Can you make a killing
buying fixer-uppers?
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, improvements 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?
Do You Know What You Want?
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 down payment, 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 down payment or less. .
In addition to a down payment, purchasers also need cash for closing
costs (the final costs associated with closing the loan).
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.
How Much Can I Afford?
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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If
you are considering buying a home, this handbook published
by the Minnesota Attorney General's office, can offer
information on several aspects of home buying, including
financing, legal rights, and appendices, such as an
inspection checklist and a sample purchase agreement.
Home Buyer's Handbook
Or
The Home Buying Guide
Which is produced by the
National Association of Realtors! |
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