Take Advantage of Low Rates, Prices to “Trade-Up”

Earlier this month, I blogged about an interesting phenomenon whereby borrowers are pumping money into their mortgages as part of a refinancing, whether by necessity or by personal choice. Today, I want to report on another against-the-current trend: trading-up.

Trading-up is a term used to designate the selling of one’s home in favor of buying a more expensive, and presumably more appealing one. During the housing bubble, trading-up was seen as symptomatic of lax lending practices and the consumer trend to own the most expensive home possible. In hindsight, many of these mortgages were basically unaffordable to the borrowers, which is why this mindset is at least partially responsible for the ongoing foreclosure crisis.

On the one hand, the current wave of trading-up mirrors the housing boom. Basically, homeowners are taking advantage of record low mortgage rates, and substantially lower housing prices to sell their current homes and move into more expensive ones. The WSJ, which recently published an article on this very subject, cites a handful of cases about homeowners that have managed to double the size of their homes while raising their respective monthly payments by only a few hundred dollars. (It should be noted that this doesn’t take into account closing costs for the new mortgage, which are probably paid out of pocket).

On the other hand, these borrowers are being praised as savvy and opportunistic. While some consumers are either waiting on the sidelines or stuck in underwater properties, others are charging ahead audaciously and trying to find some way to take advantage of the current housing situation.

What about borrowers who are underwater? According to research, most borrowers will (irrationally) avoid selling their homes if it means taking a loss. A recent study showed that “sellers were so averse to nominal losses’ that it affected their behavior. Those who were selling their homes in down markets and faced the possibility of nominal losses kept their homes on the market for much longer than other sellers, in some cases to their detriment.”

Perhaps due to the fact that losses suffered on one’s home are not tax-deductible, or perhaps for sheer pride, it seems underwater borrowers will either (deliberately) default or wait out the storm in the hopes that housing prices will rise again at some point. Selling at a loss is not on the table. Experts point out that this mindset is fundamentally irrational, since the low price received for selling one’s home should be offset by a low price paid for a different home, but to little or no avail. I guess some borrowers are impervious to logic.

It remains to be seen whether this phenomenon will catch on, whether at all or to the meaningful extent of spurring a recovery in housing prices. On the one hand, there’s never been a better time to buy/borrow. On the other hand, there is both the possibility that housing prices could fall further and that the economic recovery will fail to take hold. Under such conditions, the re-emergence of trading-up would probably seen as misguided at best, and disastrous at worst.