It’s not as simple as sale price minus purchase price.
I see it all the time and I’m as guilty as anyone. You get the Zillow or Redfin alerts telling you “your home’s value went up by 10% in the last year!” Dang! Maybe we should think about selling this house? In this post we’ll break down all the costs that aren’t quite as in-your-face when it comes to calculating “profit” on the sale of a home.
Is it time to upgrade?
No! Especially if you have any hope of FIRE (financial independence/retired early). “Upgrading” your house usually just means getting more than you need and paying for it by staying on the treadmill even longer. Find a way to live where you’re *already* living and stop letting HGTV tell you what you need.
We all have a tendency to imagine how much nicer it’d be with a dedicated office, or a home gym, or any other number of things. The problem is, all of that has a real and permanent cost. You can always invent ways to tailor your house to every desirable use case, but then you end up with things like a 56,000 square-foot, $25M $14M mansion that’s been on the market for 9 years.
Remember that FIRE isn’t about what you make, it’s about what you spend. You can follow the 4% rule and retire at 30 with $600k if you’re only spending $24,000/yr. Laddering-up to a ‘nicer’ house is just going to mean you need to keep working to keep paying that mortgage, when you’re already living where you are now.
Alright, you’re convinced that you don’t need to upgrade, but the market’s hot and you could cash out and walk away with a nice profit. Hopefully you don’t need to live anywhere else in the same market, because that “hot market” means you’re gonna be overpaying as a buyer.
The Numbers
HCOL (high cost-of-living area)
In this example, we’re going to take the actual townhouse that I currently own outside of DC (recall that the impetus for this site is our staggering debt):
Purchase Price: $457,000 (“cost basis”) in 2011
“Zestimate“: $636,000 (“sale price”)
– Outstanding Mortgage: $360,000 (“liability”)
= Cash Proceeds (what people wrongly call ‘profit’): $276,00?
While it’s [kind of] true that I could walk away with $267,000, my profit wouldn’t be anywhere close to that. Let’s break the numbers down and see what we’re *not* factoring in…
“Cost Basis”
Generally, when you have an investment, your cost basis is the amount you paid for whatever you invested in. Since we’re talking about selling a house for profit, don’t be fooled…it’s an investment. Susceptible to capital gains tax and everything, just like stocks. It’s easy to think of the price you paid for the house as your ‘cost basis,’ but in reality it’s not even close.
When I bought the house, there were closing costs and fees (whether paid at closing or rolled into the mortgage), immediately pushing that number up to $467,000. Also, interest on a mortgage is typically front-loaded, so we can add every dollar I’ve paid in interest. Using a mortgage calculator online and plugging in my numbers, I can look at the amortization schedule to see that in the last 10 years, I’ve paid $155,000 in interest. So my real cost is now closer to $622,000.
I don’t claim to have kept receipts for everything we’ve done to the house in the last 10 years, but to name a few memorable ones…$6,750 for an HVAC system, $5,000 for a roof, $3,000 water heater & related, $2,000 for carpet, $2,000 for blinds, $115/mo in HOA fees, $6,000/yr in property taxes…all of these are very real costs that went to the house instead of saving/investing. Just adding up what I enumerated there (which is by no means everything), my real cost is now:
| item | cost |
| principal paid | $102,000 |
| closing costs | $10,000 |
| mortgage interest paid | $155,000 |
| property taxes | $60,000 |
| HOA fees | $13,800 |
| Carpet/Blinds | $4,000 |
| HVAC | $6,750 |
| Roof | $5,000 |
| Water Heater | $3,000 |
real cost | $359,550 |
“Profit”
Okay, so you can probably guess where this is going…but we’ve come this far. Let’s say Zillow or Redfin or whatever is dead-on accurate. I could sell the house for $636,000, and since my mortgage balance is $360,000, I’m walking away with $276,000. Still a nice payday, right? No!
In all likelihood, you’re using a realtor to sell (hey, it’s a hot market, someone has to juggle these competing offers). Let’s say you’re a good negotiator and you get the agent to agree to 5% instead of the usual 6%. That’s $31,800 out of the proceeds. But the buyer has a home inspection and they find a few things that need fixing. It’s nothing major, but now the clock is ticking so you pay $3,000 for some minor repairs. Now you’re walking away with $241,200.
So…how much will I really make selling my house?
We’ve established that the actual money I’ve put into the house in the last 10 years totals up to about $359,000. After the sale described, I’m walking away with $241,000. That means in real terms, selling this house right now will net me a grand total of -$118,000. Yes, I’m losing 6 figures on this sale.
The Caveats
Unsurprisingly, there’s more to this story than what we laid out here. Capital Gains taxes can have a significant impact and we didn’t even look at them (yet). Many would also argue that we can’t play the numbers like this, because after all…it gave me a place to live in for 10 years. Sure…but remember, we’re talking about selling for profit. The $359,000 I’ve spent on the house could have gone into any number of investments (index funds, for example) and made me money. They didn’t, and looking at it that way means I’ve spent $3,000/mo to live in a house and walk away with nothing. Not great! What if I’d rented a room for $1,000/mo and invested $2,000/mo? I might not be writing this post because the internet sucks from my boat!
I’m not oblivious to my privilege, and I know that a $500k townhouse is an absurd example in much of the country. So in a future post we’ll run these same numbers using a house in an LCOL (low cost-of-living area).
The Takeaway
This is all converging on a topic we’ll cover in the future, and that’s opportunity cost. The money you spend on something today is money you *could* have been investing instead. Getting into a cycle of “my house appreciated, I can sell it and buy a bigger house for the same payment!” is one of the biggest ways to take money *away* from other opportunities. Don’t let the desire for a little more comfort or convenience leave you stuck in the rat race one day longer than you need to be!
Would you choose the bigger house if the cost were listed in ‘additional years you need to work?’