Primary Residence: Hold or Sell?

Question

Curious to get other perspectives on this topic. I’ve been throwing around the idea of buying another primary residence (upgrading), but the current mortgage rate makes it a little tougher of a decision.

Background:

Young family living in CA (Bay Area).
We own our current primary residence with a 30 year fixed mortgage at about 3.25%, purchased ~$1MM, worth ~$1.4MM.
We want to upgrade homes, planning for a growing family.
Looking at ~$1.7MM-$2MM (interests rates do have some influence on this).
We invest in real estate (buy and hold) out of state. The only real estate in CA is our primary.

Options:

1. Sell the current primary residence, take advantage of $400k tax free (capital gains exclusion), use the proceeds to fund the down payment (20%) on the new house. Downside is that the new house is probably going to be just over double the current mortgage rate.

2. Keep the current primary residence as a rental, liquidate other assets to fund the down payment on the new house. The positive side is that we hang onto a historically low interest rate, and would eventually cash flow sooner with rents rising over time (who knows how long). The downsides are that we aren’t too keen on owning rentals in CA given potential tenant issues, the lack of cash flow, etc. Appreciation, while nice, would also come into play on the new primary residence.

I understand the part of the discussion which comes down to staying more invested in real estate versus other assets (primarily equities).

The real question comes down to whether or not it makes sense to give up the low interest rate. So far, more signs are pointing to yes.

- We would be able to upgrade our primary residence. Of course there is a non-financial aspect to this decision.
- We stay invested for future appreciation on the new primary residence. If all goes well, we probably would live there another 5 years or so and hopefully upgrade again.
- We take advantage of the capital gains exclusion.
- We stay a bit more liquid, given it is easier to sell out of the equities we hold versus having to tap into equity if we kept the current primary residence.
- We don’t have to be landlords in CA, at least not feeling like we’re stuck in that situation.

Am I missing anything?

Ryan Lam · Answer

That’s a great point about securing a lower starting point for property taxes, especially if I’m bullish on real estate here long term.

Arlen Chou · Answer

@Ryan Lam it sounds like you are not hurting for money since you are actually considering holding on to the current home. Many people couldn't swing the coin to go from one Bay Area home to another without selling. Is there are timeline in your move?It is hard to give specific advice without knowing which city you are in and how much equity you have in the property. However, at a 3.25% 30 year fixed rate, you basically should have free money in your original home loan. It will make cash flowing much easier with a low fixed rate.If there isn't time pressure and you have a good chunk of equity in the property, I would suggest you hold on to the current home and pull a HELOC BEFORE you get the other property. Pull the cash and "season" it in your account for 3 months. Yes, you will pay interest for 3 months, but it makes your "cash" position look good after the seasoning period.

Make sure the rental income can cover the original loan and the HELOC and then use the HELOC money as your down payment for the next home.

This only makes sense if your home is in a good Bay Area city with appreciation potential. At the very least, it should be in a good neighborhood of a larger city with mixed real estate demographics. The locked in low interest rate you have coupled with appreciation, over time, will create real wealth for you and your family.

I would be really interested in knowing what signs you are seeing that tell you giving up a 3.25% 30 year fixed rate is a good thing.

I personally have used this strategy in the Bay Area and it has been a force multiplier in my real estate growth.

Good luck!

Arlen

Jonathan Bock · Answer

Nope, just get it sold on to the next.

I personally believe the "lock in effect" for your property taxes is more impactful and beneficial to you than mortgage rates long term. I wouldn't mind having a prop 13 like ruling in PA not going to happen..

We are both advisors and know that financially suboptimal options are fine for a primary residence it's all psychological and emotions based like almost every other financial decision.

Still look for that bargain purchase though that's the fun part right?

Jonathan Bock, CPA

Rick Albert · Answer

Thanks to life events, even your next place may not be your forever home.

This sounds more like an emotional move, which is totally fine. If you don't want to be landlord in CA and you are in the negative cash flow, then it might make sense to sell it and move on. Alternatively, you could sell it, put parts towards the new house, and the rest towards other investments.

Ryan Lam · Answer

That’s another really good point with the loan but down. I haven’t done the math on it, but we purchased in 2019 so we’re still very much in the earlier years of the amortization schedule so payments are light on the principal pay down.

We were looking for more space. Originally we figured if we were going to spend the money, might as well also get into a nicer neighborhood and better school district. The current area is far from bad, so the back up plan would be to stay and build up. The hard part with staying is that we don’t see ourselves living here forever; we could, but will always think in the back of our minds “i’d rather live here or there” although I know that is something that is always going to be the case to some degree.

Ryan Lam · Answer

$1.7MM would be the lower end, where we could swing it at ~6.5% on a 30 year fixed without any lifestyle changes.

The closer we get to $2MM, doable but there probably needs to be some sacrifice on the lifestyle side.

Keeping both properties and using our existing heloc was a thought, but the numbers didn’t work out. Assuming our current is worth $1.4MM, we’re at about $600k in equity. We have a heloc from a little while back, I’m trying to remember but maybe $250k range. The problem is that market rents aren’t enough to cover the mortgage as we would be about $1k/month short. Then you throw the heloc interest on top, that becomes more challenging. I could make the argument that it is an investment so that $1k/month isn’t entirely lost in the long run, but I also feel like finding cash flowing properties would be a viable alternative.

Also the big kicker is the capital gains exclusion. That comes out to ~$400k that would be excluded from capital gains tax, which would account for about $60k. If we held it beyond 3 years as a rental, this opportunity goes away.

We’re in a good neighborhood in San Jose. Median sale price ~$1.7MM. The appreciation play is there.

Have you found any ways to work things out if the rents aren’t enough? we thought about renting by the room, but that may not even be enough extra to be worth it. we also thought about only selling some equities (stock) and using some HELOC, with the intent of further selling equities if needed. But that is a lot more unknowns, heloc rate, stock market performance, tenants, etc. would all be variables difficult to control at once.

no specific timeline, but within the next year sounds reasonable.

Rick Albert · Answer

There is also the loan buy down factor. If you lived in the property two of the LAST five years, then if you rent out the previous home for two years, then sell, you still qualify for the capital gains exclusion. Even if values stay the same, you still net more because of the loan buy down.

Alternatively, if there are certain upgrades you want in the next home, can you do it in your current residence? Normally I wouldn't recommend this because the cost of doing the work is more expensive than buying another property that already has it. However with the interest rates the way they are, it may make sense.

Sean O'Keefe · Answer

I'm based in the Bay Area -> following

Primary Residence: Hold or Sell?

Most Popular Reply