -- has been plagued with financing difficulties since the credit crunch hit in August 2007. Jumbo loans -- for amounts over $417,000 -- generally have a higher interest rate and more stringent lending criteria.

According to DataQuick Information Services, approximately 57 percent of the home loans issued between January and July 2007 in Alameda County in the East San Francisco Bay Area were jumbo loans. In October 2007, the percentage of jumbo loans in Alameda County dropped to about 36 percent. Jumbo financing may become easier to obtain when investors regain confidence in the home mortgage business. Until then, trading up is fraught with difficulties in the current market.

HOUSE HUNTING TIP: For years, trade-up buyers have preferred to buy their new home before selling the old one. Today, it's easy to make an argument that the more prudent way to make a trade-up move is to sell your home first before buying a new one. In addition to more rigorous financing qualification, it's difficult to know in advance how long it will take to sell your home and for how much. The inconvenience of renting for awhile may be far less onerous than the financial misery you could experience if you buy first and discover you can't sell your old home.

Back in the soft market of the 1980s, some trade-up buyers who bought first ended up having to sell the trade-up home they'd just bought because they were unable to sell their old home. In one case, the trade-up buyer ended up moving back into the house that she'd hoped to sell, forfeiting the $50,000 she'd spent on buying the new home, which included the cost of interim financing.

In Closing: There will be plenty of opportunities to buy good properties at fair prices in the current market. Just make sure that you don't jeopardize your financial security in doing so.