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.

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.

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.

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.

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.

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.

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.

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.

A deficiency is the amount that you still owe the bank after the bank forecloses.  If you are selling your home short of what you owe, or you are about to experience a foreclosure, then this information is important for you.  As always, please seek professional legal council when it comes to your particular situation.  I can help you sell your house, but I’m not an attorney.  We leave that up to the legal experts.

Arizona’s anti-deficiency laws are changing effective September 30, 2009!

The change is designed to limit the type of borrowers that will qualify for anti-deficiency treatment. Set forth below is a general outline of Arizona law regarding when a borrower may be subject to a deficiency action or sued on its note following a foreclosure or short sale. However, borrowers must understand that these are only general rules — every situation must be analyzed carefully based on the specific facts – consult with a professional at all times to determine your rights and obligations in connection with a foreclosure or short sale.

1. In Arizona, if a borrower fails to pay its loan, a lender can foreclose its Deed of Trust lien either judicially per A.R.S. § 33-721
2. If the foreclosure price does not pay a lender what it is owed, the lender may generally seek a deficiency against the borrower for the difference. However, certain states, including Arizona, have what are called anti-deficiency laws that bar a lender from seeking a deficiency in certain situations.
3. In determining if anti-deficiency rules apply, the first step is to confirm what law applies to the loan, particularly the lender’s remedies under the Promissory Note. The applicable law should NOT be assumed. Read your Promissory Note and other loan documents carefully and understand their terms.
4. Assuming Arizona law applies to the lender’s rights under the Promissory Note, Arizona’s anti-deficiency laws are found in 2 places – in A.R.S. § 33-729(A) (regarding judicial foreclosures), and A.R.S. § 33-814(G) (regarding trustee’s sales).
5. In both judicial foreclosures and trustee’s sales, anti-deficiency rules apply only if the property being foreclosed meets the following criteria: (a) 2½ acres or less; and (b) limited to and utilized as a single one-family or single two-family dwelling. However, on July 10, 2009 Governor Brewer signed into law a change to A.R.S. § 33-814(G) which will take effect September 30, 2009. In addition to the above requirements, the trustee’s sale statute will also require that: (a) the trustor has lived in the property for at least 6 consecutive months; and (b) a certificate of occupancy has been issued. Until September 30, 2009, there is NO requirement that the trustor use the property as a residence – residential investment properties satisfy the anti-deficiency criteria. Effective September 30, 2009, investment properties sold at trustee’s sale will NOT qualify for anti-deficiency treatment if the trustor has not lived in the property for at least 6 consecutive months. Commercial properties and loans secured by residential homes being developed for sale but never used as dwellings don’t qualify for anti-deficiency treatment. In addition, a deed of trust that is a lien against more than one property will not be subject to anti-deficiency rules — the deed of trust needs to be a lien against a single trust property.
6. A.R.S. § 33-729(A) also requires that the loan be a purchase money (“PM”). However, the trustee’s sale statute, A.R.S. § 33-814(G), does NOT require that the loan be a PM loan. A PM loan doesn’t lose its PM nature when it is refinanced. However, cash out refi’s raise interesting issues.
7. In a judicial foreclosure, only a PM lender on qualifying residential property is prevented from seeking a deficiency; a nonpurchase money (“NPM”) lender is not – it can obtain a deficiency following a foreclosure or sue the borrower on the note.
8. In a trustee’s sale, both PM and NPM lenders that foreclose on qualifying property are prevented from seeking a deficiency and from suing directly on the note.
9. Junior liens extinguished by a 1st position foreclosure may be able to sue on the note. The issue is whether the junior loan was a PM or NPM loan – if it was a PM loan on qualifying property, the lender can NOT sue the borrower on the note following the foreclosure; if it was a NPM loan, the lender CAN sue the borrower.
10. If a lender can not seek a deficiency, then the lender can NOT waive its security and sue directly on its note. This means that a lender under a PM loan on qualifying property will NOT be able to sue the borrower on the note. This rule also applies to short sales. Note there are gray areas regarding cash out refi’s. Other Lender claims are also not barred – e.g. mortgage fraud.
11. Even if anti-deficiency rules apply, a borrower will be liable to a lender for any diminution in value of the trust property due to voluntary waste. In other words, don’t damage the property, take fixtures, A/C units, etc., or let the Property go to waste.
12. Real property taxes are NOT an owner’s personal obligation, but only a lien against the real property. However, HOA assessments ARE an owner’s personal obligation and if not paid can result in credit damage, lawsuits and other collection efforts.
13. Last, but not least, consult with qualified tax professionals BEFORE deciding to do a short sale or foreclosure. 1099 income, gains, losses and other tax consequences may result from foreclosures, short sales and loan modifications. Know what tax consequences you will face and plan accordingly.

I cannot tell the future, but I can see when there’s a break in a pattern, as you will also see indicated in the graph below. Whenever a market corrects, it usually over corrects to a comparable intensity of the original inflation. Prices were so overinflated, and people have SO overreacted, that the low prices in the valley are deflated and can be considered as artificially low as they were high.

Average Monthly Sales

If I base my opinion simply on the pattern in this graph which outlines average monthly sales in the Greater Metropolitan Phoenix Market, then we are on track to recover, and we will bounce back. Since Arizona is a national leader in real estate trends, we should see a healthy recovery. Again, I cannot predict the future.

It was towards the end of 2003, beginning of 2004 that things started to exponentially bloat, soaring to ridiculous heights, and absolutely crashing as quickly as a 747 filled with solid lead.

In August of 2005, my neighbor bought the same unit I purchased in 2003 for $200,000.00 more than I paid for mine. They are still there. Oops.

The market’s plateau began in approximately June of 2006, rose a bit more, and then decidedly burned in flames at about January of 2008, through March of 2009. The number of homes sold began to increase in May of 2008, but the price continued to drop.

What would have happened if we had continued to grow at a normal, typical rate of 4% per year?  Perhaps the following, showing a line drawn at about a 4% increase over the same period of time.  This shows that a starting value of $175,000.00 would over the time represented in this graph, grow to approximately $244,000.00.

Average Sales with Assumed 4% Annual Increase

One could argue at this point one of two possibilities.  Either a) the market will quickly correct, over correct, and bounce back and forth over the next 8 years or so to find equilibrium along that blue line, or b) the blue line must be adjusted down, erasing all of the growth in this millennium.

If that’s the case, then the home you’re living in, which is now worth what it was pre-Y2K, will not be worth what it should be worth for as long, if not longer than it takes to re-write the entire first decade of this century.  To reach home prices that we should be at, we’re looking at roughly 10 years of steady growth at a “normal” rate.

The problem is that nobody knows what normal is anymore BECAUSE OF THAT GIANT HUMP in the middle of the chart.  Who’s to blame?  Many people think it was the government forcing the banks to lend to people who couldn’t afford it which drove them to “get creative.”  Dave Ramsey calls “creative financing” “Too Broke to Buy a House.”  I tend to agree.

Either way, it will be interesting to see what happens, and ultimately, it appears as though we’ve experienced the beginning of the bottom of this roller coaster ride.  Which means one thing…

If you haven’t bought a house yet, it’s time to buy.  There’s blood in the streets and the street sweepers (the investors) have been very busy recently.  Don’t miss out.

The article, written by Ardell, touches on the apparent importance of the assets that a property owner may have that could affect the bank’s decision regarding whether or not a short sale will be approved.

At present, there’s no guarantee that any lender will approve a short sale, ever.

Just because the value of a property is obviously less than the amount owed, that does not mean that the seller’s lienholder is going to approve the short sale.

Consider this.  If a property owner has a net worth of $1,000,000.00 and they decide to quit paying their mortgage, what happens?  The bank forecloses.  It doesn’t matter if the seller has money or not.  They have made a decision to walk away, and one thing is certain…if you have a home with a mortgage and you quit paying it, the bank will foreclose.

So, when this seller, who arguably is walking away from a moral obligation, decides to attempt to sell the property to reduce their potential deficiency liability and potential income tax liability for current market value, which may be less than what they owe, would it, or would it not be in the bank’s best interest to allow the short sale?  If they don’t allow it, will they waste money on the foreclosure process, and lose money when they list it for sale for less than market value?  They will.

Ardell’s Auto Metaphor

You lend your friend $10,000 to buy a car. He decides to sell it when he still owes you $8,000.  He tells you someone is willing to pay $5,000 for the car and he wants you to take $5,000 as payment in full.  You look at his offer, you find out he he has $15,000 in a savings account.  You find out the blue book value for the car is $6,500. The person who wants to buy the car for $5,000 is getting impatient wating for an answer. What would you do?

My answer?  It doesn’t matter to me whether or not my friend has money in the bank.  The only thing that matters to me is how much the car is worth on the open market, and how much is being offered.

The what you may be missing about this example is the fact that my friend has made a decision to eliminate a debt, and he’s going to do it one of two ways…he’ll either a) let the car get reposessed, or b) try to sell it for as much as he can and ask for a forgiveness of the remaining debt.  True, he may no longer be a friend, but that’s what he’s doing.

So, what do I do?  Well, in this case, the car should sell for $6500.00 based on Kelly Blue Book private sale.  I as the lender now have a few options.  I can a) take the car back, or b) agree to sell it for the offering price, or c) require that my friend find a buyer willing to pay market value.

Perhaps the cost of repossessing the car, reconditioning the car, licensing and registering the car, and re-marketing the car will exceed $1500.00, the difference of market value and the current offer.  In that case, I would be an idiot not to take the offer.  I as the lender, will make smart decisions in mitigating my loss, which means that I would in fact approve the sale.

If all of my costs to resell that car are less than $1500.00, then I would deny the sale and require a higher price.

Should you just take the car and try to sell it for the $6,500 or better, so that you can still collect the amount your friend owes you after you sell the car?

This is a classic example of the tug of war that we face with lenders between the concept of Loss Mitigation and Collections.  At this point, I’m not interested in collecting.  I’m interested in preventing further loss, because I know that my friend is not going to pay.  So, I want to get the car OFF of my books as quickly as possible for as much as I can possibly salvage with as little time invested as possible.

If I am concerned with collecting, knowing that my friend has the money to satisfy the debt, I will surely become bitter at him for not paying, and then I will do something stupid, like refuse to agree to mitigate my loss, which in the end will eat up time and energy, and money.  Give me my $5000.00, get the headache out of my life, and let me put that money somewhere it can begin earning again.

Is it possible to short sell more than one home of the same owner who has plenty of money in the bank but has chosen to walk away from their obligation?  Yes.  Is it right for them to walk away?  That becomes a moral question that the seller would have to ask of his self.

Bank executives understand loss mitigation, and they don’t care about each person’s personal financial situation.  They care about 3 things and 3 things only.

1. Is the owner walking away from the property?
2. What is the market value of the property?
3. What is the current offer?

Anything else has zero bearing, from the bean-counter’s perspective.

Some second lenders (junior lien holders) will hold up the sale of a property because they just want to get back at the seller for not paying.  This is a ludicrous path to follow, because it gains them nothing.  If the senior lien holders were to behave the same way, then ultimately they lose more than if they allow the short sale.

Do lenders have to approve short sales?  No, they do not.  Would it be better if they did?  Yes, but only if it means avoiding foreclosing on the property, which is something that the bank cannot prove the owner has actually decided to allow.

]]> http://www.realscottsdaleliving.com/2009/06/19/its-a-bottom-line-issue/feed/ 0 http://www.realscottsdaleliving.com/2009/06/05/low-ball-appraisals-cause-problems/ http://www.realscottsdaleliving.com/2009/06/05/low-ball-appraisals-cause-problems/#comments Fri, 05 Jun 2009 20:23:34 +0000 Jon Griffith http://www.realscottsdaleliving.com/?p=555 The original article was posted on the NAR website and I have re-posted it here. I don’t typically copy others’ articles since I enjoy writing my own, but for the sake of getting the word out, because I am in the middle of this problem right now, I thought I’d pass it along:

Real estate practitioners in Nevada, one of the areas hit hardest by foreclosures, say low-ball appraisals are slowing sales and preventing recovery.

Mark Stark, CEO of Prudential Americana Group in Las Vegas, says he thinks appraisers are too focused on projecting how much prices could fall rather than reflecting what values really are.

“The appraisers are being very conservative,” Stark says. “They are trying to cover themselves.”

Mark Madsen, communications director for Raintree Mortgage Services, says appraisers are just doing what they’ve been told. “I think appraisers are scared to get blacklisted,” he explains. “If the appraisals are too high, then banks may no longer accept appraisals from that person.”

Source: Brian Wargo, Las Vegas Sun (06/05/09)

My recent experience involved Bank of America on a beautiful home well worth the offering price in Gilbert, Arizona.  Bank of America’s appraiser came in $20,000 short on a property that was worth every penny of the offering price based on comps and upgrades.  There’s no doubt about it.  As a result, we have been forced into a tailspin of events that have caused everyone grief due to the affect that the appraisal had on the loan to value ratio and the ability for my buyer to obtain conventional financing at that ratio.  It’s a nightmare, to say the least.

The lenders, in conjunction with government regulation, seem to be causing the real estate practitioners to bang their heads against the wall as they attempt to put good buyers into properties that they CAN afford.

Supply and Demand

When a supplier (people selling homes) floods the market with too much product (houses) the buyers tend to take longer to choose what they want.  As a result, sellers who are tired of waiting will lower their prices to spur the buyer into taking action.  This is a natural movement that many sellers miss because they don’t understand the LAW of supply and demand.  When the supply is low, buyers climb over themselves to bid on what product is available which drives the price up.

The red line represents the supply.  The green line represents the demand.  The point at which they cross is the market value or market equilibrium.  This is the price that we aim for when we price a home.

The graph can be interpreted as such.  On the demand curve (green) when the price of the product is $1.00, the number of units sold will be 100.  When the price is $10.00, the number of units sold will be about 14.  It’s the economists challenge to set the price of his product as close to market equilibrium as he or she can whereby the most money is made for the least amount of production.  100 units sold X $1.00 = $100.00.  14 units sol X $10.00 = $140.00, but 50 units sold at a price of $6.00 each is $300.00.

Shifting Curves

This is the important note for supply and demand.  When supply is increased, the entire red curve shifts to the right by the number of units produced.  Assuming demand remains the same, the point at which the lines cross will naturally fall and the price will naturally fall.  If the price is not adjusted, the product will not sell.  If demand increases at the same rate as the supply increases, then the price will remain the same because market equilibrium will simply follow along.  True, more product will be sold, but the price will stay put.  Remember, when supply and/or demand increases or decreases, the entire line shifts left or right.  For example, if demand suddenly dropped off for a given product like homes, and there was an excess of supply or a surplus such as we have now, the price point would fall dramatically.

Buyers Market

In Phoenix, we have a surplus of homes.  Nation wide we have a shortage of buyers because of tightened lending.  In many cases, the buyers are really still there, but they’re just afraid to move forward and/or they don’t realize they actually can get a home loan.  While the buyer’s market exists, it means the influence of movement on the supply and demand curve has shifted to the demand curve.  Buyers can ask for more, and have more to choose from than ever before, so why not wait it out?

On the contrary, if it’s a buyer’s market and there is blood running in the streets, take advantage of it because you won’t want to be buying in a seller’s market.

Well, you could still benefit from that profit of $420,000 if you had rented your home out and put someone else’s money to work for you.  But let’s think bigger now.

Let’s say for the sake of argument, that you did have $200,000 in the bank.  What would you do with it?  Honestly, that’s between you and your financial advisor, but let’s look at a basic example.

Assuming you are doing quite well financially and you have a large income, let’s say you decided to split that balance up into 5 equal portions of $40,000.00 each.  Then, you shop around and locate five $200,000 homes that would make great rentals.  You put $40,000 down on each property and the bank extends 5 loans to you in the amount of $160,000 each.  You now own 5 homes, and you owe the bank $800,000.00.  You’ve shown that you can afford the monthly payments, and you’re off and running, hopefully earning a standard property appreciation rate as averaged over the past 10 years or so.  As in my previous example, assuming all of the properties appreciate at 4% annually for 30 years, by the end of that time you will have 5 homes completely paid off all worth $620,000 each for a total real estate portfolio worth 3.1 Million dollars.

What if I’m unable to carry that much debt?

Quite honestly if you cannot afford the debt, you’re setting yourself up for financial disaster, which is where lots of people are right now.  Not only did they invest in a portfolio of properties, but they paid way too much for them on loans with interest rates that are about to adjust upwards and have no equity gained because the home’s value has dropped.  Not only that, but the loans that were written for them were interest only, so every dollar spent goes straight to the bank and nothing goes into the house.

But, for the sake of this example, if you cannot afford to make the house payment, then you find someone who can.  Someone who is willing to rent will cover your costs, provided rental rates exceed your mortgage payment.  So let’s see…

You own 5 homes to the tune of $1,000,000 ($200,000 X 5) and your initial investment is only $200,000.00.  You owe $800,000 in loans, and your monthly mortgage requirements on each home are somewhere in the $1200.00 range.  You manage to put renters in each house at $1300 per month, creating a passive income of $500.00/month ($100.00 X 5 Homes).  The renters pay your mortgage bill which saves you the $200,000 in interest over the 30 year period.  At the end of it all, you’ve tied up $200,000 to leverage the growth of one million dollars worth of real estate resulting in a portfolio of homes worth $3.1Million dollars in 30 years, owned free and clear.

Not bad, but not without risk.  Always remember that there’s risk, and be prepared for the hard times, like when the rents are low, or when you can’t get someone into the home.

No.  There is always risk involved.  There is the possibility that your home will not increase in value, in which case you would end up owing more on the house than it is worth.  So now what?  Sell the house?  Not likely.  You’ll have to ask the approval of your master, the bank.  Think about it.  You started free and clear with $20,000.00, and now the bank owns you, and your $20,000.00.  The debtor is the lender’s slave.  However, if you don’t use the $20,000 for leverage, it won’t grow fast enough to outpace inflation and in 10 years will buy half as much as it can now.

Is it possible to buy a house without borrowing money?

Of course it is.  You just have to have enough money.  Banks are opportunistic.  They know that most Americans don’t have $200,000 sitting around in the bank.  The system has been designed to allow you to enslave yourself under the lender for a small fee, every month.  Here’s how the transaction goes down, it’s quite simple.  You show the bank you can pay the monthly mortgage payment, they write a check to the current owner of the home, then you pay them back over time.  They take your down payment and invest it, and they collect massive amounts of interest from you every month on the outstanding balance of the loan.

In the previous scenario, you made a profit of $200,000 over 30 years.  Imagine if you had paid for that house up front, free and clear.  Your profit would have been $420,000.00.

The truth is, it’s not impossible to get a loan.  Why would they say this?  Because they continue to look in the rear view mirror at all of the high risk, no documentation, interest only loans they wrote over the past few years.  Guess what…those people are not the right people to be buying a home.

So who is it that can actually buy a house right now.

Well, obviously cash buyers can buy a house, but they are few and far between.  The next group of people are the only other group that really have a chance of buying a house right now.  That’s you and me.  The hard-working american who pays his bills on time, consistently, has a low debt to income ratio (and remember that lenders calculate debt to income ratios by including the potential loan that you’d be getting from them,) and has a good credit score.

If you fall into this category, and you’re renting, STOP THE MADNESS.  Buy a house.  Don’t worry so much about the fact that it may not be the perfect home.  Find something suitable that you might be able to turn into a rental down the road, and buy it, and live in it, and make it a home.

If, however, you’re low on income, have nothing to put down, have a low credit score, and don’t may your payments on time, then you can forget about home ownership.  Some people will always be renters.  If this is you, I would recommend learning as much about managing personal finances as you can from someone who knows before you consider even attempting to buy a house.

1. You’re going to lose your job soon.
2. Your interest rates are going to increase.
3. You should not by a house.
4. The world as we know it is gone forever.

ENOUGH ALREADY!

An article posted today at Marketwatch.com states that…

The purchase of a house is the ultimate confidence indicator, and if there’s anyone out there with any confidence these days after what the markets and the financial sector have been through, then you’re talking about the true eternal optimist.

Are you that optimist?  Are you someone who wants to “indicate confidence?”  We in the real estate business know the value of home ownership.  We understand that when you buy a home, you put part of your payment into the value of the house, and part of it goes to the bank.  When you rent, which is what many people who are sitting on the fence are doing, all of your payment goes to the owner of the home, and none of it is invested.  Furthermore, none of your payment will help you reduce your tax liability at the end of the year.  And historically over time, your home will increase in value.

Are you interested in giving yourself a raise?  Then buy a house.

the housing market looks like a sunken soufflé

What a way to make a soufflé unappetizing.  But we’re not talking about food are we.  We’re talking about the concept of buying low and selling high, and the only thing that sunken represents to me is a low point, which is when I would buy.  What about falling prices?  When buyers hold out, sellers drop their price.  That’s just basic supply and demand.

But why, ultimately, are you thinking about buying a home?  Is it purely financial?  I would hope not.  This “sunken soufflé” could give you a perfect opportunity to finally secure a home.  Not a house, not an investment for quick profit, but a home.  Somewhere you can relax and entertain.  Somewhere you can raise your children over the next 10 years.  What you need is a place to call home.

If you look at the market in this light, it makes perfect sense to buy a home.  Real estate is and always has been a long term wealth building investment vehicle, but more than that, it’s your little piece of America that you can rest upon every night when you come home from a long day at work.

The answers are Yes, No, Yes. But we have a more fundamental issue at hand aside from all that we hold dear to our hearts in this capitalistic world. The issue is that we’re greedy and we’re impatient.  Realize that investing is a long term process.  It requires patience and persistence.  We’re not talking about wasting away our retirement in two seconds at the craps table.  We’re talking about creating long term wealth for you and your family and their children and their children.

Can you get rich by borrowing money?

You bet you can.  You can get stinking filthy rich.  How?  By using a little bit of money to push around a large amount of money.

Let’s say you had $20,000.00 to your name.  That’s it, $20,000.00, no more, no less, and you wanted to purchase a home priced at $200,000.00.  Do you have $200,000.00?  No way, but you were patient and persistent enough about your spending to save 10% of that.  Should you be rewarded for this type of behavior?  Probably not.  It’s just savings.  Good for you.  So how do you acquire an asset worth 10 times as much as you have in the bank?  And, why would you want to do that?

Well, that’s easy.  Firstly, you find someone who is willing to cough up the difference of $180,000.00, you pay them a premium for it over time, and voila, you have your $200,000.00 house.  By the time you’re done paying for it, assuming you buy now, you will have paid $400,000.00 for your $200,000.00 home.  Well, that’s sounds stupid.  Why would I do that?  Here’s your answer:

When you use a small amount of money to leverage a large amount of money, you have the potential to realize gains calculated on the larger amount rather than the smaller amount.  So by the time you’ve paid off your loan in 30 years, it is likely that your home will be worth far more than the $400,000.00 that you paid for it.  Let’s say that after 30 years your home is worth $620,000.00.  You paid $400K for it, so your $20,000 grew in 30 years to $220,000.00.  Not bad.

Stay tuned for the next in this 3 part series…