Real Estate Finances

What Would an $80,000 House Really Cost?

July 5, 2011 By Jon Griffith Leave a Comment

There are no simple answers to this question. When you buy a house, you incur all types of costs depending on your particular circumstances.

Some of those costs could be loan origination fees, title insurance, home warranty, escrow fees, document fees, HOA transfer fees, etc. These are all up-front costs, some of which can be rolled into your loan, some of which cannot.

If you pay cash for your $80,000 home, you’ll still be paying a small amount above $80,000.

Now, if you think of cost in the way that you should be thinking of cost, you’ll be considering the actual cost of owning the home, which would include not only out of pocket expenses, but also long term costs, recurring costs, and opportunity costs.

Long Term Costs

If you’re purchasing on a loan, then you need to look at an amortization schedule which shows you the total amount of interest paid to the bank. Add that to $80,000. Now, project a potential increase in property value over time (which cannot accurately be predicted) and combine all of the numbers to see if you break even, or if you’re ahead of the game.

Recurring Costs

Deferred maintenance is a part of life. You WILL need to replace expensive parts of your house over the life of the home. You’ll need a new roof, new fascia boards, a new water heater, new appliances, air conditioner, you name it.

Opportunity Costs

This is probably the hardest to calculate. Opportunity costs are the losses you would incur had you done something else with your time or money. This can really only be measured after the fact, or loosely projected up front.

As you can see, the question asked is much more difficult to answer than one would expect, especially if you’re used to considering only what the monthly payment will be.

Filed Under: Buying A Home, Real Estate Finances Tagged With: cost, home, house, opportunity

Is That Investment Profitable?

April 29, 2011 By Jon Griffith Leave a Comment

I was poking through some of the properties in the Historic Phoenix Districts and I came across one that caught my attention, much like it would many people.

Aside from owning your primary residence free and clear and reaping the increasing valuation over time, there are two ways that I can think of off the top of my head in which you can invest in a single family home. In both instances, the purchase price of the home determines the ultimate return on your investment.

Method 1 – The Flip

The goal in the flip is fast turnaround. You need to know what to buy, where to buy it, when to buy it, for how much, and the cost of reconditioning. You also need a lot of cash on hand. It’s a venture that requires that you spend time doing your due diligence to ensure that when you sell the house, you actually make money. Don’t be too quick to purchase a $40,000 home thinking you can turn around and sell it for $140,000 (it’s happened dozens of times in the Coronado District) and walk away with $100,000 in pure profit. You’ll be spending quite a bit of money and time reconditioning, remodeling, and marketing the property. Sales commissions alone could run you nearly $10,000, and you’ll need to have a great team of contractors who do honest, quick work at a fair price.

Method 2 – The Rental

This is my preferred method. My real estate philosophy is to own as many paid-for homes as possible to generate passive income, and increased property value over time.

The rental is also a tricky beast. One might think the following:

“I’ll buy a house that needs minor repair for $50,000. I’ll put $10,000 into repairs, and then rent it for $600.00/month.”

Obviously location is going to play a part in how much you can charge for rent. Now, let’s make a mistake in calculation. Based on the above numbers, I could make the mistake of dividing my total cost ($60,000) by the monthly rent ($600.00). If I do this, logic would tell me that it will take 100 months, or 8.3 years to get my $60,000 back.

That’s nice, but not true, because we’re working with something called “Net Operating Income” which is what you’re left with after you pay your expenses, which you MUST consider before you go crazy buying that property.

So what are the operating expenses?

If you pay cash for the property, your expenses will be less, and you’ll also be able to choose your tenants wisely, because you won’t make desperate decisions under the pressure of a mortgage payment.

The First Expense will be property taxes. When you own your house free and clear, you still have to pay annual property taxes. They are never the same year after year, and as the value of the house goes up, so does the tax bill. I’ve looked up the tax bill on a property in Phoenix with an approximate value of $50,000, and the total for the year is about $1090, give or take.

The Second Expense we’ll take into account, is property insurance. We must insure the home. We don’t insure the tenant’s belongings, we only insure the home for the cost to rebuild it. In our current market, we can buy homes for less than it costs to build them, so determining this number is going to be dependent upon a long interview with your insurance company, and it will be affected by your credit profile, as insurance companies definitely take this into account. Let’s say, for gits and shiggles, that your annual insurance bill is $350.00 for $100,000 in coverage.

The Third Expense you’ll need to consider is your annual repair bill. If you think you can get away with renting your house out without expected repairs and deferred maintenance, then you’re delusional. You WILL have repairs. A roof WILL need to be replaced. A water heater WILL go out. Set aside 10% of your annual rental income to cover expenses. That’s $720.00. It may be conservative, but I feel better that way. One would rather err on the side of safe, than not. If it’s not all spent, put the difference in a reserve account and save it for larger repairs and emergencies. I don’t typically endorse a home warranty, but if you want to calculate it into your expenses, add $350 per year. That rounds out to $1070. With a warranty, the annual repair bill could be lower, as some of the repairs will be covered by the warranty.

Quick recap. We’ve racked up 3 expenses now:

Taxes – $1090 +/- per year.
Insurance – $350 +/- per year.
Repairs – let’s call it $1000.00.

On to the rest…

The Fourth Expense will be the vacancy rate and it will vary depending on the health of the rental market and the location of the property, condition of the neighborhood, etc. Vacancy must be calculated because you WILL have months in which you have no tenants. Calculate 5 to 10 percent of the annual gross rental income. In this case it will be $360 – $720 per year. This may not become a realized expense, or it may be larger one year over another. It truly depends on the performance of your rental.

The Fifth Expense will be property management. If you choose to have a property management company handle the acquisition of tenants, collection of payments, and facilitation of repairs, you can expect to pay somewhere in the area of 10% of your gross rental income. That’s another $720 per year.

So lets do the math on all of these costs:

Income – $600/month = $7200.00/year.

Expenses (annual)

Taxes – $1090
Insurance $350
Repairs – $1000
Vacancy – $720 on the high side.
Property Management – $720+

Total annual expenses: $3880.00 +/-

Are you starting to see how this works? And these are very rough estimates. So how do we calculate a) the amount of net operating income we’ll have at the end of the first year, b) the time it will take to recover our initial investment, and c) the annual return as a percentage.

The NOI (Net Operating Income)

Simply subtract from the gross rental income ($7200.00) the annual expenses ($3,880.00) and you’re left with $3,320.00.

The Time It Will Take to Recover the Initial Investment

Divide your initial investment by your NOI. $60,000 divided by $3,320 = 18 years.

The Annual Rate of Return

Divide your NOI by the total investment. $3,320 divided by $60,000 = 5.53%, not including increased property value.

As you can see, what appeared to be a really cheap way to get into the market to invest in a rental could suddenly not be worth the time and effort. You could cut corners to maximize your annual return, but that may come at a greater cost to you in other frustrating areas, like having to market the rental yourself, deal with bad tenants, evictions, etc. Blech!

The real value I hope that you take away from this article is how important it is to do your research before pulling the trigger on that real estate investment, or any other investment. It’s never a good idea to get into something until you know exactly what it is that you’re getting yourself into, and as you can see, there are many factors to consider.

I’m not discouraging you from investing in rental properties, as it is a fantastic long term solution to building long term wealth. In fact, after 18 years, you may have a house that’s worth $100,000 generating $3,320 in passive income every year, but if you really think about it, $100,000 in value returning only 3.32% annually isn’t such a great investment. You’d want to keep hunting for something better.

For instance, if the original cost of the home was only $30,000 (and they exist), you recoup your cash in 9 years and your rate of return is now 11%. Much better. Or if your $60,000 home had a rental rate of $900.00/month, then your NOI would increase from $3,320 to $7,420 yielding an 8 year return at 12.3%.

Over all, the original scenario isn’t that great. You’d probably be better of putting $60,000 in a growth stock mutual fund for 18 years at an average of 8-10% per year. At the end of 18 years of compounding growth you’d have about $650,000 – $1,200,000 socked away. There aren’t many, if any $600.00 rentals that will appreciate from $60,000 to $650,000 in 18 years.

Filed Under: Buying A Home, Real Estate Finances Tagged With: house, investment, property, rental

Defaulting on Your Home Equity Line of Credit (HELOC)

April 16, 2011 By Jon Griffith Leave a Comment

If you’re not aware of what a Home Equity Line of Credit is, here’s a simple explanation.

If you purchase a home for $100,000 and the value increases to $150,000.00 you can borrow money against the value of your home. There are basically two ways to do this.

Cash Out Refinance:

That’s when you refinance the entire loan at a higher dollar amount than your original loan. 80% (typical refinance amount) of $150,000 is $120,000. So, if you owe $80,000 on your original loan, (again, you purchased with a conventional in this example) then the old loan would be paid off, and you would receive the difference of $120,000 less $80,000 for a total cash out refinance of $40,000 and a total loan amount of $120,000. Another way to look at this is that you’re digging yourself deeper into debt for a longer period of time.

Home Equity Line of Credit (HELOC):

This is when you present the value of your home to a lender who is willing to give you cash in exchange for a security interest in your home. For example, your $150,000 home which only has a loan of $80,000 on it has $70,000 in equity which any lender would be happy to help you tap into for an annual interest rate. If you do so, a 2nd lien will be placed against your home and you will have two payments. The first payment will remain as it was, and the 2nd will become a revolving line of credit much like a credit card.

It is questionable whether or not the first loan could still be considered, or at least a portion of it could still be considered a purchase money loan. (That’s a loan that was used to buy the house) and this is important when figuring out whether or not you can be handed a judgment if you default. A HELOC, on the other hand, is simply a revolving ATM cash line of credit with a low interest rate and interest only payments. Again, you’re still borrowing money from the equity in your home.

We all know what happens when we stop paying our 1st lender. They typically exercise the right to sell your house at a Trustee Sale. What is unclear to many is what happens when you stop paying your 2nd payment, but continue to pay the 1st.

Possible Outcomes

There are a few things that a lender on a HELOC may do to resolve past due payments. While the note is secured by your property, if you don’t have any equity in your property, then they aren’t going to exercise their right to sell the home, because the 1st lender will receive all of the net proceeds from the sale, and the 2nd will simply be out of luck.

So, they could, but likely won’t file a Trustee Sale notice to sell the house out from under you. Each lender is different in how they approach collecting bad debts.

Another solution would be to allow you to re-instate the loan by getting caught up. There is a period of time that the lender will give you, which is defined by each lender, and usually never adhered to 100%, in which you can do this. If you get caught up, plus all late fees, then it’s likely you can continue in good standing in the future.

If they grow tired of waiting for you to communicate with them to get caught up, and they recognize that there is no equity in your home, there will be a point at which they decide that it’s time to dump the bad debt. They do this by charging it off. This involves selling off the debt, most likely to an in-house collection company under their corporate umbrella, and then hiring an attorney to handle communications with the delinquent borrower. When the file is sent to the attorney and charged off, you can basically kiss all chances of re-instating the loan good bye. It’s at this point that you’ll start receiving scary letters from the attorney, and you’ll have only two options.

1. The worst option, get sued, go to court, have a judge slap a judgment against you, have your wages garnisheed or your account levied, and be forced to pay back what you owe, with steep annual simple interest penalties, is possible.

2. The better option is to settle for less than the amount owed, which is not always a guaranteed option. In the Short Sale world, this is what we do in order to make the 1st and 2nd go away. Sometimes even a 3rd lender is involved. In the world of HELOCs where you’re not past due on the 1st, and the 2nd has threatened to sue you, your bargaining power increases dramatically…but only if you have money to settle.

About That Bargaining Power.

Money talks. Think about this. If I owe you $100.00 and I pay you $50.00, then I don’t pay you for a few years, it’s likely that there will be a point in time that you write it off or forget about it. It’s at this point that I come to you and ask you if I can settle the remaining debt for $10.00. You figure, heck, it’s the best I can get, so sure…I’ll do it. That’s the risk you took in loaning me the $100.00. The catch is that I have to have the $10.00 to pay you. Oh, and that you’ll probably never loan me money again, and have probably written me off as a trustworthy person.

So, in the case of a HELOC, your best method to avoid a law suit is to bring a settlement to the table. Many lenders will be happy to accept ten, fifteen, even twenty cents on the dollar to satisfy the debt.

BEWARE! Your settlement agreement with your lender when it comes to a HELOC must include a release of lien on your property as well as a full release from the remaining debt. Have an attorney look at your lender’s settlement offer, which should be in writing, always!

Consequences

Your credit is already damaged because you’re late on the payments anyway, so that’s no longer a concern. You’ve probably already dealt with that part emotionally. The one BIG consequence to debt settlement of this magnitude is that the forgiven debt will be looked at by the IRS as income. Any time you settle debt for less than the amount owed, the difference is considered income.

To understand that better, think of it this way. Your lender handed you $100,000. You had $100,000 come “in” to your account. You failed to pay it back. They wrote off a portion, and the amount you didn’t pay back becomes recognized as income.

It’s going to be up to your CPA to determine whether or not income tax is owed on the amount forgiven.

The moral of the story? Stop borrowing money. Start saving.

Filed Under: Living Debt Free, Real Estate Finances Tagged With: debt, money, Possible Outcomes, property

The Beginner’s Guide to Financing

March 30, 2011 By Jon Griffith Leave a Comment

This is a very basic explanation of what financing is in the housing world.

When someone doesn’t have enough money to purchase a good or service, such as a home, they typically look to someone who does who is willing to lend that money to them.

In exchange for the use of someone else’s money, the borrower pays a small premium in the form of an annual interest rate.

For example, at the time this was written, interest rates were found to be around 4% to 5% annually. In other words, if you borrow $100,000 at 4% per year, that means that you will pay your lender approximately $4,000 in interest for the first year.

Your payments each month consist of up to 4 parts which are paid to either the bank you borrowed the money from, or the company that your lender hired to collect your payments (servicer.)

(1) One part is called the principal which represents the amount that you owe, and (2) one part is the interest, which is paid to the lender in exchange for borrowing the money. The (3) third payment is a semi-annual (that’s twice per year) property tax payment. The home owner is responsible for paying those taxes, but in most cases, the lender requires that your payment include enough to cover the semi-annual tax payment, and they end up paying the tax bill for you out of what’s known as an impound account. Sometimes there’s a (4) fourth part, and that’s called Mortgage Insurance. If you purchase home with less than 20% down (in other words, $20,000 in this example), then the lender will require that you pay an insurance premium every month. They do this to ensure that they get paid if you fail to make your payments.

At the beginning, MORE of the payment is interest, and less is principle. As time goes on, the interest paid every month decreases, because it is calculated based on the amount you still owe, which is also decreasing. By the time you reach the half way point, usually 15 years, the amount you pay in interest and the amount you pay towards the loan is nearly the same. Later in the life of the loan, you will be paying much more on the loan, and much less in interest.

This is called amortization (the death of a loan) and lenders do this to ensure that they get most of their investment back at the beginning, rather than at the end.

I can’t stress enough how beneficial it will be to you and your family to only consider 15-year fixed rate loans. Anything else will cost you much more and be much more of a risk to your financial well being.

Filed Under: Real Estate Finances Tagged With: home, interest rates, money, paying

The Right Time to Buy a Home May Not Be In A Down Market

August 25, 2010 By Jon Griffith 1 Comment

It’s all dependent upon the interpretation of the term, “The Right Time to Buy.”

For a pushy sales person, the right time for you to buy a home may be RIGHT NOW! TODAY! Don’t WAIT…can’t you smell the steak on this grill? But the truth of the matter is, the right time for you to buy a home is when you are able to, financially. There aren’t any programs, tax credits, special incentives, or “great deals” that should make you feel as though you’re losing out if you don’t buy, especially when you’re not ready to handle the responsibilities associated with owning a home.

That includes when the market is down. In fact, I would submit that the fluctuation in the market is going to affect only a few things for the buyer who is ready, and those things are location, location, location. True, a down market (or a market where real estate is on sale, like it is now) it would be the best time to buy for someone who is ready to buy. But, it may not be until the market has climbed a bit before you’re prepared.

Your finances should be in order before you consider such a commitment. You should have 6 months of reserves based on the prospective home’s costs to survive if you experience an emergency. You need health insurance. You need to be generating income. You need to budget and plan your retirement and your children’s college funds. AND you need to be in the mindset that you won’t enter into a purchase contract on a home until you can put 20% down and take out no more than a 15-Year fixed rate mortgage that carries no more of a payment than 25% of your net take-home pay. You need to have all of your debt paid off, have no car payments, no credit card balances, and no student loans. If you’re about to get married, wait until you’ve been married for a year before buying, even if you’re financially ready.

Sound like an unreasonable proposition? It’s very possible, provided you’ve made some good decisions along the way. If you haven’t, and you’ve gotten yourself deeply in debt, don’t buy a house yet. Wait. I don’t care how “good of a deal” it is, and how “down” the market is. You may not be ready to buy that house until the market is up, in which case, you’ll buy something a bit smaller, perhaps in a different location, but with the goal of owning the home free and clear as fast as possible so that you can pursue the next venture.

The right time to buy a home is when you have a plan that will lead you to not having payments on it.

Filed Under: Helpful Hints, Real Estate Basics, Real Estate Finances Tagged With: debt, home, house, market

Can You Appreciate This?

August 15, 2009 By Jon Griffith Leave a Comment

In most instances, real estate increases in value over time. That makes it a great investment. But as you think about your “investment” consider that those who pay cash for their homes, which most people cannot do, realize the greatest return on their investment.

Let’s take a look at the value of a $100,000 home over a period of 15 Years. I use the 15 year mark because I’ve been converted from the 30-year mindset to the 15-year mindset. Thanks Dave!

In this model we’ll set a steady 5% annual rate of return. Take a look at the chart below as it illustrates the annual growth over the 15 year period.

When you’re done paying off the loan, assuming that the property values increase at a steady average, you should see results much like these, where your gain is approximately $98,000.00.

Comparing Cash Buyer to Mortgagor

Obviously the cash buyer’s return on investment is much greater because they have no interest payments, and they may even have residual rental income on top of the increase in value. This is what will put them ahead of inflation.

But what if you do have a mortgage? Let’s say you purchased a $100,000 home with 3.5% down and a 15-Year fixed note for $96,500 (there are also closing costs, but we’ll leave those out for this illustration). Below is a chart that shows you how much it will cost you to borrow that money:

As you can see, over the course of the loan, you will have paid $39,507.42 more for the home than the cash buyer. Subtract that from the increase in value over 15 years and you have a net gain of $58,485.74.

So, what in terms of rate of return is $58,485.74 over 15-Years on an original purchase price of $100,000.00? That’s a tricky equation, but it yields a rate of return of about 1.97% annually. Add inflation of about 3% – 4%, and you’re losing value.

However, after those 15 years, you now have a paid for home, and you can start using your income to reverse the process to enjoy years of compounding interest on your investments.

The bottom line is that in order to really realize the investment power of real estate, you need to pay cash for your home before throwing away years of interest payments to the bank.

That loss of $39,507.42 invested in growth stock mutual funds averaging 10 – 12% annually over a period of 15 years will grow exponentially.

Filed Under: Real Estate Finances Tagged With: cash buyer, compounding interest, interest payments, mortgage, rate of return, return on investment

The Consequences Of Holding Out

August 14, 2009 By Jon Griffith Leave a Comment

There are three compelling reasons to get a move on when it comes to buying a home. 1) You may be eligible for that $8000.00 first time home buyer tax credit, 2) homes are on sale, 3) most importantly, interest rates will probably increase.

The $8000.00 Tax Credit

First time home buyers have been given a gift from our all knowing, all powerful federal government, provided they close escrow on a home before December 1st, 2009. For more information about this program, and whether or not you qualify, please visit this page.

Homes are on Sale

As you’ve already heard over and over again, due to foreclosures and short sales, homes are at incredible prices, but that won’t last forever. Real estate, over time, is bound to increase in value, especially in Scottsdale.

Interest Rates Increasing

This is the overlooked component by many. So many people look at the price of a home and forget that borrowing money costs money, and waiting for the price of a home to decrease even more could very well be offset by an increase in the interest rate on your loan. At the same time, if you wait too long, you’ll miss out on an additional $8000.00 tax credit from the government.

A $100,000.00 home financed for 15-years on a fixed interest rate of 4.85% will cost you a total of $140,940.00. The same home at 5.85% will cost you $150,940.00. If my math is correct, that’s $10,000.00 more. Divide $10,000 by 15 years and you need to recover $667.00 per month in property value appreciation to offset the loss.

If you wait thinking that $100,000 home may sell for $90,000 in a few months, at 5.85%, which is what the interest rate may be in a few months, you’re paying $145,395.00 for a home that you could have purchsed at 4.85% for $140,940.00. That means that waiting around only saved you $5545.00, not $10,000. AND, you missed the tax credit, so you’re out a potential additional $8000.00.

Shown above, your 15-year fixed mortgage at 4.85% will cost you a total of $140,940 over the course of 15 years with a monthly payment of only $783.00.

The following shows that the same mortgage at 5.85% increases your payment by about $50.00/month and costs you an additional $10,000 over the term of the loan.

The graphic below illustrates that waiting for a $10,000 decrease in price puts you at risk of getting a loan at a higher interest rate, assuming interest rates increase, which most of us expect to happen. Your savings would be determined by subtracting the cost of your $100,000 home at 4.85% from the cost of the same home at $90,000 at 5.85%. The difference is $5545.00. Not as much of a savings as you would have liked.

Filed Under: Real Estate Finances Tagged With: first time home buyer, first time home buyer tax credit, first time home buyers, interest rate, interest rates, money costs

Are You Really Ready to Buy a House?

August 2, 2009 By Jon Griffith 1 Comment

For most, buying a home is the largest purchase they’ll ever make, and it will most likely become the largest portion of their monthly budget as well. There are many programs that have been put into place to make it easier for you to buy a home, but the question you must ask yourself is whether or not you’re truly ready to buy.

I love when I have the opportunity to teach a client about real estate while finding them their first home, but many times, I have felt like telling my client that they’re not ready to purchase a home.

Perhaps that is because I’m rather conservative with finances. I am a tried and true believer of old school finances, which you may be familiar with if you’re a fan of the Dave Ramsey show. Dave Ramsey is a financial expert above all financial experts, who applies common sense and real math to financial equations with the premise that you can become wealthy, self-insured, and be able to live the life you’ve always dreamed about if you simply exercise some patience and hard work.

Those of us who “have to have it now” are part of the majority of people who believe the only way they’ll ever have $500,000.00 in the bank is if they win the lottery. It simply isn’t true.

The simple rule that I follow when I advise clients who are looking to buy a home is to keep their total housing expenses, which include their mortgage payment, taxes, and insurance to about 25% of their take-home pay. This allows you to make room in your monthly budget to do those things that most people say they’ll do, but never get around to doing, like investing for their future, and their family’s future.

If you’re not investing, you’re losing, and there’s no reason in today’s day and age to believe that your payments to “social insecurity” will come back to you by the time you retire. You’re on your own, and you better be doing all you can do to make sure you have taken care of yourself and your family through retirement.

So How Much Home Can You Afford?

Based on the 2009 IRS tax tables, an individual making $40,000.00 per year will owe $6200.00 in taxes. With a smart plan, you’ll be saving that money in an interest bearing money market account rather than withholding it from your paycheck. Why let the government earn interest on your earnings? That leaves you with $33,800 in take home pay. This is your budget. Divide that by 12 and you have an idea of what you have to live on every month. In this scenario, it’s $2816.00. If you follow the 25% rule, your house payment, including taxes and insurance, should be no greater than $704.00 per month.

Another point to note is that you want your mortgage to be no longer than 15 years, and when interest rates are low, you want to fix that rate for the entire loan. So how much home can you afford?

Assuming you’ll be going with an FHA loan with only 3.5% down on a 15-year fixed rate mortgage at approximately 5.3%, the sales price of your home should be in the $90,000 – $95,000.00 range, and no higher. (click here for a list of currently available homes in this price range)

By sticking to the basic rule of 25% of your take-home pay going towards your housing, you should be in great shape to help build your future. Compromise your savings, and you’ll be throwing away your future. If you aren’t able to live by a strong, well-planned budget, and you’re attempting to devote too much of your monthly payment towards your home, you will become house-poor, and you won’t have much to show for it. If this is you, perhaps it’s not the right time for you to buy a house.

Filed Under: Living Debt Free, Real Estate Finances Tagged With: Buying A Home, common sense, dave ramsey show, financial expert, monthly budget, social insecurity