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Financial Peace University Part 5 – Tips on buying and selling real estate



Buying a homeFor this installment of the Financial Peace University series, I’ve summarized some of Dave’s main tips about buying and selling real estate (along with my commentary) into list form.

Dave is a proponent of purchasing your own home, but only in a very responsible manner. He points out that real estate is a good investment for the following reasons:

  1. Home mortgages act as a forced savings plan.
  2. Owning a home is a hedge against inflation.
  3. If you live in a house for 2 years or more you don’t have to pay taxes on the appreciation (limited to $250,000 per person).

However, Dave doesn not recommend using real estate as an investment unless you can pay cash outright.

The most powerful point Dave makes about buying or selling a home is that these are the largest transactions most people will make in their lifetime. As a result, it’s possible to lose or make a lot of money depending on how you do it. It’s well worth putting in some extra effort and hiring expert help to ensure you maximize the benefits and gains of real estate transactions.

Here are Dave’s tips on buying and selling real estate.

Tips on selling a house

  1. Don’t “live” in your home when it’s on the market – You have to think like a retailer and market your home. When your home is on the market, you must constantly be thinking about how others will percieve it. You can’t really live in your home as usual when it’s on the market – it has to be ready to show at a moment’s notice. Don’t require the buyers to use their imagination.
  2. 50% of real estate sales come from the sign out front and curb appeal – Make sure the outside of your home looks nice and well groomed. Tear out overgrown shrubs and trees. Paint the outside. Repair damage in the concrete. My own personal tip is to take a photograph of your home; you tend to see flaws much more easily looking at a photograph for some reason.
  3. Get a good realtor. He/she will make your more than what they cost you. A good realtor knows how to market your home, negotiate (good cop, bad cop), and evaluate the value of your home better than you do. Don’t hire a relative as your realtor. Interview realtors. They should be in the $1 million club (have sold $1 million in real estate in the last year). They should present to you their plan and referrals.
  4. Don’t buy home warranties unless it’s a condition of the sale.. They’re not worth it.
  5. Appraisals aren’t the law, but they’re better than your “feelings” – Appraisers give only an opinion and don’t have the final, difinitive value for your home. However, their estimate will still be more accurate than your gut feelings.

Tips on buying a house

  1. When buying a home buy title insurance – Title insurance is worth it. It covers you when there’s unclear ownership of house (e.g. aunt suzy never signed off on sale of house and still has rights to the home). It also covers undiscovered liens against house.
  2. Get a survey when buying – Oftentimes, the advertised property boundaries and the actual boundaries are quite different. This is particularly true on a property without clear boundaries such as fences.
  3. If you use an agent to buy, get a “buyers” agent – a “buyers” agent is an agent that only represents you, the buyer. Some agents represent both sides – the buyer and the seller – and therefore have an inherent conflict of interest. A buyer’s agent will only have your best interest at heart.
  4. Don’t buy at the top of the neighborhood, but at bottom – The crumbiest house in a nice neighborhood will inherently be worth more by virtue of the neighborhood. If you fix it up at all, the value of the house can significantly increase. In contrast, if you buy the nicest house in the neighborhood and fix it up, the value can only increase so much because it will typically stay within the range of the value of the other houses in the neighborhood.
  5. Houses tend to appreciate most in locations with views and on the waterfront
  6. Look for houses that don’t look nice and you can get a bargain – This is the inverse to the principle of marketing your house – you want to look for owners that haven’t marketed and presented their house very well. If you can use your imagination and overlook cosmetic flaws that can be easily fixed, you can often get the best deals. A little imagination and elbow grease can go a long way.
  7. Always buy a home that is attractive from street and has a good basic home plan – It’s very hard and costly to make changes to the bones of a house. Unconventional home plans and lots can be very hard to sell.
  8. Get an independent house inspection when buying – Getting an independent house inspection will not only protect yourself against hidden flaws and problems, but you can also use it in the contract as a way out of the deal if things don’t line up to your expectations. In many cases you can negotiate to have seller pay for home inspection
  9. Don’t take out a mortgage for more than 25% of take-home pay (e.g. after taxes, 401k, etc.) – Dave recommends putting down as much as you can on your house. His suggestion to take out a mortgage for no more than 25% of your take-home pay is radical but would save people endless financial headaches if followed. See my earlier post about calculating how much of a mortgage you can afford.
  10. You should put at least 10% down – Dave ideally recommends paying cash for your home but recognizes that most people won’t do this. Instead, pay as much down as possible. Most people follow the opposite advice and try to pay as little down as possible.
  11. Never get a 30 year mortgage – get a 15 year mortgage instead – Again Dave goes against common practice with this recommendation. If you already have a 30 year mortgage, he recommends you keep it and pay it down like a 15 year mortgage. If the current interest rate is lower now, re-finance to a 15 year mortgage. The idea that you’ll take out a 30 year mortgage and pay extra is statistically not true. In the end, you’ll just pay what is required. Sam’s note: I agree that most people won’t pay extra on their mortgage. However, if you have a proven track record of controlled budgeting, go ahead and do it. Because my wife and I keep to a tight zero-based budget, we are successful following this strategy.
  12. Never get an adjustable rate mortgage – Adjustable rate mortgages are meant to protect banks against decreasing interest rates, not to protect you. Particularly in today’s environment interest rates are historically very low and for the most part have nowhere to go but up. Another reason to avoid ARMs is that 35% are calculated inaccurately. If you already have one, make sure you audit it. Dave recommends refinancing your ARM if you have one.
  13. Put 25% down to avoid paying Private Mortgage Insurance (PMI) – PMI costs roughly $75/mo for every $100k in loan value. If house appraises to 20% equity, call the mortgage company to remove the PMI. The bank may require an appraisal. Once your equity reaches 22% of the value of the house, the mortgage company is required to drop the PMI without notice.
  14. Avoid FHA and VA loans – FHA (Federal Housing Administration) and VA (Veteran Administration) loans are not good deals and are meant for people without enough money to get into a home otherwise. They are guaranteed by the government. FHA and VA loans charge an MIP which is just like PMI, but it’s carried throughout the life of the loan so they are more expensive.


Posted in Real Estate | 8 Comments »

8 Comments to “Financial Peace University Part 5 – Tips on buying and selling real estate”

  1. sabrina Says:

    You know, I am really not sure I buy the “forced savings plan” argument. First of all, you throw away a LOT of cash at inception on closing costs. If I closed on a condo for myself today, that’s eight to ten grand I’ve spent on closing costs, for no direct benefit. That’s huge! Then there’s moving and the associated costs, and you know, I really need a new sofa for the new place, the old one is just so ratty… Plus, all the interest money is mostly thrown away — sure, you can deduct it, but a deduction against your taxable income isn’t the same as having cash in hand; you save less money than you spend — and there’s a /lot/ of interest paid off in those first five years. If I rented for half the cost of a mortgage payment, I could put the rest in even a low earning savings account and it’d be more directly beneficial (especially if it was intended to buy a property later, with a fatter down payment, thus causing lower payments and a shorter loan term — which I see are also a couple of recommendations, but I thing most people tend to focus on the good (”Equity! Savings!”) and not the bad (”Saving now to buy later? But that’s hard…”).

    I think the “forced savings plan” argument is only a good one to make if the person intends to stay there for 5-10 years, at least, and they’re really bad at actual saving. I mean, *really* bad at it, at least enough to justify throwing away the closing costs. Otherwise, just get a savings account, set up direct deposit, and enjoy having your landlord fix things for you.

    JMHO!

  2. sjpeer Says:

    JMHO,
    You bring up some very good points. I definately agree that buy a house should in no way be considered a replacement for saving money for retirement or other purposes. In fact, the spirit of what Dave is saying was not that you should buy a house specifically as a forced savings plan. Rather, he framed it as being one of the side benefits.

    While your suggestions about setting up a savings plan are sound, I’ve been surprised at how many people have a hard time doing so. It’s hard to save when you’re living beyond your means. For such people, having a house at least forces them to make payments and build equity. The downside is, many of them then go and take out home equity loans and spend the equity!!!

    I agree if you’re only going to be in one place for 2-3 years you’re better off renting and saving the difference. In fact, I think Dave’s 5 year rule of investing (that you should invest in mutual funds if you’re savings horizon is greater than 5 years) could apply quite nicely to real estate – If you know you’ll be around for 5 years or more, buy, otherwise, rent.

    Lastly, I agree that the costs of owning can be much higher. Most people don’t consider all the costs which is exactly why they get in over their heads.
    Sam

  3. MONEY BLUE BOOK Says:

    I think #4 is my favorite real estate advice. It’s all about location location location they say…but the location is also relative. Better to be a small fish in a big pond than the other way around when it comes to real estate. The small fish has more room to appreciate!

    – Raymond

  4. Jill at housewifery.wordpress.com Says:

    This post and comments were perfect timing; they resonate with a recent decision my husband and I made e.g. to delay home ownership (…you’re welcome to view a quick video clip per above; it was fun to cut). Although I concur with the purchasing tips, it became clear that our overall fiscal health would be unstable if we bought our first home now. We live in downtown DC and walk to work (…sold car years ago to rid the budget of said payments). We’d have to liquidate our emergency reserves for the down/closing costs. So we’re holding tight for now.

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  6. Kathy Says:

    I’ve always thought you shouldn’t live in your home when it’s for sale but many will tell you they sell quicker. It’s good to see my thought confirmed. I do not like going into lived in homes and do not want strangers lurking through mine while I’m here.

    Good tips.

  7. Investment purpose Says:

    Good Post.This information is really beneficial for buying, selling and maintaining the property for investment purposes. Thanks for giving such valuable information.

  8. iarenoob Says:

    I think if you are going to purchase a property investment you should also get insurance such as fire or flood. I don’t see it being a “forced savings” since if you do get a mortgage, you are putting a lot of money towards interest on the first half of the loan period. If you are able to find out how much to prepay on the principal then the interest can get waived. I agree with getting an inspection because sometimes there are some problems that you cannot find such as mold.. though you may be able to smell it. If you are looking to make some quick profit, you can flip the property.. buy it low fix it up and depending on your market you can either sell it low or sell high.

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