What do you get when you mix low mortgage interest rates, weak real estate prices and increasing foreclosures? You might get the perfect opportunity to buy a home. And this truth is not lost in my own circle of friends. I have one friend who writes me weekly about how terrible the property market is, but I know he’s excited about the prospects of buying in at some point.
Sure, times continue to be very uncertain, but there’s that aforementioned trifecta of factors aligning here to assist serious homebuyers with cash and savings who are ready to enter the marketplace. I think it’s possible to get a great deal, if you know how to shop.
How To Make The Best Home Buying Decision: Ask These Questions First!
While it’s the American Dream to own a home, it’s not always THE best path for everyone, for the simple reason that not everyone can afford it. Forget what the subprime mortgage lenders told you 4 or 5 years ago — not everyone can be a homeowner. It just won’t make sense in the long run if you think that your house will serve as your retirement fund or piggy bank for the future. The days of fast rising home valuations are now over. So before you start making open house calls, it’s good to take a step back and ask yourself a few questions.
1. Can you afford it?
Don’t just use “low mortgage rates” as an excuse to go house shopping. Face a mirror and be honest with yourself: can you handle it if rates soar in the future? Assess your cash flow and debt situation today and into the future. Don’t just jump at a real estate opportunity just because mortgage rates are so low and tempting. Determine a comfortable real estate price range by using a simple formula; lenders may use this rule to get some idea of the amount of mortgage money that home buyers might qualify for.
Formula: (Monthly Income – Existing Monthly Debt) / 3 = Maximum Monthly Mortgage (You Can Afford)
For more information, check out how to calculate your debt to income ratio to see how healthy your finances are. In addition, be aware of the true costs of home ownership before making this kind of huge financial commitment. If you’re ready to move anyway, then get pre-approved for a mortgage before you go home shopping. It makes the process easier when you find the house you want to buy. It also lets realtors and homeowners know the bottom line about what you can afford.
2. Are there other housing options that make better financial sense?
There are several exogenous factors — again, the low rate lending climate, your credit history and score (which can affect your loan status), your financing options, the size of your down payment, projected housing costs — which you can use to compare home ownership against other living arrangements. Should you rent or buy? You need to compare different living and lifestyle options before you proceed.
3. Do you have money for a down payment?
Most lenders want a down payment of 20 percent or more. This can hold many people back from buying a home. While some real estate investors or “experts” advocate engaging in maximum leverage, it’s not something I am personally comfortable doing. So before plunging into a home purchase, I am the type who makes sure that I’ve got enough savings for a down payment. Still, if you don’t have the money, there are programs out there to help you become a homeowner. I’ll list them here, but this is not something I’d personally pursue, since I eschew creative financing by principle:
- Private mortgage insurance, known as PMI, allows you to make a down payment of less than 20 percent. The lender agrees to lend you more than 80 percent by insuring the remaining percentage on your behalf. Often you need to pay up three to six months of your mortgage payment upfront with a PMI fee on your monthly mortgage. When you are at 20 percent equity, the PMI is dropped.
- Piggyback loans are secondary loans beyond your primary mortgage loan. Buyers can get two loans – one for the mortgage and one for the down payment. Piggyback loans carry a higher interest rate and are typically extended for ten years. Buyers should beware of getting in over their heads by carrying two loans. If you can’t afford any down payment, can you really afford the home?
- The Department of Urban Development (HUD) offers a down payment assistance program. It works much like a piggyback loan except the rates are lower.
- FHA loans can be secured by low income home buyers with a down payment of as little as 3.5 percent. The property must meet the FHA eligibility criteria.
- No down payment loans are available for veterans and military members through VA approved lenders. Even second time home buyers can use this option to find a house. This is a good opportunity for homeowners who need to downsize.
Even Foreclosures and Handyman Specials Can Be Out Of Reach
There are other ways to get in over your head besides a big mortgage loan with high interest rates. While foreclosures and handyman specials can be excellent deals, you must carefully weigh the work and costs involved. A lot of people may miscalculate the expenses involved with working with a fixer-upper, and sometimes, even committing to such a purchase can be too much of a stretch. Just because a house is selling for what seems like a song doesn’t mean that it’s really the deal that you think it is.
Here’s a story I’d like to share: at one point, my friends had purchased a handyman special. With the sellers driven to pre-foreclosure, they thought they’d buy this house for a great price. It was a spacious place with a huge yard and was selling at a great low price. How could they pass this up?
Nowadays, they still reside in their home, but it looks a lot more like work and a lot less like heaven. Unexpected health problems in their family made it tough to maintain a large home. And ironically, they’ve also found themselves in a pre-foreclosure situation… and remain in their handyman special, almost ten years later.
So before you make a home buying decision, make sure you consider the costs involved very carefully. Your house isn’t a bargain if you lose it a few years later to foreclosure!
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{ 4 comments… read them below or add one }
Very good advice but I find many people have an innate, personal desire to own a home that has nothing to do with whether the decision makes sense for them or not. Homebuying is not a logical decision making process for most people.
Just a clarification on the down payment suggestions you made–FHA loans, although they allow you to put only 3.5% down, also charge mortgage insurance, both up front and every month. Piggyback loans have nearly disappeared.
However, the HUD programs you talked about are available through housing nonprofits (not directly through HUD). Only people with modest incomes for their area can qualify however.
Keep spreading the word that homeownership is a big responsibility and not for everyone. It’s the message that many homeowners now in foreclosure needed to hear before.
Interesting points here. I agree with most on them. First, it is very tough to get loans for people. If you are a first time home buyer you can go for an FHA loan but after that, you better have a down payment.
In my recent house flip, I had several people ask me about rent to own options. Only about 10% of those actually make it to the sale 1, 2, or 3 years down the road.
I agree with the comments about handyman specials too. You can find deals out there but do not get in over your head. If you are not handy, I would not recommend going that route. It is a LOT of work. However, if you are handy, I think you can really grab some good deals out there – just be careful.
At the end of the day, keep your credit score good, and save for a down payment. That is your best option.
@Pamela,
Thank you for making the clarifications. I will make some updates reflecting some of the things you’ve said, particularly the details on getting loans and financing, especially when you don’t have a down payment. I can see how some of these financing methods have been altered to address the problems brought about by the real estate crisis of recent years. I agree with you as well, with letting people know that the whole “American Dream” of owning a house is a myth. There’s no reason why you shouldn’t pursue it, but make sure you are realistic about it too.
@thehouseflipguy,
Thanks for sharing your experiences! I had entertained fantasies of getting into real estate investing via foreclosures or fixer uppers. And why not? The market is crumbling and there are fabulous opportunities everywhere, right? Well, I have to remind myself often: “not so fast”. I am sure many people get the wild and bright idea all the time, without checking the realities. Given that my spouse and I are VERY unhandy, I doubt it’s going to work out for us, if we tried this. So our real estate investing is currently limited to REITs at this time. Or if we get into investing, we’d have to select properties that aren’t going to need as much TLC.
I wish my sister-in-law and her family had seen this before going through what they went through in England. They were sold an endowment mortgage in early 2000 that ultimately caused them to foreclose when it “short-fell”. Owning a home, truly, isn’t for everyone…