To add on or buy is question

Q. My wife and I have lived in Arlington for the last eight years. We have a 30-year fixed rate at 5.25 percent with a balance of $240,000. We have just had our second child, and we are starting to outgrow our house. We are looking at two scenarios and would like your opinion.

Our first option is to move. We have very good friends who live around the corner and will be relocating this spring. They have offered to sell us their house for $700,000. Looking at recent sales of houses that size, I think it’s a great deal. We would be able to sell our house, conservatively, for about $550,000 and use the proceeds as the down payment. The house is much bigger than ours and needs a little upgrading, but we really like it.

Our second option is to remain in our house and build an addition. We’ve had a couple of contractors come in and we are told that the two-story addition we are considering will cost between $200,000 and $225,000. Living in a house under construction doesn’t really appeal to us, but we like the idea of being able to design our addition the way we want it. We also hate the idea of giving up our 5.25 percent fixed rate.

On the other hand, buying our friends’ house is a great opportunity. They would give us up to six months to sell our house, although I don’t think it would take nearly that long. Both my wife and I have good jobs, salaries and credit.

Any comments?

My first comment is to suggest that you continue your due diligence and your decision will eventually become obvious. Let’s take a look at the pros and cons of each scenario, starting with remaining in your home and building an addition for $225,000.

Pros:

You are able to custom-build the addition to your specifications.

You won’t have to sell your house in a market that clearly favors buyers.

You can possibly keep your $240,000 fixed-rate mortgage at a below-market 5.25 percent rate.

Cons:

Building an addition, even with all the responsibilities in the hands of a general contractor, and living in a home that’s under construction can be stressful - especially with two small children.

You run the risk of cost and time overruns, compounding the stress level.

Financing options may be limited. While most home equity lines are tied to the prime rate, making them currently very inexpensive, the prime rate is likely to increase in the future. Fixed-rate second trusts will carry a higher rate and are harder to find, thanks to the credit crunch.

Let’s now consider purchasing your friend’s home for $700,000.

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