Facts, Fiction, and the Fantasy of Real Estate

So you are thinking about buying a home, and are exploring your options. The old school philosophy is 20% down, but is putting your hard earned money down the best option for you? Do you have money to put down? 5%, 10% 15% or 20% are the most common down payments without question, but is this the best way to spend your money?

That is what this entry is about. Of course this issue is not black an white – every situation is different, therefore I suggest you use this discussion as a guide for your personal situation, and if you have questions you can either comment for a board range of opinions and suggestions, or email me and I will provide you with my professional opinion confidentially: peter@approved-online.com.

 The obvious first step is deciding whether or not you have money for a down payment. For those without any real savings this is an easy conclusion. For other that have savings that they can put toward a down payment but will virutally tap you, this is a serious question that needs to be given some thought. Then there are those of you that have enough savings to allow you to make a down payment without wiping out your entire savings.

100% financing can be accomplished in all of these situations, but the advantages and disadvantages are a little bit different based on the above situations. The most obvoius advantage of 100% financing is you are not using any of your own money to buy your own home. Leveraging someone else’s cash even if it is an institution’s is one of the best kept investor secrets. Donald Trump has gotten to where he due to his ability to find financing for major projects. Using some else’s money allows you to use your money in other ways while benefiting from the appreciating investment you are still apart of despite your not contributing initial capital. If you put zero money down and the property appreciates 20,000 dollars; that’s an incalcuable/exponential return on investment (ROI) where if you had invested 30,000 initially and made 20,000 your ROI would be 67%. Of course 67% is not bad, but if you had financed the full loan and had put your 30,000 in a Mutual Fund that had a 15% ROI. Not only would you have 20,000 from the appreciation of your home, you’d have an additional 4,500 profit from investing that 30,000 in another investment – point in fact you have diversified.

Now for the majoy disadvantage, if you’re home doesn’t appreciate, there are only two other options, it retains its value and you sell it for what you bought it at, or it depreciates, and you owe more than it is worth. Despite this disadvantage, the potential for depreciation (home value holding is not really as large of a concern) is something that any homeowner faces. Had you put a down payment down, you just lost that money (or a part of it) and can no longer look to alternative investments. If you used 100% financing, yes you owe more than it is worth, but if you plan on sticking around for a while, you still have money you would have used as a down payment to make money in an alternative investment, stocks, bonds, money markets… you get the point.

 Which brings us to the next point. How long do you plan on staying in the home and how is the local housing market? These are very important questions. Real estate is a long term investment. Yes we have all heard of house flipping and pyramiding (I’ll write about that at a later date if you haven’t so don’t forget to subscribe to my blog) and the fortunes people have made. But just like day trading they can lose it just as quickly… anyone else hear about the day trader who recently lost 5 billion in a single week? Well flipping real estate is like investing in penny stocks – they can go up quickly and down just as fast. Of course it is for different reasons – many equity is not liquid and it takes time to sell a home, so if you are spread to thin and are unable to sell you start reducing prices and a slippery slope follows. I make this point because real estate is a long term investment. If you are planning on staying in your home for a long period of time, then 100% financing makes more sense than if you plan on moving in 6 months. Of course this conculsion is based on todays flat market. Two years ago I would be singing a different tune. If you happen to be in an area (real estate markets are obviously regional) that is booming than you may take a hard look at 100% financing so you can flip, but I’d make sure that look is a HARD look… 100% financing is risky right now if you are thinking short term because if values fall and you wnat to move and don’t have the capital to pay off the loan that is now for more than your home is worth, things can get ugly. Generally speaking of course, real estate will appreciate which is why 100% financing is much safer for this type of borrower.

Probably the only real disadvantage 100% financing has is its effect on a borrower’s cashflow. You will pay more for this type of loan, moreover you will probably have a second that is at a higher rate than you are willing to consider. My advice is consider it, because it isn’t the rate on the second that is going to run you under. It is the blended rate – the combining of the 1st and 2nd – that matters. To find your blended rate. multiple your first rate by 80% and your second rate by 20% and add those two numbers together (formula for your typical 80/20 loan), that is your blended rate. NOw for the good news these rates are tax deducible so you have a larger write off than you would with a single loan (obviously you should discuss this with your tax preparer), so if you can afford the payments and are not stretched to thin, then you still may want to consider it.

Finally we come to programs…. This is where the qualified buyer (assets)  has the advantage over the under qualified buyer (no assets). If you are in a position to put money down, you will most likely be able to get a longer fixed term on your first then you would if you cannot put any money down. Remember these loans are great as long term vehicles. Getting into a loan that you are going to need to refinance in a couple of years because of an adjusting rate is basically like selling your home, you are going to need to get an appraisal done which means if value has shifted against you, that rate will probably go up, and you will be paying significantly more than you ever thought it would cost you. This is why we are starting to see more and more foreclosures, so if you don’t think it will happen to you, I hope you are right, and consider yourself warned.

These are the nuts and bolts. I could go on, but this will give you enough to get started, and allow you to consider the options in front of you. Ultimatley you should talk with a professional that understands your future goals and is willing to go over the specifics on your situation. This is an important step that should not be overlooked. If you find youself working with someone that is taking the hard line and telling you what you should be doing without listening to your position, than take a step back and find someone that is not going to pressure you, and above all things, make sure you are comfortable and understand the program, if you are not, no matter what the benefits are, you are going to be living in a constant state of fear and will never be happy. Get all the facts, know how the program works and you are comforrtable with it. Only when these things fall into place will you have a finance program in sync with your overall financial goals.

 peter@approved-online.com