9 - Buying a House for 20%, 30% Off - Or More
Buy land. They ain’t making any more of the stuff.
All You Need To Know
You aren’t even close to buying a house or condo or whatever but you should be planning on it only because most people do end up owning something, somewhere along the line. Planning for it and preparing for it will build wealth in the long run.
Buying a house is one time when a good FICO score really is necessary. A good score will make getting a mortgage easier and you will get the best interest rate on the loan. As noted earlier, the best ways to get a good FICO score are 1) pay your bills on time 2) don’t apply for a lot of cards and 3) pay off your credit card balances.
Paying off your balances will also get rid of the credit card debt and free up money for the down payment on a house. Down payments may seem to be things from the past as the market accepts everything from 20% down to zero down but there is a price for less than 20% and it is significant. Less than 20% down results in a less than optimal interest rate on the loan and you have to buy PMI which is short for Private Mortgage Insurance. Put 10% down and take out a $150,000 mortgage and PMI will cost you at least $65 a month, or an additional $780 a year or an additional $3,900 over five years. Putting 20% down AND having a great credit rating will really pay off because the difference between an interest rate of 6% and an interest rate of 8% on a $200,000 loan is $228 a month, $2,736 a year.
So what? Well, over the life of the loan you will pay out $82,080 more for the 8% loan than the 6% loan.
But for now just pay your bills on time to improve your credit rating and start saving money for that down payment. Relax and read on as we come to the fun part which is finding a house for 10%, 20% or 30% off.
Houses Are Always Too Expensive
Housing prices are, no pun intended, through the roof. Housing has been called a bubble but in financial circles bubbles are only recognized after they burst as in the dot.com bubble of late ‘90’s. Housing may have been bid up recently but to the first time buyer anytime, houses are always too expensive, especially in the area where you want to live.
Because when you start thinking about where you want to buy, you start thinking like an adult which is really scary, at least it was to me. You want to live where 1) there are nice houses, 2) good schools (which means you are thinking about kids which is also really scary), 3) access to transportation and 4) opportunity for appreciation, or at least not depreciation.
At this point we will go with a true life example. I want to stress here that this is not meant to be prideful or boasting but I am convinced that examples of things that have been done in real life are much more useful than just telling somebody how to do something in broad terms. So let’s go back in time and walk through how we got a house for 30% off in one of the most exclusive suburbs in the Chicago area.
When we last left Sue and Bill in the chapter on renting, I was very comfortable in our coach house off Lake Michigan, enjoying the sound of the waves hitting the beach less than a 100 yards away. Perfect until Sue looked up from the latest Pioneer Press paper and said, “Interesting.” An ad for a house caught her eye and we started down the slippery slope toward home ownership. “Let’s just drive by.” Another nail in the coffin. As we all learned in some science class, Nature abhors a vacuum so just when you think you got it locked, Nature comes along and shakes things up.
On the positive side, things were getting a bit better financially. Sue had a full-time teaching job and I had two years under my belt at The Quaker Oats Company with a promotion and one on the horizon. We were funding our retirement plans and saving some on the side thanks to our low monthly rent payment plus frugal living. So we “drove by.” And I had a panic attack because, after we “drove by” I studied the ‘Houses for Sale’ section in earnest and determined that we could afford NOTHING. We could not qualify for anything. We didn’t have the 20% down payment on anything and our salaries could not meet the standard percentage test that banks use to determine how much they will lend.
Banks do weird things every once in awhile like make bad loans and then they collapse and the taxpayer pays and they get conservative and then we start all over again but they do usually apply some basic rules on how much they will lend. They will lend to you to buy a house IF your future monthly mortgage payment is less than 28% of your monthly gross pay. Another test is that all your debt—proposed mortgage plus car loan plus student loans plus credit card debt—does not exceed 36% of your gross pay. There is a little wiggle room here but not much and there are a few more tests the banks use but if you can’t pass these, you flunk.
And we flunked, to quote Dick Cheney, Big Time.
Raise The Bridge or Lower The River
Life likes to work in threes-three legs on the stool, three sides of a triangle, the Marines use three men to a squad because anything more than that gets confusing. And we had three variables-the 20% down payment, our salaries and house prices. The first two variables were not variables, they were facts, there was not anything we could do about them. At that time, banks required 20% down, period. Our salaries were basically fixed. They would go up but not by twenty or thirty percent. So the only real variable was the house price and that would impact the other two variables. I had to get the house price down because a lower house price meant a lower down payment in absolute dollars AND a lower house price meant that we would meet, or at least get closer, to the 28% and 36% bank tests. Simple but how do you get the house price down?
Didn’t have a clue. So the first step was to define the area we wanted to live in. If that wasn’t affordable, go to Plan B. And guess what, we narrowed it down to the most expensive suburbs in Chicago. Way to go. Why? Well, not because we were status happy but the area had (still does) the best transportation, best public schools, was near Lake Michigan, stately homes, established downtowns, and had the best potential for continued appreciation. And trees. Sue loves trees.
The area is the North Shore excluding Evanston but including Wilmette, Winnetka, Kenilworth, and Glencoe. If you’re sitting in San Francisco, this probably means nothing but think Burlingame, San Mateo, Palo Alto. If New York, think Scarsdale and Westchester. Dallas means Park Cities. You get the idea. I figured our chances were zero but it would be a ‘learning experience.’
The Learning Curve
Looking around takes a lot of time and generates a lot of frustration but it also generates a lot of thought which leads to knowledge. And knowledge is power. Here is what we learned and how we leveraged the knowledge to lower the price and make our variables work.
Lesson 1-In any town, no matter how rich, there are ugly houses. Ugly house means everything from décor like the BatCave to badly maintained, nearly falling down houses. They are out there. Don’t ask why somebody would live in a dump or decorator challenged environment in one of the most expensive areas in the world but they do. One house had footprints painted on the ceiling of the living room. Your job is not to figure out the thinking but to find the house and envision what it would be like after an overhaul.
Lesson 2-There are always people in trouble and trouble usually means divorce, loss of job, or transfer. We found all three in our house search and in one house. People in trouble need to get out of trouble and pricing suffers accordingly, for them but in favor of you.
Lesson 3-No offer is too low. Start below what you can afford and work your way up.
Lesson 4-The hardest lesson is not to fall in love with a house. Have the guts to walk away because if it doesn’t work, it doesn’t work. And there are a lot of houses in the world.
Here’s how we applied these hard learned lessons. We learned Lesson number 1 because real estate ads are written in code, not a very difficult code, but a code nonetheless. “Charming” means small. “Needs a little TLC” means it is falling down. “Unique” means weird. You get the picture. Read the ads, look at the houses and you figure things out pretty quick. But don’t put a lid on what you look at. Don’t pass on going to see something even if it out of your price range. We had to think this way since everything was out of our price range. True Story-a couple we came to know bought a house that was in their price range. They didn’t look at the house we eventually bought because it was out of their price range. By the time we negotiated our final price, it not only was in the other couples price range, it was below what they paid for the smaller house. So, look at everything.
We also found a realtor that thought like we did, kind of. She showed us one house that was pretty close to our ‘range’ and then drove us past another that was way out, or so we thought. She took us through it and it was a challenge but had ‘potential’ and, more importantly, a seller in trouble. In fact, the seller wasn’t even there. Her situation was a divorced mom of two who got transferred to Minneapolis and the house was on the market for too long and her company was telling her to dump it because they were picking up part of her mortgage payments as part of the transfer package. So she was in trouble because she had to sell her house to get the company off her back and free up cash to buy a house up there. Let the negotiations begin.
First the positives and negative, pros and cons. Pros on one side of the sheet of paper, cons on the other. Pros-great suburb, great schools, walk to the train, walk to downtown, big lot, 100 year old house with ‘charm’, and, of course, trees. Cons-100 year old house with 100 year old furnace, no air conditioning, and enough work to keep us busy for years, six in fact. Final con-we could not afford it.
Because the mortgage would have been way out of the ranges, 28% and 36%, that the banks dictated. So lower the price. Now, these are 25 year old prices so don’t gag but the strategy is key so ignore the numbers except as guideposts.
Here are the facts:
Original Asking Price was $124,900.
Price recently dropped to $110,000 which means to most realtors that the negotiating is basically over.
Our top offering price dictated by the bank variables (and just squeaking through) was $90,000.
So how do we not go over $90,000? Try and remember Lesson 4 which was having the ability to walk away. This was getting harder and harder but we vowed to walk away if necessary.
Just The Facts
Next some basic math. Negotiations and bargaining tend to end up in the middle-you want a $100 for something, I offer $80, we settle at $90. So we figured that if she wanted $110,000 and we could realistically pay only $90,000 then we could only offer $70,000. Even our realtor balked at that one. “No way.” I said, ‘I know no way but if we start higher we can never get to $90,000.” We argued and talked and argued and talked. Finally she said, “How about a little more?” “$72,500 tops.” Ok.
The howls were heard at Wrigley Field but the important thing was that the seller didn’t say no completely. No way, No good, calling me a few bad words but she didn’t end it. She countered, we countered, again and again. Nothing heard for a week, silence, another counteroffer. The dust settled at $88,500. We made our top limit with a whopping $1,500 to spare. We were the proud owners of a house that needed some TLC.
In the next six years we painted, drywalled, tore out walls, bathtubs and furnaces and replaced. Not for you? Why not? Anybody that does these things for a living is a high school graduate at best and the skills are basic. You just need the determination and lack of cash to learn them.
Anyway, sold it for $157,000 six years later. Pretty good return, huh? $157,000 minus $88,500 divided by $88,500 equals 77%. Wrong. We put 20% down so the gain was $157,000 minus paying off the remaining mortgage of about $80,000 divided by $17,700 (our down payment of 20% of $88,500) equals a return on investment of 435%.
This may not be your experience. You may make mistakes and you may lose money. But you do have to live somewhere and having a strategy-find somebody in trouble in a good location—will work more times than it fails. Good luck. But remember, you don’t have to do anything right now except get your FICO score up and save some money.
And finally, there is a saying in real estate investing-You make money when you buy the house, not when you sell it. Now you know what that means.