Real Estate Basics

The Debate Continues: One User’s Opinion on Renting vs. Buying

As with anything, there are pros and cons that change with every complicated variable involved.  The concept of buying being better than renting is relative to the context of each side of the equation at any given time.  No two situations are the same, but generally speaking, assuming certain conditions are already met, owning a home is MUCH BETTER for long term wealth building than renting.

In an article that I wrote back in 2008 on the SonoranHouse.com blog, I illustrated the financial benefits of renting vs. buying.  Here’s what one user had to say, along with my thoughts on the response:

WRONG… Renting is FAR better and Cheaper than buying a house.

Not so fast.  There are too many variables involved, and each situation is different, but the principle cannot be disputed.  Owning is a long term prospect.  Not short term.  In order to conclude that owning is better, one must assume that the property will be held for as long as possible.

1. The down payment is $20,000 OUT OF YOUR POCKET on day one. SO by purchasing a house you are immediately $20,000 POORER the day you buy your house. In contrast, you can RENT and only pay a SMALL deposit equal to 1 months rent and keep the rest of your $19,000 to use as a safety net to pay the rent with and live an easy STRESS FREE life knowing you have the rent covered for 19 months if it’s a $1K a month rental.

When you pay a deposit to a landlord, it is a fee that can never be recovered.  When you put money down on a house, you are instantly investing your hard-earned cash in an appreciating asset.  You are not spending the money.  Again, if your investment mindset is short term and you sell your home too quickly, you will certainly cut into your initial down-payment unless your property experiences unheard of appreciation in a short time period.  Not likely to happen again.  Buying real estate is a long term wealth building investment.

A rule of thumb for an emergency fund is 3 to 6 months worth of living expenses.  If your rent is $1000.00/month, you have 19 months of rent paid for, but that doesn’t take into account the rest of your expenses.  If a down payment on a house depletes your living expenses, they you are not ready to buy.  Your down payment should be above and beyond your 3 to 6 months.  So, if your expenses are $2000/month, you should sock away about $12,000.  The rest can be used towards your future down payment.  This all assumes that you are completely out of debt.  If you aren’t, then you shouldn’t be buying a house in the first place.  Most renters do not have this much money saved up and they live paycheck to paycheck, so they feel they NEED to have some sort of financial buffer to buy them time.

The problem with this is that they never get OUT of the rat race by behaving this way, and they never put their money to work for them.  They will live the rest of their lives working for their money.  What would be the difference between having 19 months of STRESS FREE living in a home that is appreciating in value versus apartment living with the same amount of a safety net?  The difference is that part of your monthly payment is being added to the home’s equity.  Some of that payment will be recovered.  NONE of the rent will.

2. The Tax Deduction is nonsense… You spend $1.00 in Mortgage Interest to deduct .10 cents off your tax bill. HARDLY a “savings” at all. Your still LOOSING .90 CENTS in interest!! WAKE UP PEOPLE!!

Tax Deductions are a poor excuse for people who are poor to continue to be poor.  The argument here is that it makes sense to pay the bank $1.00 in interest to avoid paying the government ten cents.  Obviously that is flawed thinking.  Spending 90 cents to save 10 is absolutely ridiculous.  That is why the largest mortgage anyone should be financing is a 15-Year fixed.  Obviously paying cash is the best way to buy a house.

3. When you own a house you pay PROPERTY TAXES each and every year. These taxes are about 1.5% of the value of your home or around $3000 a year. That’s $3K a year your LOOSING if you own a house.

Hmmm…let’s see.  Property taxes at $3000/annually, deductible at your tax bracket rate, or $12,000 wasted on rent.  Personally, I’d rather put the remaining $9,000 in growth stock mutual funds to offset the perceived loss, because by the time my $9,000 per year is invested over 30 years, it will pay the property taxes a few thousand times over.

4. When you own a house you pay Property INSURANCE on your house each year. This will be about 1% of the value of the home so figure $2000 a year on a $200K house.

I own a $200K home.  Taxes and insurance annually do not exceed $3000.00.  In fact, they don’t exceed $2000.00.  This has everything to do with location and tax rates.  Again, I’d rather cough up $2000/year for insurance than blow $12,000/year on rent.  So based on points 3 and 4, which add up to $5000.00, I’m still ahead with $7,000 invested annually in growth stock mutual funds.  Come to think of it, my down payment of $19,000 as used in this example will be reimbursed fairly quickly.

5. When you own a house you pay for ALL MAINTENANCE/REPAIRS/REMODELS. This means spending about 1.5% of the value of your home EACH YEAR to keep it in livable condition so figure another $3000 a year on maintenance/upkeep.

Nobody forces remodeling, so we’re going to remove that from the equation.  Deferred maintenance is a price that everyone has to pay for, whether you own, or you rent.  As the king of your castle, you determine what’s used on your property to improve and maintain it and you have a choice over the cost/savings realized from it.  By renting, you have no control over these things, and the cost of rent is at the discretion of the landlord, who can easily raise it high enough to force you out to make room for someone else as a result of increased management costs.  Owning your own home offers greater long-term housing security.

6. In order to “get your money back” out of your house you will need to SELL your house. This means FINDING SOMEONE ELSE TO BUY IT. You’ll have to pay Closing Cost, Real Estate fees, etc. and it can take a LONG TIME to find a buyer. THEN even if you sell, you will have to live somewhere so you would have to turn around and buy ANOTHER house or do what most smart people do in the first place… RENT.

False.  As a long term investment, the asset appreciates and the value of the loan decreases over time.  If you paid cash, you have an instant money making machine creating passive income.  If you didn’t, you’ll eventually reach a point at which renting your home to someone else will generate positive income above what you owe on the mortgage payment.  The tone of point number six seems to emphasize the dependence upon cash in the bank to provide a safety net.  Obviously if you’ve been able to save $19,000, you’re making more than you’re spending, so the time that it takes to sell should be irrelevant unless you’re forced to move via relocation or other circumstance beyond your control.  It’s true that if you sell too early, you’ll erase your gains because you didn’t have a long term mentality.  There is so much more risk to buying a home when you borrow, but if you are able to pay cash for a home, then I’d say you’re living well financially.  One’s intelligence is not a factor determined by the decision to rent or buy.  One’s wealth, however, is.  If you want to get rich and live free like nobody else, then you’ll invest wisely.  Renting is not investing.

Owning a house ONLY makes sense IF you could pay CASH for it. Even then, your still going to “Throw money away” on Taxes, Insurance, Maintenance, and the excess bills that come from owning a house when if you RENTED many of those bills are included in the rent.

Paying cash for a home ISN’T THE ONLY time it makes sense to buy a home.  It is the BEST practice for sure, but you’re not throwing money away on taxes because your home is appreciating in value, and in theory, you’re renting that home out, collecting $1000.00/month rather than spending it.  Can you imagine how nice it would be to be able to put $12,000.00  less a few expenses every year without having to work for it?

The fact that there are additional bills when you own versus renting is also a false assumption.  Do the math over a long period of time.  Take the appreciation of real estate and the potential passive income from owning a rental and see where it would be in 30 years if invested wisely, long term.  Compare it to the real costs of owning.  Remember, we’re talking about ownership versus renting.  We’re not talking about owning a high cost property that has no potential to generate future income.  That would not be a wise investment.  Of course, you could just keep on throwing your hard-earned money away.  In fact…

…I’ll look forward to renting one of my properties to you because you sound like the perfect tenant.

A Few Things That Can Screw Up A Short Sale

Aside from the normal list of problems that a home can encounter through the Escrow process, there are a few things that happen that are specific to Short Sales that can kill the deal.  I’ve outlined 5 that I have come across and a little bit about each experience.

Failure to Provide Documentation

Your REALTOR®’s job is to help you sell your home before it forecloses.  This means marketing it well, pricing it right, attracting an offer, then submitting the offer to the lender.  The process for each lender is different, but similar.  There is one consistent factor that will slow down a short sale every time and that is the failure of the Seller to provide their REALTOR® with the documentation that your lender requires in a timely fashion.  Every day you wait to provide that information is another day closer to foreclosure.  When your REALTOR® asks you for documentation, make sure you provide it as quickly as possible.

Bad Broker Price Opinion (BPO)

One of the first actions that the lender takes on your house is ordering a Broker Price Opinion on the property to get a bottom line number from which negotiations can be based.  BPO agents are many, and as expected, when you’re dealing with a lender who doesn’t know the market, you’re also dealing with a lender who doesn’t know that the BPO agent they’ve hired to provide the price opinion may also not know that market.  If the BPO comes in at a price that your REALTOR® knows is invalid, or off-base, it places more of a burden on them to provide substantial data to prove that the offer that you’ve received is a fair market value offer.  If you can’t prove that, then the buyer will need to increase their price, or you’ll be looking for a new buyer, and that eats up valuable time.

Poor Pricing Strategy

Your REALTOR® should have a pretty firm grip on the market where your property is located.  This will enable him or her to develop a pricing strategy within the given time frame to lead the market in aggressive yet fair market pricing in order to attract an offer as quickly as possible.  You’re selling short, so price is of little or no concern to you, as you won’t be seeing any of the proceeds.  Your goal is to get out of the house as soon as possible.  Follow your REALTOR®’s advice on pricing and price adjustments, provided he or she knows what’s going on.  If they don’t, move quickly to find someone who is qualified.

Slow Response Times

In a real estate transaction, there are literally a dozen people involved in the process.  In a short sale transaction, there are even more people involved.  In fact, the people at the bank are probably the most likely to delay the process, and that’s pretty much a guarantee.  It’s important that you have someone on your side who is quick about getting the information that you were quick to provide to the lender.  It’s also important that your REALTOR® have the experience to orchestrate most of the transaction, including being involved in the buyer’s side of the transaction.  Buyer’s lenders are the second most liable party in the loss of time throughout the transaction.  Some of these you’ll have no control over.

Mortgage Insurance

If you don’t have mortgage insurance on your note, it’s possible that the investor who purchased your note took out a policy without you knowing.  This is perfectly fine for them, but once the loan servicing company (the company that you send your payment to) approves the information that they have received from you and your REALTOR®, it’s time for them to submit the file to the investor.  If the investor took out a policy on his or her investment, then they will have to deal with the approval of the mortgage insurance company, and that can be difficult, but possible.  Many times MI companies will ask you to sign a personal guarantee to pay back a portion of the deficiency (what you’ll still owe after selling) instead of releasing you completely.  I work hard to make sure this does not happen.  After all, you’re selling your home for less than it’s worth, and you’re doing so because you don’t have any money.

In a real estate transaction, there are literally hundreds of things that can stop everyone in their tracks.  The five short sale obstacles that I’ve offered you here today are some of the most common hiccups I’ve experienced.

What is Escrow?

Escrow, according to the Online Etymology Dictionary, is a “deed delivered to a third person until a future condition is satisfied.”

Let’s do a backyard bargain example of escrow.  Bob is selling a lawn mower for $400.00, and Joe wants to buy it, but Joe and Bob don’t know each other very well.  They both, however, know Fred very well.  Joe has $50.00 in his pocket, but he’ll need to come up with the balance by borrowing it.  He’ll also need to have a mechanic take a look at it before he commits to buying it.  Bob accepts $50.00 from Joe to hold the lawn mower until it is inspected and the loan comes through, but since Joe doesn’t know Bob very well, Joe tells Bob that Fred will hold the $50.00 for both of them until the deal goes through.  Joe gets the loan, inspects the lawn mower, and decides to move forward with the purchase.  Joe’s bank wires the funds to Fred, Fred tells Bob that the funds are good, and Bob tells Fred that it’s okay to release the lawn mower to Joe.

As a buyer or seller, it’s important to be sure that all of the conditions of the property sale have been met before the property and money changes hands.  It is:

“A transaction where one party engages in the sale, transfer, or lease of real or personal property with another person who delivers a written instrument, money or other item(s) of value to a neutral third party.”

In the case of real estate in Arizona, this would be the Title/Escrow company.  The escrow company holds the money or the items until a specified condition has been met, at which point the item(s) or money is released.

The escrow holder, who is impartial to the terms of the transaction, carries out the written instructions given them by the people involved in the transaction (the buyer and the seller.)  The instructions are in the terms and conditions of the purchase contract.  Included in this is the receiving of funds and documents necessary to comply with those instructions, and completing or obtaining the required forms and handling delivery of all of the items to the proper parties upon a successful completion of the escrow period.

When all of the instructions have been carried out, including providing tax statements, loan documents, earnest deposit(s), and other particular services to be paid to principals to the transaction, a successful closing can take place and the property ownership transfer can be recorded at the county recorder’s office.  This is when title to the property changes hands and title insurance policies are issued.

What is a Loan Status Report?

In Arizona, our Residential Real Estate Purchase Contract includes a section for financing that requires a document called the Loan Status Report be included with the contract if financing is being sought by the buyer.  If the transaction is a cash transaction, we skip this requirement.

The Loan Status Report, as required by Section 2d, Lines 62-63, which states that:

“The AAR Loan Status Report (“LSR”) with, at a minimum, the Buyer’s Loan information section completed, describing the current status of the Buyer’s proposed loan, is attached hereto and incorporated herein by reference”

is required if you’re seeking financing.

Why?  Because the seller needs to know that you’re serious about buying the house, and that you’re actually able to buy the house.  When you open escrow, the status of the property will be changed from Active, to either Active with a contingency (AWC) or Pending.  This makes it less likely to attract attention, and essentially “takes it off the market.”  Time is money, and of the essence in a real estate transaction. 

Feel free to download a sample LSR today!

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