This post utilizes a housing equity calculator to estimate
the impact of a move from one house to another on lifetime house equity. The blog is important for a number of
reasons.
First, house equity is increasing as a share of total wealth
for new retirees. This is not a good
trend. Current retirees are more
reliant on house equity than past retirees because defined pension plans are
scarce and for many people 401(k) balances at retirement are low.
Second, people who move and take out a new mortgage may end
up having to continue paying on their mortgage in retirement. Many financial advisors believe that it is
appropriate for people to keep a mortgage in retirement as long as they have a
large 401(k) plan. My recent essay on
this topic suggests otherwise.
Third, the loss of equity associated with moving to a new
home and obtaining a new mortgage may encourage some people to stay put even if
this decision entails turning down a promotion or a better job in a distant
city.
People need to be aware of how their decisions impact the
amount of house equity they will acquire during their entire lifetime. One important decision involves mortgage
choice. People who choose a 15year
mortgage will acquire more equity than people who choose a 30year mortgage. A second decision, the one discussed here,
involves the decision to move. A person
who moves from house to house prior to paying down their mortgage is likely to
acquire only a small amount of housing equity.
This post is based on question twelve in my workbook
“Solving Financial Problems in Excel”
Question Twelve: This problem examines the potential cost of
moving on ultimate house equity accumulated over a period of time.
In this problem all houses are purchased with 15year FRMs
at an interest rate of 5.0%. Also, all
houses appreciate in value at a rate of 1.0% per year. These
assumptions can of course be altered in a spreadsheet.
At the beginning of a 15year period two people purchase a
$300,000 house. One person stays in the
same house for all 15 years. The other
person buys a new house identical in value to the one he is currently living in
after 7 years.
The sales commission on the first house is 6.0%. In addition, closing costs on the new house
are equal to 4.0% of the house price.
The second person lives in his second house for eight more
years.
How much equity do the two people have after 15 years?
Answer: The house equity calculation for the first
homebuyer involves only one home. The
twohome house equity calculator used in the previous problem needs to be
modified to include the 4.0% closing costs on the purchase of the second home
for the second home buyer.
The results presented in the table below demonstrate the
high cost of moving when all financing is done with 15year mortgages. The person who stays in the same house for
15 years has equity of $348,291. The
person who moves to an identical house after 7 years has house equity of
$215,036. The difference in house
equity is $133,255.
Note most of the difference in equity is due to the
reduction in the payoff of the mortgage.
Only around 25% of the loss in house equity is due to the sales
commission on the first house and the closing costs on the second house. Nearly ¾ of the loss in house equity is due
to a reduction in the pay off the mortgage.
(Mortgages pay off more rapidly near the end of their life. Since Person B sells his first house he does
not enter the rapid payoff period for his mortgage during the 15year period.)
The
Potential Loss of House Equity From Moving


Person
A Lives in One Home for 15 Years

Person
B Lives in One Home for 7 Years and One Home for 8 Years


Assumption

Price of First House

$300,000

$300,000

Assumption

Mortgage
LTV First House

0.90

0.90

Assumption

Mortgage $ First House

$270,000

$270,000

Assumption

Mortgage
Term Years First House

15

15

Assumption

Mortgage Interest Rate

0.05

0.05

Calculation

Mortgage
Payment First House

$2,135

$2,135.14

Assumption

Holding Period First
Home

15

7

Calculation

Mortgage
At End of First Period Holding Period

$0

$168,653.73

Assumption

Annual Appreciation
First House

0.01

0.01

Calculation

House
Price At End of Holding Period First House

$348,291

$321,641

Assumption

Sales Commission on Old
House and Closing Costs on New House

0.10


Calculation

Loss
of Equity due to Commission and Closing Costs

32,164.06


Calculation

Available Equity First
House

$120,823


Assumption

Fraction
Used for Down payment First House

1


Calculation

Down payment Second
House

$120,823


Assumption

Price
Second House

$321,641


Calculation

Mortgage Second Home

$200,818


Assumption

Mortgage
Term Second Home

15


Assumption

Mortgage Interest Rate
Second Home

0.05


Calculation

Mortgage
Payment Second Home

$1,588.06


Assumption

Holding Period Second
Home

8


Calculation

Mortgage
at End of Second Period Holding Period

$112,357.98


Assumption

Annual Appreciation
Second House

0.01


Calculation

House
Price at End of Holding Period Second House

$348,291


Assumption

Sales Commission

0.06


Calculation

House
Equity After 15 Years

$348,291

$215,036

The loss in equity is smaller but still considerable when
30year mortgages are used instead of 15year mortgages. This is so because equity accumulation under
30year mortgage is very slow until the final years of the mortgage.
The decrease in the tax deduction of the mortgage interest
for the person who entirely pays off their mortgage will offset part of the equity
difference but the offset is relatively small.
Author’s note: I have recently published a number of
financial math posts like this one, which are solved with Excel financial
functions. Topics covered include,
evaluating different mortgages, calculating the repayment period for a person
with multiple credit cards, impact of student loans and consumer debt on the
mortgage qualification decision, affect of endofcareer market downturns on
401(k) balances, and the choice between a Prius and a Corolla.
These problems are all described on the following page.
Links to answers for 10 of the problems and links to my
workbook are included on that page.
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