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Can you make a killing buying fixer-uppers? |
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Many people are enticed by the
prospect of making money by
repeatedly buying rundown homes,
moving into them, fixing them up and
reselling them for a profit. The
strategy has become even more
popular in recent years, thanks to
homeowner-friendly changes in the
capital gains portion of the federal
income tax code. Given all the right
circumstances, fixer-uppers can be a
lucrative investment, but they're by
no means a sure bet or a license to
print money.
Is the fixer-upper life right for
you? Here are some questions to
consider:
1. Do you have the expertise
required to meet with contractors or
make major improvements yourself?
Most homeowners know how to paint a
bedroom or install a new light
fixture, but those routine chores
are a far cry from adding a second
bathroom, remodeling an out-dated
kitchen, landscaping an entire front
yard and the like. Tackling these
improvements without the necessary
experience and expertise can lead to
costly mistakes. And if the home
really only needs easy, inexpensive
or purely cosmetic repairs, your
efforts probably won't add enough
value to be profitable.
2. Do you have a working
knowledge of which improvements are
likely to add value? As a
general rule of thumb, improvments
that are invisible to home buyers or
merely bring the home in line with
expected minimum standards don't add
much resale value. If you make the
wrong improvements, you won't see
much, if any, return on your
investment. Another potential
pitfall is over-improving the home
compared to other homes in the
neighborhood.
3. Are market conditions in your
favor? There's nothing worse
than buying a fixer-upper with the
intention of making a profit in a
couple of years only to discover the
real estate market has turned sour.
If home values are depreciating,
your fixer-upper might be worth less
than you paid for it even if you
make wise investments in
improvements.
4. Are you prepared to pack all
your belongings, put your home on
the market and move every few years?
Moving is time-consuming and
stressful, even when it's
anticipated and welcome. Will your
spouse cooperate with repeated
packing and unpacking? How will your
children cope with switching to a
new school every few years? Will you
be able to bond with your neighbors?
How much will it cost to move your
furniture and household goods?
5. Will transaction costs wipe
out your profit? A convincing
argument can be made that even the
considerable advantages of
homeownership aren't always worth
the transaction costs associated
with buying a home for a short-term
residency. The same advice should be
taken to heart before you buy a
fixer-upper with the goal of making
a profit. Will the higher resale
value of the home exceed your
purchase price, plus your
investments and your transaction
costs? If so, will the profit-even
tax-free--be adequate compensation
for your time and effort?
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Do
You Know What You Want? |
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Whether you
are a first-time homebuyer or
entering the marketplace as a repeat
buyer, you need to ask why you want
to buy. Are you planning to move to
a new community due to a lifestyle
change or is buying an option and
not a requirement? What would you
like in terms of real estate that
you do not now have? Do you have a
purchasing timeframe?
Whatever your
answers, the more you know about the
real estate marketplace, the more
likely you are to effectively define
your goals. As an interesting
exercise, it can be worthwhile to
look at the questions above and to
then discuss them in detail when
meeting with local REALTORS®.
Do You
Have The Money?
Homes and financing are closely
intertwined. (Financing is the
difference between the purchase
price and the downpayment, commonly
referred to as debt or the
mortgage.) The good news is that
over the years new and innovative
loan programs have evolved which
require a 5 percent downpayment or
less. In fact, a number of programs
now allow purchasers to buy real
estate with nothing down.
In addition
to a down payment, purchasers also
need cash for closing costs (the
final costs associated with closing
the loan). Several newly emerging
loan programs not only allow the
purchase of a home with no money
down, but also underwrite closing
costs.
Not
everyone, however, elects to
purchase with little or no money
down. Less money down means higher
monthly mortgage payments, so most
homebuyers choose to buy with some
cash up front.
As to
closing costs, in markets where
buyers have leverage, it may be
possible to negotiate an offer for a
home that requires the owner to pay
some or all of your settlement
expenses. Speak with local REALTORS®
for details.
Is Your
Financial House in Order?
Those great loans with little or
nothing down are not available to
everyone: You need good credit. For
at least one year prior to
purchasing a home, you should assure
that every credit card bill, rent
check, car payment and other debt is
paid in full and on time. |
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Look
at your income to get a
guesstimate
As you
think about applying for a home
loan, you need to consider your
personal finances. How much you
earn versus how much you owe
will likely determine how much a
lender will allow you to borrow.
First,
determine your gross monthly
income. This will include any
regular and recurring income
that you can document.
Unfortunately, if you can't
document the income or it
doesn't show up on your tax
return, then you can't use it to
qualify for a loan. However, you
can use unearned sources of
income such as alimony or
lottery payoffs. And if you own
income-producing assets such as
real estate or stocks, the
income from those can be
estimated and used in this
calculation. If you have
questions about your specific
situation, any good loan officer
can review the rules.
Next,
calculate your monthly debt
load. This includes all monthly
debt obligations like credit
cards, installment loans, car
loans, personal debts or any
other ongoing monthly obligation
like alimony or child support.
If it is revolving debt like a
credit card, use the minimum
monthly payment for this
calculation. If it is
installment debt, use the
current monthly payment to
calculate your debt load. And
you don't have to consider a
debt at all if it is scheduled
to be paid off in less than six
months. Add all this up and it
is a figure we'll call your
monthly debt service.
In a
nutshell, most lenders don't
want you to take out a loan that
will overload your ability to
repay everybody you owe.
Although every lender has
slightly different formulas,
here is a rough idea of how they
look at the numbers.
Typically, your monthly housing
expense, including monthly
payments for taxes and
insurance, should not exceed
about 28 percent of your gross
monthly income. If you don't
know what your tax and insurance
expense will be, you can
estimate that about 15 percent
of your payment will go toward
this expense. The remainder can
be used for principal and
interest repayment.
In
addition, your proposed monthly
housing expense and your total
monthly debt service combined
cannot exceed about 36 percent
of your gross monthly income. If
it does, your application may
exceed the lender's underwriting
guidelines and your loan may not
be approved.
Depending on your individual
situation, there may be more or
less flexibility in the 28
percent and 36 percent
guidelines. For example, if you
are able to buy the home while
borrowing less than 80 percent
of the home's value by making a
large cash down payment, the
qualifying ratios become less
critical. Likewise, if Bill
Gates or a rich uncle is willing
to cosign on the loan with you,
lenders will be much less
focused on the guidelines
discussed here.
Remember that there are hundreds
of loan programs available in
today's lending market and every
one of them has different
guidelines. So don't be
discouraged if your dream home
seems out of reach.
In
addition, there are a number of
factors within your control
which affect your monthly
payment. For example, you might
choose to apply for an
adjustable rate loan which has a
lower initial payment than a
fixed rate program. Likewise, a
larger down payment has the
effect of lowering your
projected monthly payment.
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