Real Estate Traps To Avoid
Real estate is supposed to rival gold as one of the safest investments you can make. As the late rancher (and multimillionaire) Roy Rogers put it, "Buy land. They ain't making any more of the stuff."
SEE: Exploring Real Estate Investments
So why does a brief observation of the housing market tell us otherwise? Foreclosure, subprime loans, predatory lending, defaults, homeowner assistance … all these terms have become part of the national lexicon in the last few years, leading the easily intimidated to think that it's impossible to ever build wealth (or at least not lose it) via real estate. Like most things in life that come with a reward, successful real estate transactions require diligence and discipline. They also require you to steer clear of some easily avoidable pitfalls.
Get Emotionally Involved With a Property
You say you "fell in love with" that custom-built 1960s-era, two-bedroom bungalow with the trellis and the orange trees? Good for you. Make sure you let the seller know that, so he can raise his price accordingly. Because monopoly power is a wonderful thing to give to the person you're doing business with. Also, don't think about resale value. The more tailored a piece of real estate is for you, the less appeal it'll have to the public at large. If you ever want to sell it, you will have fewer potential buyers.
When you start thinking in non-financial terms, you're already losing. Yes, a house has benefits (and drawbacks) beyond its price. That's not the point. The point is that every transaction involves tradeoffs, and a slightly less desirable house at a far more agreeable price can make the difference between building wealth and overextending yourself.
You fall in love with people, maybe pets. Which is to say, beings that don't come with inherent economic potential. Real estate is for investing in, not for having an irrational attachment to.
Buy the Pick of the Litter
The neighborhood is so-so, but the house in question is radiant. It's twice as big as any other on the block, with decorative water fountains and a regulation basketball court to boot. It stands to reason that such a house will make a better investment over the crumbling shacks adjacent to it, right?
It won't. You might not like this reality, but a house's surroundings have as big an impact on its value as the house itself. The most modest single-family home in Chicago's Gold Coast will appreciate far more than a palace in Hunters Point, San Francisco.
Remember, sticker price is everything
A $100,000 house beats a $110,000 house every time, right? How couldn't it?
Interest rates, for one thing. Remember, a typical real estate transaction is different than buying an everyday item. When you purchase real estate, you're not trading a flat sum of your money for a good or service. You're trading what's essentially a reverse annuity (from the seller's perspective) for land and any improvements. That "annuity" – monthly or semimonthly payments from you – is subject to several variables.
Shopping around for a favorable interest rate is at least as important as shopping around for a suitable price tag. Taking out a mortgage loan with a few basic points in your favor can put you in a considerably larger house than you might otherwise have budgeted for. (Or, if you prefer, keep you in a smaller house at a much lower payment.)
Put Down as Little as Possible, Preferably Nothing
Why should you have to delay your gratification? That's for suckers! You want what you want when you want it. Saving up 20% of the price of a house for a down payment could take years. Much better to obtain 100% financing, and pay private mortgage insurance until you've got 20% equity in the place. Which could take years, but what fun is it to buy real estate if you're not going to flush at least a little bit of money down the toilet in the process?
Never leave money on the table. By the same token, never spend money you don't need to. When you put nothing down, you're already overextending yourself. Putting anything less than 20% down requires you to take out extra mortgage insurance courtesy of the lender, which is the equivalent of undergoing a credit check that costs you hundreds if not thousands of dollars every year.
The Bottom Line
When you buy a house, you're buying it all: not just four walls and a roof, but decades' worth of mortgage interest and possibly, mortgage insurance. It's helpful to think of the entire purchase as one item, and understand that a $100,000 house can end up costing you over $190,000 among principal, interest and insurance - to say nothing of taxes.
Understand that a desirable property has financial potential. Most people who switch houses, whether they're trading up or trading down, never think to keep the original house and rent it out. "That's unrealistic. I need the cash to buy the new place." What if you rented it out for a premium, and used the difference between the rent charge and the mortgage payment to pay for part of the new house? Or perhaps you could engineer a lease option, whereby a renter can choose to purchase the house after a fixed period if he has the wherewithal?
Yes, a house is a home. But you're missing out if you see it as nothing but. Real estate is a financial instrument that, under the right conditions, can help you generate lasting wealth.