Real Estate Finances

Can You Appreciate This?

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.

The Consequences Of Holding Out

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.

Are You Really Ready to Buy a House?

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.

Arizona Anti-Deficiency Laws Are Changing

The following information was provided by Marc McCain, Attorney at law, regarding the changes that are coming regarding the Arizona Anti-Deficiency legislation.

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.

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