Buying a Home 3: Refinance, Foreclosure, Making Money in Real Estate

buying a homeBuying a Home Part 3:  Is buying a home a good idea and is it an asset or liability?

The answer of a home being an asset or liability is not so straightforward, and may be either or both.  The reason for this is that if you have a mortgage and make payments, it goes on your taxes as a liability.  However everyone needs to eat and sleep and it’s nice not to have to pay for someone else’s mortgage through rent.

You can also build up equity in the home you own, as it increases in value, which can help you with extra cash that you can invest elsewhere.

Many times buying a home means we will have a mortgage thus obtain a liability. However owning the property outright means its stated as an asset, because it has value, and may even be worth more than you paid for it.

So it really depends on who owns it (you or the bank), how much you paid for it, and how much it’s worth.

As far as being a good idea to own a home, it kind of depends on what you own, where it is located, and how much it costs to rent a house.  If you buy a house in need of allot of repairs, in a lousy neighborhood, paid a high price for it, and have to drive a long way to work and back, than its a probably a lousy idea to own that house. However, if you are near your work, get a good price, for a decent house, in a good neighborhood, than it’s probably a good idea to own that house.

Also if rent is so low in the area you want to live, than it’s probably a good idea to save on the mortgage payments, and put your money to work elsewhere.


snorkelingWhat does it mean to refinance, what does it do and what is underwater?

When buying a home sometimes we get locked into a high interest rate. To refinance something means to go back to your lending institute to try to change the conditions of the loan.  The good thing about refinancing is you may be able to lower your monthly payments, get more cash out of the loan, or change the length of the loan to best suit your long term objectives.

The problem with a refinance is they usually cost thousands of dollars to process, and puts you farther into debt.  The term underwater means that the loan amount is greater than the value of the property, and that the owner may not be able to keep making the payments. Let’s look at all three reasons why people refinance.

1. Changing the length of time.  The longer you take to pay off the loan, the lower your monthly payments will be.  However the more you pay in interest in the long run. Many do this to help them afford the home they live in, because now the monthly payments are lower.


2. Changing the amount you borrow.  This can only be done if the banks send out their appraiser, to determine if the current value is higher than what you owe on the property (called equity). If the difference is significant, than a bank may loan you up to 80% of the difference in value. For example if you owe $100,000 on a home, but it’s appraised at $200,000, the bank may loan you up $80,000 in cash on top of your current loan.

The bank will also add the processing fee (often up to 10% of the cash amount) on top of this figure, and then change the amount you owe each month (or lengthen the terms of the loan).  This may be a good way to get extra cash, but has also caused many problems and forced people to lose their homes later on.  The reason for this is people will spend this new money foolishly, and then not be able to afford the higher mortgage payments a few years down the road.


 3. Lower your monthly payments.   This does not mean the bank lowers the amount you owe; it just means they either make the length of time longer, or by lowering the interest rate on the loan.  By making the loan term longer, they can lower the monthly payments, and stretch out the amount of time needed to pay off the loan. This has allowed people not to have to go into foreclosure, but the bank makes more in fees and interest in the long run.

The other way is to lower the interest rate.  If you lower the interest rate on a loan, the monthly payments decrease, because most of your monthly payments go to just pay off the interest.  With the interest lower, the overall cost of the loan decreases, as does the monthly payments.  Now obviously the best deal for the bank is a longer loan, but sometimes you can renegotiate both, because it’s better for the bank to have you making payments than to go through a foreclosure.


jumping-off-cliffI hear about foreclosed homes and buying on short sale, what’s it mean?

When buying a home sometimes a foreclosure or short sale can save us some money. A foreclosure is when a bank or lending institute takes back a property when someone is unable or unwilling to make the payments on their mortgage.  This process is called foreclosure, and typically will not start until someone is 3 months behind on payments.

When it comes to real estate the truth is banks technically own most properties.  When you get a loan on a property, car, or other large purchase, the bank keeps the ownership papers, which they sign over to you when you finish paying the loan.  If you stop making payments, the bank has the right to take ownership of the property.

The laws change state-to-state, and country-to-country, and some states allow the bank to come after the previous owner for the balance of what is owned after the property is resold. The foreclosure typically takes a few months, to a few years to complete.

Some institutes will work with you to refinance, or to change the conditions of your loan to help you make your payments.  When a property is foreclosed on the bank will typically try to sell it right away, and list the property as a “bank owned” property.

A short sale is when a previous owner can sell the property before it’s foreclosed on.  This allows the bank to sell the property, while the owner is released from the obligations of a legal foreclosure (which goes on their financial records).  The problem with the term short-sale is a short-sale can take a long time to process.

This is because different, more complex rules apply to short sales which include – the previous owner or renter may still live in the property, the bank has to decide if they want to sell to the new buyer at a lower price, new buyer has to process many legal documents and prove they can afford the property etc.


buying a homeBuying a home: How do I make money on real estate?

If you buy property as an investment, you can make money by selling a property for more than you bought it.  You can also make money by renting or leasing the property to others. However you must take into account the amount of money spent in taxes, insurance, maintenance, management and buying and selling fees involved in the process.  This is called cash flow.  The way you make money is for this to be positive, meaning you take in more in rent than you spend in expenses.

When buying a home the break down basically includes.

Income:  Money brought in by renters, or by the amount of money made through various lease agreements.  There is also equity that can be derived from the property, over time, if the value increases above the original purchase price. If the price increase is real enough, one can get a loan, on this value, from the bank or mortgage company.  If you use this money foolishly it will just put you farther into debt.  However, if you invest this money wisely, like purchasing another property, you may be able to increase your income through this new investment.


Down payments:  The down payment is the amount of money you have to pay to purchase a property.  This amount typically ranges from 10 – 30%. The rest can be covered by a loan.


Mortgage payments:  A mortgage is the amount you own a bank or lending institute that loaned you the money to buy the property.


Interest payments:  The interest payments are the amount of money that goes to pay the interest on the loan.  The amount you borrow is called the principal, and both are included in the monthly mortgage amount. In the beginning most of your payment goes into the interest, later in the loan more goes into the actual loan. So the sooner you pay off the loan the less you pay in interest.


Price paid for the property:   The price includes all the fees and service charges paid during the process of purchasing a property. If you paid cash for a property than you will not have to pay a mortgage, or mandatory insurance, and can save a ton of money.  However since many interest payments on loans is tax-deductible it may be better to get a loan depending on your situation.


Taxes:    Taxes on real estate are generally called property tax.  The amount is usually derived out of charging a certain percentage of what the property is worth.  Each area has a different formula, and some states have extremely high property tax, and can be higher than insurance and management fees combined.  There is also capital gains tax charged on the profit you make after you sell a property it held for more than two years.  For a primary residence after two years there is no capital gains tax.


Insurance fees:    If you have a loan from a bank, than they will need you to buy and maintain insurance on the property.  Usually it involves casualty and general liability like fire, flood, earthquake, tsunami, hurricane, personal injury etc.  There is also mortgage insurance, which covers your mortgages if you can’t make the payments.  It often various region to region, and the amount may change on what the property is worth, location, kind of property, and what is required by law.  If you paid for the property with cash, than it’s usually left up to your own discretion as to what kind of insurance you need to purchase.


Management fees:  When you have an investment property someone has to manage it. If you do not know how, or do not live near the property, than you will have to pay for someone to manage the property.  This typically includes hiring someone, or some company to find and keep renters, deal with complaints, find maintenance people for upkeep and repairs, handling paperwork and helping with taxes and insurance. The fee generally ranges from 8 – 15% of the income generated by those paying rent.


Maintenance fees:  These basically include everything to keep the property in good shape and rentable.  For residential it runs about 12 – 15%, and for commercial property it can run 18-22% of amount of money brought in each year in income.  Of course this is just an estimated figure and it is itemized out over the life of the property. When you buy a condominium or townhouse there is a monthly fee that all unit owners pay, which covers most of the exterior, landscaping, site work, parking etc.


Buying a Home Conclusion:

It may all sound like a lot of work, and it is. Although if you don’t handle stress well, and shy away from complicated transactions, than you might look into another form of investment.  As in every transaction, the above items might not all apply, but most will be a part of the process. If they are, each needs to be included in the decision of buying a home or purchasing real estate and remember it is an investment. If you already own a property, than here is what you can do to decide if you are cash flow positive.

If you do not own a property yet, but want to, than you have to try to find out what each may cost you. You can do this by researching history of the area, how much rent is nearby, what kind of utility costs there are, how are property taxes charged, what kind of loans are available, etc.

To find out if a property has good cash flow, just add up all the items above in an expense column, and minus the total from how much the property brings in over the year. This figure will give you a good idea on how the property is as an investment or on which areas you can change to make the property a good investment (typically by trying to negotiate lower taxes, cheaper insurance, lower maintenance fees etc.)

Remember when buying a home it’s best to run these figures out over a time, say at least 3-5 years.  You can also check to see what other similar properties are selling for, and see if the value is increasing or decreasing.  This way you can get a feel for how much the property is making, or loosing, and whether the property has a chance to increase in value over the time you want to keep it.



For more information on Buying a Home.

Buying a Home 1: Understanding Real Estate

Buying a Home 2 – Realtors, Escrow, Appraisals, Assessments

Buying a Home 3: Refinance, Foreclosure, Making Money in Real Estate


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