Buying and Selling: February 2006 Archives

Yes, I've always kind of liked Paul Simon. But this post was inspired by something I ran across from FATCO. And just to make certain you know, it's fifty ways to lose your money if you don't have title insurance.

You don't want problems from prior ownerships to interfere with your rights to your property. And you don't want to pay the potentially ruinous cost of defending your property rights in court.



A title insurance policy is your best protection against potential title defects, which can remain hidden despite the most thorough search of public records and the most careful escrow or closing.



For a one-time premium, a title company agrees to reimburse you for loss due to defects existing prior to the issue date of your policy, up to the policy amount. And, should it be needed, the policy also provides for the cost of legal defense of your title. The standard coverage policy protects you against such potential defects as:

Now, I'm going to star the ones I've got personal experience dealing with.

*Forged deeds, mortgages, satisfactions or releases.

*Deed by person who is insane or mentally incompetent.

Deed by minor (may be disavowed).

*Deed from corporation, unauthorized under corporate bylaws or given under falsified corporate resolution.

*Deed from partnership, unauthorized under partnership

agreement.

*Deed from purported trustee, unauthorized under trust agreement.

Deed to or from a "corporation" before incorporation, or after loss of corporate charter.

*Deed from a legal non-entity (styled, for example, as a church, charity or club).

*Deed by person in a foreign country, vulnerable to challenge as incompetent, unauthorized or defective under foreign laws.

*Claims resulting from use of "alias" or fictitious namestyle by a predecessor in title.

*Deed challenged as being given under fraud, undue influence or duress.

*Deed following non-judicial foreclosure, where required procedure was not followed.

*Deed affecting land in judicial proceedings (bankruptcy,

receivership, probate, conservatorship, dissolution of

marriage), unauthorized by court.

*Deed following judicial proceedings, subject to appeal or

further court order.

Deed following judicial proceedings, where all necessary

parties were not joined.

Lack of jurisdiction over persons or property in judicial

proceedings.

*Deed signed by mistake (grantor did not know what was

signed).

*Deed executed under falsified power of attorney.

*Deed executed under expired power or attorney (death, disability or insanity of principal).

Deed apparently valid, but actually delivered after death of

grantor or grantee, or without consent of grantor.

*Deed affecting property purported to be separate property of grantor, which is in fact community or jointly-owned

property.

Undisclosed divorce of one who conveys as sole heir of a

deceased former spouse.

*Deed affecting property of deceased person, not joining all

heirs.

Deed following administration of estate of missing person,

who later re-appears.

Conveyance by heir or survivor of a joint estate, who

murdered the decedent.

Conveyances and proceedings affecting rights of service-member protected by the Soldiers and Sailors Civil Relief Act.

Conveyance void as in violation of public policy (payment of gambling debt, payment for contract to commit crime, or conveyance made in restraint of trade).



*Deed to land including "wetlands" subject to public trust

(vesting title in government to protect public interest in navigation, commerce, fishing and recreation).

Deed from government entity, vulnerable to challenge as unauthorized or unlawful.

*Ineffective release of prior satisfied mortgage due to acquisition of note by bona fide purchaser (without notice of satisfaction).

*Ineffective release of prior satisfied mortgage due to bankruptcy of creditor prior to recording of release (avoiding powers in bankruptcy).

*Ineffective release of prior mortgage of lien, as fraudulently obtained by predecessor in title.

*Disputed release of prior mortgage or lien, as given under mistake or misunderstanding.

Ineffective subordination agreement, causing junior interest to be reinstated to priority.

*Deed recorded, but not properly indexed so as to be locatable in the land records.

*Undisclosed but recorded federal or state tax lien.

*Undisclosed but recorded judgment or spousal/child support lien.

*Undisclosed but recorded prior mortgage.

*Undisclosed but recorded notice of pending lawsuit affecting land.

Undisclosed but recorded environmental lien.

*Undisclosed but recorded option, or right of first refusal, to purchase property.

*Undisclosed but recorded covenants or restrictions, with (or without) rights of reverter.

*Undisclosed but recorded easements (for access, utilities, drainage, airspace, views) benefiting neighboring land.

*Undisclosed but recorded boundary, party wall or setback agreements.



*Errors in tax records (mailing tax bill to wrong party resulting in tax sale, or crediting payment to wrong property).

Erroneous release of tax or assessment liens, which are later reinstated to the tax rolls.

*Erroneous reports furnished by tax officials (not binding local government).

Special assessments which become liens upon passage of a law or ordinance, but before recorded notice or commencement of improvements for which assessment is made.

Adverse claim of vendor's lien.

Adverse claim of equitable lien.

Ambiguous covenants or restrictions in ancient documents.

Misinterpretation of wills, deeds and other instruments.

Discovery of will of supposed intestate individual, after probate.

Discovery of later will after probate of first will.

*Erroneous or inadequate legal descriptions.

*Deed to land without a right of access to a public street or road.

Deed to land with legal access subject to undisclosed but recorded conditions or restrictions.

Right of access wiped out by foreclosure on neighboring land.

Patent defects in recorded instruments (for example, failure to attach notarial acknowledgment or a legal description).

Defective acknowledgment due to lack of authority of notary (acknowledgment taken before commission or after expiration of commission).

Forged notarization or witness acknowledgment.

*Deed not properly recorded (wrong county, missing pages or other contents, or without required payment).

Deed from grantor who is claimed to have acquired title through fraud upon creditors of a prior owner.

The ones below this require extended coverage from a title company

Deed to a purchaser from one who has previously sold or leased the same land to a third party under an unrecorded contract, where the third party is in possession of the premises.

Claimed prescriptive rights, not of record and not disclosed by survey.

*Physical location of easement (underground pipe or sewer line) which does not conform with easement of record.

*Deed to land with improvements encroaching upon land of another.

*Incorrect survey (misstating location, dimensions, area, easements or improvements upon land).

"Mechanics' lien" claims (securing payment of contractors and material suppliers for improvements) which may attach without recorded notice.

Federal estate or state inheritance tax liens (may attach without recorded notice).

Pre-existing violation of subdivision mapping laws.

*Pre-existing violation of zoning ordinances.

*Pre-existing violation of conditions, covenants and restrictions affecting the land.



Post-policy forgery against the insured interest.

*Forced removal of residential improvements due to lack of an appropriate building permit (subject to deductible).

Post-policy construction of improvements by a neighbor onto insured land.

Damage to residential structures from use of the surface of insured land for extraction or development of minerals.

Many people talk themselves out of title insurance, claiming it won't happen to them. They think they've just saved hundreds to a couple of thousand dollars. And they have, if none of the above things (as well as others) happens. But the reason you carry insurance to insure yourself against losses that you cannot afford. If you lose that bet, you've potentially lost the entire property, and many times this is precisely what happens. Mr. Jones owned the property for many years before he died, and his estate sold to Mr. Smith who lived in it for fifteen years and then sold it to you. But Mr. Jones had a quickie marriage before he went off to World War II, forgotten but never legally dealt with. That woman's son finds the marriage certificate and checks to see if Mr. Jones left any property. Guess what he finds. Guess who may really own "your" property?



If I have a property, I'll pay a second time to make certain there's a policy of title insurance covering me. This stuff happens.



Caveat Emptor.

UPDATED here

We live in (A California city). In a 2 bedroom 1 bath home on approximately a 20,000 Sq. ft. lot. It is easily worth 500K to 600K with a current mortgage of $116,000. The mortgage/Title is in the name of my father and his wife 90% and myself and my wife with a 10% interest.

My father who is 75 and retired wants to take out about $80,000 cash which would create a new loan of approximately $200,000. He currently has a very small income from investments and lives in a paid off home in (out of state).

He would like to gift this (California) home to us and we would like that also.

Based on your expertise what is the best way to transfer the property to my wife and I and at the same time obtain a cash out stated income loan. How will a lender expect this to be handled? Do we all qualify together and the lender then allows my father to transfer/gift title at the close of escrow?

I realize that whatever lender wants to make the loan they will want to have my wife and I qualified to be on title. Since we have a 10% interest I would assume that we could all be asked to show assets and income. This might be complicated. I am a realtor but I haven't made much money in the last two years because I've worked on a business startup currently breaking even with no income.

My wife has a terrific long term (16 yr) job with a law firm. Gross income $85,000. All of our expenses are very low and the last time I looked our credit was a 785 FICO score. When I do the front end ratio 28 with only my wife's income it appears to be no problem at all. When I do the backend it's a little more snug but definitely doable. I've racked up some credit card debt funding the startup business. I can pay it off but I would like to retain working capital handy for my business.

I believe a stated income loan would be the best way to go.

Here are the assets and documentation I would be willing to show, and the lenders exposure to the property.

1. We would have approx. a 36% LTV at the end of the transaction. 300k+ equity
2. Assets in a 401K of $200,000 +
3. Approx. $30,000 in savings accounts
4. Approx. $40,000 in negotiable stocks
5. I will of course provide credit reports.
6. Employment documentation for my wife only.

I believe my father and his wife have approximately $200,000 in mutual funds plus social security and she has a part time job doing a water district's billing.

This one is fairly complex on the surface. Issues that I see right off:

-family transfer
-documenting current interest
-structure of transaction
-Will your father be selling you some of his interest as part of this transaction?
-likely the cash out quitclaim issue
-Who is going to be primarily or completely responsible for new loan
-verification of rent/mortgage.

You say that you are already on title of record, and that the desired end state is to have you and your wife owning the property outright.

The best way to structure this is probably as an actual sale
transaction. Your father selling you and your wife a larger interest. Because this is a family transfer, you still would likely qualify to continue having it taxed based upon original acquisition price, but that needs to be checked, either through the county or your title insurance company for the transaction. You also need to scrutinize the current owner's policy of title insurance to see if it will continue coverage. There have been changes in the industry since the property was bought. If it doesn't, you're going to want to buy a new policy.

Now there is a standard policy with every lender I've ever done business with. If someone is brought onto title via quitclaim, you can't get cash out for six months after that date. This prevents several sorts of fraud. I am going to presume that you've been on title longer than six months.

Now, there are three ways that suggest themselves to structure this transaction. Each have their potential advantages and disadvantages. First though, we need to take a look at another issue.

In all real estate transactions, and for all loans, the method of evaluating the property is the so-called LCM, or "Lesser of Cost or Market," method. Market is what similar properties around yours have sold for within the past twelve months, and that is what it is, and is computed by the appraiser.

Cost is the purchase price. In refinances, there is usually no purchase to consider, because the value has changed since purchase. In purchases, there usually is.

Whichever of these two numbers is less determines the value of the property, as far as the lender is concerned. It doesn't matter if similar properties are selling for four million dollars - if you buy yours for one hundred thousand dollars, the lender will loan as if the value was $100,000. It can't be any higher than that, because the seller willingly sold to you for that amount. If the property was worth more, they would have required you to pay more.

For family transfers (and indeed, any related party) this presumption goes out the window. Parents do all kinds of stuff for their kids that they wouldn't do for anyone else, and vice versa. Lenders still won't loan money based upon a number above nominal purchase cost, however.

Furthermore, there have been a sufficient number of scams over the years that they will take additional measures to protect themselves. The presumption of willing buyer and willing seller is violated on both ends of these transactions, and many times it has been A selling the property to B for an overinflated price for the purpose of getting a loan and departing at midnight, leaving the lender holding the bag. Remember, I told you in my very first article here, is that because the dollar values are so large on real estate transactions, every single one is heavily scrutinized for fraud. There's a reason for that. These additional measures differ from lender to lender, and some lenders will not undertake related party transactions at all. When I'm getting loan quotes from lenders, if it's a related party transaction, then words to that effect are the first words out of my mouth. It saves a lot of time and effort.

Now, I mentioned there being three ways I can see that make sense to approach the transaction?

The first is a full price sale with upfront gift of equity. You buy the property for $600,000. They sell it to you for $600,000, but give you $340,000 in equity in addition to the $60,000 you already own. You get a loan for $200,000 (actually a bit more to pay for costs), the old loan gets paid off, your father gets his $80,000. This has the advantage of being a true picture of what's going on. The problems are that to the lender, this screams fraud. They're not likely to be too worried that its for below market value, but $340,000 is a lot of money. They are going to want to see evidence that there's not some loan going on under the table between you and your father, because that would affect whether or not you qualified for their loan. Furthermore, estate tax isn't completely dead yet and could be ressurrected even if it does die, and this would have significant estate tax implications.

The second is full sale price with subsequent gifts of equity. Sell it for full price, from you and your wife as ten percent and your father and his wife as ninety, to you and your wife as twenty-five percent and your father and his wife as seventy-five. They can then give you a gift of forty thousand of equity each year. You can even combine this with the initial sale, making your interest thirty percent, which might make the loan easier. In this case, you are all four probably going to be on the new loan to get the best rates, as $200,000 is about thirty-three percent of $600,000 - a larger amount than the equity you and your wife currently have under this scenario. There is a further major difficulty with this lies in the possibility that the complete equity may not be gifted in your father's lifetime.

The third way is to sell the full property at a reduced sale price. Approximately $300,000 would probably be sufficient. Everything here is like the full price sale, but they're only giving you about $40,000 in equity upfront - which is within the IRS single year limits. The bank has less difficulty believing that (although they're still going to want a letter stating that it is a gift!). The downside is still that family transfer thing, and the fact that if you wanted to refinance within a year there would be appreciation issues on whether or not the bank would believe you.

All three ways have their bumps and walls which you very well might run into. Each lender has their own anti-fraud measures, and sometimes these run afowl of the best ways to structure it

Now, as to the loan itself, I have good news and bad news. I'm going to start with the bad. Verification of Rent/Mortgage is going to rear its ugly head no matter what you do. The bank is going to want to see some kind of evidence that you and your wife have been making rent or mortgage payments every month, and from all that I can see in the email, there's no evidence to support this. The only person who appears to be in a position to verify that is your dad - unless you've been writing the checks for the mortgage and can prove it. The lenders may or may not accept your father's word for it, and they are going to want evidence. If you're actually on the current mortgage, this would be extremely helpful.

The good news is that with an income of $85,000 per year which your wife alone makes and you should be able to document, you have a monthly income of about $7083. This means that the back end you'd qualify for on A paper, thirty year fixed rate basis, is about $3180 (about $2690 if we're talking about an A paper ARM). Picking a random A paper lender, I get about 6.25 percent rate thirty years fixed full documentation, which translates to a monthly principal and interest payment of a little less than $1232. With the yield curve inverted right now, the five year ARM is about the same rate, meaning there's no reason to do that instead.

Take $1232. Add $600 per month, which is about the worst case scenario for property taxes that I see (as I said earlier, you can probably preserve the current tax basis). Add another $150 per month for homeowner's insurance, which is a high estimate for most urban locales. This is still less than $2000 per month, leaving you almost $1200 of other allowable payments before you would not qualify full documentation. You can probably do stated income if you want, but that'd be giving the bank money that you don't need to.

Because of the multiple concerns, of which the most important are family transfer and verification of mortgage/rent, there are many reasons why the best way to approach this might change, but when you separate it all out, it certainly looks doable.

Caveat Emptor (and Vendor)

UPDATED here

I saw your article on on Searchlight Crusade about exclusive buyers agents and I have a couple follow up questions pertaining to my own situation that I am hoping you could shed some light on.

I don't have any buyers agent (currently). However I have spotted 2 houses in an area that I think I would like to make an offer on. Both of these houses are listed by real estate agents. I am obviously eager to save as much money as I can and think it would be great to try and save on the agent undefined if at all possible (I have bought FSBO before, so I am familiar with the process and I don't see much value add with an agent since I have already found the properties).

However I just don't get it - if I make an offer on the property by working with the sellers agent then the sellers agent gets both commissions? Is there a way to just take the buyers agent commission off the sales price? If there isn't then I guess there is no reason not
to go and find a buyers agent to assist me? Seems like a waste of money.

I have found an buyers agent that who said he will give me 50% of the commission if I sign an exclusive buyers agent contract with him however I am worried that my hands are tied if I don't end up purchasing one of these properties I have already identified (ie I could end up paying 1/2 his typical commission if I found a FSBO).

Any insight you could provide would be of great help - I love reading your stuff.

Thanks,

The first thing I need to clear up here is the nature of listing agreements. The standard listing contract form gives the listing agent the full commission for both buying and selling, and if someone other than them represents the buyer, then they agree to pay the buyer's agent a portion of that. If there is no buyer's agent, they keep it. Since you have to make your offer through the listing agent, the listing agent is get that commission, and that is as it should be. Note that I feel it is stupid to act as agent for both parties in the same transaction because seller's interests and buyer's interests are often at impasse, and when you're acting as agent for both sides, there are many potential issues which, if they happen, are lawsuit material one way or the other no matter what the agent does. If I find a buyer for my own listing, I'll find another agent I trust to do a good job, and that way there is no conflict of interest. But greed is a powerful motivator, as you yourself are illustrating. The fact is that if the listing agent wants the full commission, they will probably end up with it, and justifiably so, as they found the owner a buyer, didn't they? That's what the contract says the seller's commission is for. You saw their sign, you saw the house they listed, you made an offer through them, the house got sold through their efforts. According to the terms of the listing contract, they found you, whether you realized it before now or not. The buyer's agent commission is for an agent who has a buyer who sells them that property, as opposed to the one down the street.

Many agents make side agreements to rebate part of their commission in certain circumstances. But that potential rebate contract in this case is with the seller, not you, and is none of your business. Unless the agent has a release to discuss it with you in writing, they are violating confidentiality to do so. The seller may sell to you cheaper because of such a clause, but they are under no obligation to do so.

Now before you dismiss this with, "That's Stupid!" or something worse, because it appears that things are stacked to cost you money, consider that this has evolved over many years as the best and cheapest way to preserve everybody's best interests. Without these forms, there would be a lot more lawsuits filed over commissions, with the side effect that the lawyers get rich, and the money ends up getting paid anyway on top of that. The listing agent commission is partially a hold over from the old single listing days of half a century ago. Over time, the buyer's agent commission evolved as a way to open the system up, so that homes sold faster and those agents and offices without a large, pre-built client base could break into the business. But it's still intentionally structured that way as a way to motivate that listing agent to advertise the property far and wide and especially in all of the most effective venues. It costs money for that sign in the yard. It costs money for MLS access. It costs money for advertisements in the paper. It costs money for all the trappings that enabled someone to go find that agent and list the property in the first place. It costs that agent money just to stay in business whether they have any clients or not. It costs the agent money for the advertising to attract clients in the first place. And chances are, if they hadn't spent that money, you wouldn't have found that property, and the owner wouldn't have sold it. People think agents are making money hand over fist, when the reality is that unless they're putting in the long hours and hard work to make multiple transactions happen every month, they're just barely scraping by. Most of the successful agents I know put in sixty hours or more per week, and if they are putting in less than forty, I'll bet money on no other data that they'll be out of business in a year. This is not a cheap business to be in, or an easy one.

Put yourself in the shoes of a seller. You have a property, but you want cash. Real estate is not liquid, a property interchangeable with billions of other shares in planet earth that you can call a broker and sell over the phone because there's a ready market for shares in planet earth which are all interchangeable. Each and every property is unique. This means it is bought and sold on the basis of those unique individual characteristics. You want results, you want your property sold, and it costs money and it takes work to make buyers want to buy your property.

Sometimes the agent gets lucky, and it sells quick. Sometimes the agent works hard - and they really do work - for months with no offers despite all of it. We're coming off of a market where a monkey could have sold a residential property within a week for more than the asking price, and entering a difficult period. This requires an adjustment in thinking if you're going to do well. Average total commission paid is up locally in the last few months, from five to six percent. Particularly in a rough market, if the seller tries to sell it themselves, it will statistically take longer, and they will statistically net less money from the sale, not to mention what they spent on the property in the meantime. Some few get lucky. People win lotteries and casino jackpots, too. Betting that you'll be one of them is a sucker's game. Any number of studies and statistics show this fact, and many brokers make a good living buying FSBOs to then resell for a hefty profit. My supervisory broker, for instance. We've sold four properties he bought from FSBOs in the past month, all for a substantial profit, even in this market. Sellers tried to think like you do, and it cost them over $150,000 net of commissions, and these were all fairly quick sales. Had we tried harder to get maximum value for his money, we could likely have gotten more, but he's not complaining.

Now, with that said, let's look at your current situation. I've already covered the fact that the listing agent is entitled to that commission. Now let's put you on the other side of the table from a guy whose responsibility it is to get the best possible price for the property, and his commission depends upon how good a job he does. He does this constantly, for a living. He's set up with information to ensure that he gets the highest price. It's cost effective for him, in a way that it isn't if you aren't doing it constantly. Betting that you're better at his profession than he is would be like him betting he's better at your profession than you are. My money is on "you end up paying more than you have to."

Here's a dead giveaway that an agent's job is trickier than you think it is: That you're even talking about an exclusive buyer's agent contract in this situation. So long as you already have the property in mind, there is very little risk and only a minimum amount of work for him in the situation. He's not going to have to drive you around to four million properties over the next twelve months to maybe find one you want. This is a buyer's agent's dream situation - cut straight to the bargaining, no preliminary work. If this one falls through, he can either look for more or blow you off, depending upon what he has time for. Offer him a general non-exclusive buyer's agent agreement with a fifty percent rebate if you find the property yourself, as you did in this situation. This motivates him to do his best bargaining and looking out for your interests without sabotaging the transaction. If this one falls apart, he's still got motivation to find you something on your terms, and you're not bound to him unless he introduces you to the property or you use him for negotiations, etcetera. You get a negotiator who knows your market and should know most of the tricks and is working on your behalf, and if this one falls through you have someone who's motivated to find your something with better tools and more relevant skills at his disposal than you have. He gets a commission which, if smaller, is also easier and walked its own self in the door rather than him having to go out and spend time and money to drag it in. Everybody wins. If he won't do it, find someone else in your area who will.

(Before anybody asks, I don't propose client contracts that I wouldn't accept)

Caveat Emptor.

UPDATED here

Continued from Part 1: Preparation and Part 2: Process



This is about the long term consequences of the decision to buy or not to buy a home, and economic benefits analysis into whether you should want to buy. In order to answer the question of whether it's better to buy or rent and invest the difference, you need to compare the costs and benefits of owning to the costs and benefits of renting over a comparable time frame. If you know you're moving in three years or less, it can be hard to come out ahead, just due to transaction costs. On the other hand, if you've got the wherewithal to turn it into a rental property after any future move you already know you're going to make, that can make the owning calculation move decisively in favor of owning. Be advised, all the headaches of being a landlord are greatly magnified if you're not within easy commuting distance to keep an eye on the property yourself. Also, if you cannot achieve positive cash flow on a rental property, odds are good that you should sell it. This isn't a blanket recommendation, just a rule of thumb.



Now it happens that I've programmed a spreadsheet to answer the "buy or rent" question in a time dependent manner, which is the only way it really can be answered. I keep using a $300,000 home and $270,000 loan as my default assumptions here. I'm going to pull a few more assumptions out of my hat, but I'm going to do my best to make them reasonable assumptions. 6.25 first trust deed, 10% second for any loan amount over 80 percent of value. Five percent annual property appreciation (perhaps a tad low in the long term), 1.2% yearly property tax (darned close for most California properties), yearly tax increases of two percent (Prop 13's legal maximum in California), non-deductible homeowner's expenses of $200 per month, 4 percent inflation, $1500 in non-housing deductions on Schedule A, marginal tax rate of twenty-eight percent, and a return net of taxes on any alternative investment with the same money of ten percent. I also assume you're married (That makes a difference on how much your default deduction is).



Since state and local income taxes are different everywhere, I'm going to neglect those. They would functionally move the equation in favor of home ownership, but the effects are relatively minor in most cases. Furthermore, because investments are only worth your net proceeds after you actually sell them, I'm going to deduct seven percent of the theoretical market price of your home investment in any given year before I compare the net benefit of buying a home to renting and investing any money you didn't spend on buying. This is questionable to be sure, as most people will just spend at least a certain percentage, but I'm in the mood to be generous. You'll see why in a moment.



I'm also going to assume here, very unrealistically, that you never refinance, but that's actually a middle of the road assumption, as far as net benefit goes. The actual spreadsheet has works a couple of other assumptions, and refinancing every five years and making a minimum payment usually comes out better, while refinancing every five years and keeping a thirty year payoff goal usually comes out worse.



Here are the net results:



Year Value Rent Equity Net Benefit

1 $300,000.00 $1,500.00 30,000.00 -21,000.00

2 $315,000.00 $1,560.00 47,979.07 -12,556.04

3 $330,750.00 $1,622.40 66,906.50 -3,638.14

4 $347,287.50 $1,687.30 86,833.25 +5,776.42

5 $364,651.88 $1,754.79 107,813.09 15,711.05

6 $382,884.47 $1,824.98 129,902.79 26,189.84

7 $402,028.69 $1,897.98 153,162.25 37,237.49

8 $422,130.13 $1,973.90 177,654.70 48,879.30

9 $443,236.63 $2,052.85 203,446.90 61,141.06

10 $465,398.46 $2,134.97 230,609.35 74,049.01

11 $488,668.39 $2,220.37 259,216.47 87,629.77

12 $513,101.81 $2,309.18 289,346.90 101,910.18

13 $538,756.90 $2,401.55 321,083.67 116,917.22

14 $565,694.74 $2,497.61 354,514.53 132,677.85

15 $593,979.48 $2,597.51 389,732.17 149,218.82

16 $623,678.45 $2,701.42 426,834.57 166,566.51

17 $654,862.38 $2,809.47 465,925.28 184,746.65

18 $687,605.50 $2,921.85 507,113.76 203,784.11

19 $721,985.77 $3,038.72 550,515.76 223,936.96

20 $758,085.06 $3,160.27 596,253.68 245,391.54

21 $795,989.31 $3,286.68 644,456.99 268,228.87

22 $835,788.78 $3,418.15 695,262.65 292,534.88

23 $877,578.22 $3,554.88 748,815.58 318,400.79

24 $921,457.13 $3,697.07 805,269.15 345,923.37

25 $967,529.98 $3,844.96 864,785.74 375,205.33

26 $1,015,906.48 $3,998.75 927,537.24 406,355.67

27 $1,066,701.81 $4,158.70 993,705.71 439,490.05

28 $1,120,036.90 $4,325.05 1,063,483.99 474,731.24

29 $1,176,038.74 $4,498.05 1,137,076.39 512,209.54

30 $1,234,840.68 $4,677.98 1,214,699.45 552,063.23



Yes, after 30 years you are $552,000 better off from having bought a $300,000 home, as opposed to continuing to rent for that whole period. Not to mention that you own it free and clear for the cost of maintenance plus property taxes, as opposed to paying over $4600 per month rent.



This is a fascinating study in leverage. If, on the other hand, taxes start out at 2 percent and rise by 4 percent per year, the peak year in absolute terms is year 22, at $101,964 net benefit. On the other hand, I'm running rent increases at exactly the general rate of inflation and they almost always go up faster. Back to the first hand, resetting variables in the last set of suppositions to default and changing the appreciation rate to approximately like the long term average - 7 percent - while making a net return of 8.5 percent on investments bumps the net benefits of buying that home to $1,630,195.38. Five and a half times the original purchase price!



One more scenario: Restore to default values. Say you lose $30,000 of value, or ten percent of purchase price, in the first year. It does take longer to be ahead of the game - more than 6 years - and the net benefit after 30 years is "only" $437,223.05. For the mathematically challenged, this is still nearly one and a half times the original value of the property! Yes, the money will be worth less in thirty years. We all know about inflation. Would you turn me down if I offered to give you $437,000 in thirty years time?



I've been playing with this spreadsheet for weeks now. Under the basic assumptions I've listed above, it's kind of hard to be ahead of the game by buying a house instead of investing in the stock market after less than two years under any kind of reasonably average assumptions. On the other hand, it's very difficult not to be ahead after five to seven, and way ahead after ten.



After thirty years, most sets of even vaguely reasonable assumptions have you so far ahead by buying the home that if you didn't watch over my shoulder as I built the spreadsheet, a reasonable person would be sceptical. Heck, I knew which calculation the numbers favored, but I really never stopped to think how strongly they worked in favor of home ownership. It is difficult to come up with a reasonable set of assumptions and starting numbers where you aren't ahead by significantly more than the original purchase price of the home. Yes, we're all aware of the issues with inflation, and the ratio illustrated here, with a 4 percent rate of inflation, is a little more than three to one (which remembering the rule of 115, seems reasonable, so the first approximation check validates this). So what this means is that by purchasing a $300,000 house that you're going to live in for the rest of your life now, you're adding more than $100,000 in today's dollars to your net worth in thirty years. Actually, it's usually more. That safe, conservative, middle of the road $552,000 net result after thirty years from the first example converts to more than $177,000 in today's money! No flipping, no games, no wild schemes, no re-zoning jackpots and no wealthy benefactors to come along and pay you twice what it's worth. In fact, in this scenario you never talk to another real estate or loan person as long as you live, and you've still effectively "gifted" yourself with almost sixty percent of the property's purchase price immediately upon taking possession.



This should persuade most folks that they should want to buy a home, and that you don't want anyone else to. After all, the more poor schmoes there are, the better this will work for the rest of us. Actually, that last crack about poor schmoes isn't true, because the law of supply and demand is always in effect. But is shows how good for the overall economic health of the nation encouraging home ownership is.



Caveat Emptor.

UPDATED here

Continued from Part 1: Preparation

I am considering buying a home, although I have not made up my mind on the subject. This is not due to indecision, but rather due to a lack of necessary information. There are many factors to be considered in my case, and in order for me to make an informed decision about buying, I need to solve for several variables involving cost.



My questions to you involve what steps I can take to solve those variables. Should I begin with a pre-qualification or loan approval? Will a lender invest time and resources in me when I have no specific property in mind, and I may ultimately decide to continue renting? Should I start by speaking with realtors in order to guage what is available in my price range? Will realtors invest time and resources in me when I have no loan arranged and I may ultimately decide to continue renting?



Also, what is the proper sequence of action for someone who is seeking to collect all the relevant information in order to make reasoned decisions about buying a home?

Well, as I said in Part I, a major question is whether you can trust real estate agents to answer the question honestly. Some will, most won't. If they tell you to buy, they make money. If they tell you to keep renting, they don't. Mind you, if you can afford to buy, the numbers are overwhelmingly in favor of that, as we'll see in Part 3. Nonetheless, one trusts that you see the potential for abuse.



Nobody should have a specific property in mind when they first approach an agent. Smart buyers won't make an offer without looking at a certain number of properties first. The only exception is if you're buying the old family home from your parents or something. You've agreed on the price, and the terms, and now you're going to pay an agent to make sure all the paperwork is done and filed correctly and the inspections are done and all of that sort of stuff. This is a smart thing to do, by the way, but most people in this kind of transaction seem determined to save money when a low percentage agent's fee or some flat fee would be an astoundingly good investment.



You needn't worry about whether lenders and agents will "invest time in you." Those who are unwilling to spend time on you in such circumstances should be avoided. Yes, I want my time to be spent on people who really want to buy and are capable of buying, which is why a basic pre-qualification is among the first things I usually do. I don't want to waste your time showing you stuff you can't, or shouldn't, afford any more than I want to waste my own. But there's a lot you can do to qualify yourself, so that you know how strongly you're inclined to buy, and approximately how expensive a property. This way, you know that the agent or lender isn't leading you down the primrose path with properties you cannot really afford. This is a severe problem right now, especially in expensive areas. I've said it before and I'll say it again. You need to know how much house you can really afford in a sustainable situation, and you have to make certain your agent knows and sticks within your budget. The one who shows you the five bedroom house, when you can really only afford the three bedroom condo, is not your friend. I'd fire such an agent the first time they showed you something you could not reasonably get for your known housing budget (which is one reason I recommend against Exclusive Buyer's Agent Agreements, and don't ask for them unless I'm giving them something beyond MLS listings for their exclusive commitment). The agent who shows you the three bedroom condo you really can afford when everybody else is showing you the five bedroom house you can't, is your friend, whether the "Oooohhh" factor is there or not, and even if the "Eeewww!" factor is there. Curb appeal is how sellers sucker buyers (and yes, when I'm a listing agent I'll help you with that in every way I can. It's the most important part of my job to help my client get the best deal they can. But right now I've got my buyer's agent hat on, and my job is to help buyers see the diamonds in the rough and not pay more than they're worth).



Once you've done your self-qualification, that's when I'd go find a real estate agent. I wouldn't worry about an actual lender's prequalification as long as you know what your credit score is. A good agent is going to do a pre-qualification anyway, and if they're a loan officer as well, they'll set you up there. An agent who doesn't do loans should be able to provide recommendations for someone to do the pre-qualification, and if they don't recommend the same loan provider for the loan as did the pre-qualification, I'd go back and check with the provider who did the pre-qualification anyway, as well as finding other prospective loan providers, not to mention pointedly not accepting the new recommendation for a loan provider. Despite the fact that I'm a loan officer who also does real estate, I'm not sure I'd trust a real estate agent with my only loan application. I came to being an actual real estate agent from being a loan officer for several years first - and then I went and learned how to do real estate. The average real estate agent who does loans never spent an apprenticeship doing loans, never learned the ins and outs, and has no clue whether they can deliver what they put on the Good Faith Estimate (Mortgage Loan Disclosure Statement in California). They just figure "It's the same license, so I can, and it's an easy way to earn a lot more money from the same clients!" They don't really know loans, they've just figured out that it's a way to make more money. Furthermore, there are too many shady personalities out there, and way too many real estate agents think they know how to do loans but don't. There are a fair number of crooks and incompetents and just plain gladhanders, who only care about whether they're getting a commission on this particular offer, out there, but most of what I do as a real estate agent can be plainly seen and understood by my clients. What a loan officer does is much less transparent to even the most sophisticated borrowers until it is too late to change to another provider. I've seen way too many people burned by only applying for a loan with one provider. I've only ever not been able to do one loan on the terms quoted and locked (and I did my darnedest to help the provider who could, where most loan providers in my shoes would have obstructed to the best of their ability, as I've also learned by bitter experience), but I've seen a lot of people who applied with the loan provider who talked a better deal but who couldn't deliver any loan at all, much less the one they talked about. Many times they have come back to me in desperation two days before escrow expires, or seven days after it was supposed to expire, and I can't always help them in time then. Always apply for a back up loan, especially if it's for a purchase.



Take any newspaper advertisements you see about rate, however, with great heaping cargo ships full of salt. I'll cover what's really available later on, but for now what you need to know is that loan companies advertise with teasers like negative Amortization Loans and short term ARMs and hybrid ARMs that takes five points to buy the rate and you still won't get it when it comes time to sign the final papers. The whole idea is to get you to call, so that they can sell you what they really do have. I don't think I've ever seen a real rate on a real loan that I would be willing to get for myself advertised anywhere, in any medium. Even the so-called "best rate" websites and newsletters are notorious for cheating. I've gone right down the line calling them and asking about loans that were supposedly the standards they were quoting to, and gotten not one answer that was within half a percent of the rate quoted on the website or in the newsletter. Nor were any of the websites or newsletters I've complained to (or my company complained to, when I worked for an internet lender that was signed up with them) interested in enforcing the rules. I don't know one single loan provider who advertises actual rates that they can actually deliver anywhere. Those few companies who are actually willing to do it have all quit advertising in disgust and gone to finding clients in other ways.



Continued in Part 3: Consequences

UPDATED here

I am considering buying a home, although I have not made up my mind on the subject. This is not due to indecision, but rather due to a lack of necessary information. There are many factors to be considered in my case, and in order for me to make an informed decision about buying, I need to solve for several variables involving cost.

My questions to you involve what steps I can take to solve those variables. Should I begin with a pre-qualification or loan approval? Will a lender invest time and resources in me when I have no specific property in mind, and I may ultimately decide to continue renting? Should I start by speaking with Realtors in order to gauge what is available in my price range? Will Realtors invest time and resources in me when I have no loan arranged and I may ultimately decide to continue renting?

Also, what is the proper sequence of action for someone who is seeking to collect all the relevant information in order to make reasoned decisions about buying a home?

Well, a major question is whether you can trust real estate agents to answer the question honestly. Some will, most won't. If they tell you to buy, they make money. If they tell you to keep renting, they don't. One trusts that you see the potential for abuse.

The question here of "Should I Buy A Home" really separates into two basic questions: "How much home do I qualify for?" and "Is there a better alternative, financially?" You can then decide if buying or renting is the better alternative for you.

Qualifying yourself to buy a home, or to use better phrasing, figuring out how much home you should buy, is easier than most folks think. You can look in the classifieds section or on any number of internet sites to find out what the asking prices for properties like ones you might want to buy are in that neighborhood.

The personal information needed is easily available. First, you need to know how much you make per month, as you make mortgage payments monthly. Next, how much your mandatory payments are. Third, about what your credit score is.

Most people know how much they make per month. "A paper" guidelines go between thirty-eight and forty-five percent of gross income for your total of all required monthly debt payments. Subprime lenders will go up to anywhere between fifty and sixty, with most limiting your debt to income ratio to fifty or fifty-five percent. I'd recommend staying within A paper guideline, but calculators are easy to use. So multiply your monthly income by thirty-eight percent, forty-five percent, fifty percent, and fifty five percent. This gives you a set of four numbers, which you may call anything, but I'm going to call A0, B0, C0, and D0. They correspond to what should by standard current loan guidlines be easy total debt service payments for most folks, moderate payments, difficult payments, and extreme payments.

Now most people have recurring debt of some sort. Credit card payments, car payments, furniture payments, etcetera. This does not include monthly bills that you are paying as you go. You know what your monthly obligations are. Whatever this number is, call it $X. Subtract $X from each of those four numbers above, so that you have the numbers that you really have available to spend on housing in each of these four scenarios. I'm going to call these numbers created by subtraction A1, B1, C1, and D1.

Now these numbers you have must cover all the recurring costs of owning a home. These include not only the principal and interest payments on the loan, but property taxes, homeowner's insurance, homeowner's association dues if applicable, Mello-Roos districts here in California, and anything else that may be applicable where you want to buy. Within the industry, the acronym most often used for this is the PITI payment, for Principal Interest Taxes Insurance, with the understanding that it includes anything else necessary as well. Association dues and Mello-Roos districts are a function of where you buy. Every condominium or coop is going to have Association dues or some equivalent. Mello-Roos districts are limited time property tax districts assessed to pay for things like municipal water and sewer service for new developments. Most newer developments here in California have them, and the equivalent districts are becoming more and more prevalent in newer developments elsewhere. Homeowner's Insurance is mandatory if you're going to have a loan - no lender is going to lend money on an uninsured property, but note that even the best homeowner's policy does not include flood or earthquake coverage, so if you're buying in an area where that is a consideration, the extra cost of a flood policy or earthquake policy is probably worth it. Condominium owners should have a master policy of homeowner's insurance paid for by their association dues, but it's still a good idea to have an individual policy for your unit, called an HO-6 policy here in California.

Property taxes are paid to city, county, state and possibly utility districts, but your county tax collector should be able to quote overall rates. There is no way to know how much they will be from here, but you can make an estimate, if nothing else by calling the county and asking. Note that they usually quote taxes in terms of a percentage tax value per year. Multiply assessed value by tax rate to get a per year tax bill, then divide by twelve to get a per month value. In California, there's a rule of thumb that property taxes per month are approximately one dollar per thousand dollars purchase price per month in most places (it will be more if there's been a bond issue approved or any number of other circumstances), so take the last three digits off the purchase price and that is usually close to your monthly tax liability. $250,000 purchase price? $250 per month. $500,000 purchase price? $500 per month.

By subtracting off all those figures, you get a range of monthly payments for the loan that you can actually afford. Call these A2, B2, C2, and D2. Armed with these and your credit score, you can figure out what kind of rate you might qualify for. Right now thirty year fixed rate A paper purchase money loans of no more than eighty percent of the value of the home can be had without points at something between 6.25 to 6.5 percent. Make allowances for a significantly higher rate for the last twenty percent if you don't have a down payment, and for the whole amount if your credit is below average, or if you cannot document income via w-2s or income reported to the IRS for the last couple of years. I've got an article here that might be helpful in gaging how much of a loan you'll qualify for. You can usually get significantly lower rates by being willing to accept a hybrid ARM (I've been doing it for fifteen years), but right now with the yield curve the way it is, the difference is marginal.

Knowing the payment you can afford, the interest rate, and the term of the loan, you can calculate how much of a loan you can afford. Knowing any three of principal, interest rate, payment, and term, a loan calculator can tell you the fourth. Do this with your four values, A2, B2, C2, D2, and you get four potential loan principal amounts, A3, B3, C3, and D3. These correspond to loan amounts where the payment should be easy, moderate, hard but doable, and a real stretch. To this, add any money you have available for a down payment, and subtract projected purchase costs (maybe $1000 plus 1 percent of home value). This gives you four values A4, B4, C4, and D4. These correspond to the purchase price of the homes you can afford under those four prospective loan amounts. You can then compare these amounts with what is available, and at what price, in those areas you might wish to buy.

Continued in Part 2: Process
Finished in Part 3: Consequences

Caveat Emptor

UPDATED here