Interest Rates Affect Affordability the Most

Now that the heated market is softening, many buyers seem to be waiting on the sidelines for the once high prices to decline even more. Their reasoning is that a lower price will ease the road to homeownership. Currently, prices have decrease and seem to be stabilizing. But, the true factor that affects affordability is interest rates, which is the most powerful component of the home-buying process.

A drop in interest rates has a far greater affect on monthly mortgage payments than a drop in home prices. So, if home prices do happen to drop and if interest rates rise at the same time, that once affordable home will quickly become unaffordable.

For example, a household with an annual income of $100,000 can afford a $450,000 home at an interest rate of 5.63%. With an increased interest rate of 6.7% (approximately 1% higher), that same family can only afford a home priced at about $399,411. The only factor that changed in this equation was the interest rate. This change in interest rate resulted in a $50,000 decrease in affordability. The mortgage industry is currently predicting mortgage rates to rise by year’s end.

For those thinking of buying, look at all of your options and run the numbers with a mortgage professional. If interest rates are slowly ticking up as you wait for home prices to drop, you might unknowingly price yourself out of the market. Even worse, home prices may stay the same or increase, while interest rates increase. This will price you out even quicker. The more inventory available in your market, the more bargaining power you have. Instead of waiting for prices to drop, make an offer that is equal to your reasonable target price. Smart sellers are willing to negotiate, so you may be able to acquire that lower price by just asking for it.

Buyers are currently making great real estate purchases in this market. So make an offer, the worst that can happen is a counteroffer or rejection. But you won’t know until you try.

You can also lock in early to guarantee you a lower interest rate while you shop for a home. Locking in will preserve your lower interest rate and most mortgage programs allow you to lock in for up to 4 months.

A few ticks in mortgage interest rates can translate in an increase in mortgage of hundreds of dollars, so make a smart plan and execute.

Certain Investment Ideas may be Illegal

We can all agree that there are many ways to make money in real estate. You can buy a residential property and rent it out for a steady monthly income. You can purchase a commercial property and lease the space out the businesses for many years. On the other hand, you can acquire a fixer-upper, make some repairs, and resell it for a profit, or acquire a vacation property and rent it by the week to short-term visitors. Well as you embark on your journey of real estate investing, some moneymaking ideas may not be allowed by the local or county jurisdiction that the property resides in.

For example, early in my real estate investing career I acquired a large property with many bedrooms and bathrooms. It was formerly used as convent. At the time, it was a good deal, so I made a rush decision to purchase the house. I dreamed of the cash flow I would receive from renting it to students on a per room basis. So, I proceeded without researching the state and county laws until after the purchase. The excitement of the purchase trumped my need for due diligence. After running the house fully occupied for a few months I realized that the county did not allow that many people to live in one dwelling without being related. Soon after, neighbors complained and a county officer gave me a call. There were avenues that I pursued to legalize the "rooming house", but to no avail. Luckily, I eventually sold the property to a church for a substantial profit, but it could have ended up less favorably.

The moral of the story is that certain investment ideas can lead to violation of local laws and could become nightmares.

Below are some examples of investment ideas that sound good, but should be well researched before being carried out:

Idea 1:
Creating a rooming house out of a single family by renting each room individually. Some investors will carve out extra rooms in a single family dwelling to increase their rental cash flow. This is especially prevalent in neighborhoods near college campuses.

Check your local laws to see how many unrelated individuals can live in one house before making plans. A local housing inspector can continuously fine you for renting rooms to more people than the law allows.

Idea 2:
Creating a two-family home from a single-family dwelling. Simply installing a kitchen in the basement of a home may not be enough to make it a legal two-family dwelling.

Installing a kitchen in many jurisdictions constitutes a separate living quarters and it may violate local occupancy restrictions. If your investment property is in a single-family dwelling zone, then it may have to be rezoned by applying for a special exception to the current zoning law.

If you don't apply for and receive the special exception and the local housing inspector finds out, you could end up having to yank out the basement kitchen just to ensure the house will remain a single-family dwelling.

Idea 3:
Using a residential property to conduct commercial business. This is less prevalent, but still does occur. Some commercial business can be conducted with the proper permits or special exceptions. Other commercial businesses cannot be conducted at all and may result in heavy fines if discovered. Again always check with local and state laws to verify what you can and cannot do.

A good understanding and willingness to comply with local, state, and federal laws regarding rental properties can make the difference of having a gain or loss in your investment.

Real Wealth Through Rental Properties

Since the market has cooled in many cities, many new investors are starting to panic because they are worried about how to now make money in real estate. They can no longer buy a property, slapped on some paint, and sell it six months later for a $50,000 profit.

These investors are used to making money through quick appreciation or asset growth. This is really a secondary means of making money in real estate. The recent boom has given the false impression that property prices always go up.

The key to building true wealth in real estate is through buying and holding. Good and consistent tenants can create wealth for you by paying for mortgage, insurance, taxes, and other fees through rental payments. The power of leverage also allows you to make huge returns by using the banks money. If you put $10,000 down on a $200,000 home, with 5% yearly appreciation, you will have 100% yearly growth of the money that you actually invested.

With real estate you have many vehicles for creating and building wealth. Since it is very difficult to predict short-term prices, it is important not to rely on appreciation alone.

The following principles will help in your mission of wealth building:

Positive Cash Flow: Obtain a property that can command rents that will cover the mortgage, taxes, insurance, etc and still have something left over for reserves and profit.

Equity Growth: Assuming you have a mortgage that pays principal and interest; as tenants pay their rent, they are also paying a portion down on the balance of your mortgage. The longer you hold the property, the more they reduce the balance of your mortgage. By reducing your debt, this contributes directly to increasing your net worth.

Reducing Your Tax Bill: Through real estate you can take advantages of the numerous tax breaks offered to property owners by Uncle Sam, thus reducing your personal tax bill. This will result in increased income and equity growth.

Asset Growth: This is old fashion appreciation. As you hold your property for the long term, it will increase in value, which will increase your net worth. This is compounded by the fact that your mortgage balance will also decrease with time.

Increased Rents: Over time, the cost of living increases, this will allow you to also increase your rent. If your mortgage payment stays fixed, this can allot you hundreds of dollars of additional cash flow per year.

These principles should be considered if you are looking to seriously invest in real estate for the long term.

Promissory Notes as a Real Estate Investment Option

In this slowing real estate market a promissory note may be a good alternative for investing in properties and creating a steady stream of income. This is similar to offering someone a 2nd trust or “piggy-back” loan that accompanies a 1st trust or primary loan. This could also be a good option for sellers that may have a potential purchaser that needs a 2nd loan to complete the transaction. This scenario will only work with sellers that have a good amount of equity in their homes. The seller will need to pay off their own mortgage and have enough equity to offer a 2nd trust and maybe pocket some profits.

The promissory note process is not very difficult and I have actually done it myself. You can get sample promissory notes on the web and then have a real estate attorney look it over and fine-tune it for your particular needs. If done right, this vehicle can provide you with years of constant monthly income.

For those of you who currently have mortgages, do you often look at your statements and snarl as you notice that only $100 of your $1400 monthly payment is going to the principal balance? Well, as a promissory note holder, you will reap the benefits of this payment structure. For example, if you hold a $50,000 note at 10% interest rate over 30 years, you will receive a monthly payment of $438.79. Let say you hold this note for 7 years before the borrower pays off the remaining balance. At this point you would have collected 84 payments of $438.79, for a total of $36,858.36. After 7 years the remaining principal balance is $47,280.27. Your grand total after 7 years is $84,138.63. This equates to above market interest on your money. In addition, you have real estate as collateral that offers you additional protection. This is not a bad return as long as the property (and the individual) that you are creating the loan against is of high-quality and your Loan-to-Value is reasonable.

So, how do you evaluate a good property and borrower? The first thing to do is to complete a financial background check on anyone to whom you would consider issuing a promissory note. It is important to analyze the individual’s history in paying their bills, especially previous mortgages, rent, and other large bills like car notes. They should have relatively sound habits when it comes to these recurring payments.

The next important detail is the Loan-to-Value; the lower the combined LTV, the lower the risk of the loan. This essentially tells you how much wiggle room you have equity-wise. For example, if the 1st trust is $400,000 and the appraised value is $500,000, you can offer a 2nd trust of $50,000. This will give you a total loan-to-value of ($450,000/$500,000) 90%. This is considered a good loan because you have $50,000 of cushion in potential value depreciation. As a rule of thumb, you never want to have a 100% total LTV because it does not afford you room for a potential decrease in the value of the property. If the property has to go to foreclosure for non-payment, you will need this additional equity to assure you get your money back and cover your expenses. The first trust or primary loan gets first crack at having their money and expenses covered, so the greater the equity, the greater the possibility you have of recouping your investment. Also, borrowers with a larger down payment invested in a property are less likely to default on their payments.

The last important details are the terms of the loan, specifically the payback.

1. Amortized – most loans are paid this way. It is a combination of principal and interest payments for the life of the loan. Usually the initial payments consist of a large chunk of interest and a minimal amount of principal.
2. Balloon Payment – these loans give you a smaller monthly payment with a shorter loan term. At the end of the shortened loan term, the remaining balance of the loan will be due. Generally, this type of loan is refinanced before the balloon payment is due.
3. Interest Only – this is a popular loan that allows the borrower to only make interest payments for a portion of the loan term.

Hopefully, this gives you a good introduction to mechanics of holding a promissory note. A good starting point for advertising your desire to offer real estate promissory notes is your local real estate investment club. During their meetings they often have announcements for people looking to acquire or offer second trust promissory notes.

Consider reading more on the risks and benefits of this investment option, and if you decide to issue one, have a qualified real estate attorney or lawyer draw up the paperwork.

PMI is tax-deductible ..... for now ......

A $40 billion tax bill signed in December introduced a long awaited tax break for homeowners - tax-deductibility of private mortgage insurance, also known as PMI. This deduction is only available to homeowners with adjusted gross income less than $110,000 ($55,000 for individuals) and who itemize their deductions. The new PMI deduction will only apply to mortgage insurance contracts issued in 2007. Congress is supposed to evaluate the law at the end of the year for a possible extension.

Homebuyers may no longer have to opt for the popular 80/20 or 80/10 loans because PMI is now tax deductible. This tax deductibility makes loans with PMI cheaper than the 80/20 or 80/10 alternatives. Homeowners with PMI will now be able to deduct it from their incomes and pay less in taxes each year. It will be tough to justify going for a 80/10 or 80/20 loan if this law is made permanent. It is best to consult a good tax advisor to determine if a PMI loan is good for you.

2007 Foreclosures

It is predicted that 2007 will be a big year for foreclosure sales. Nationwide foreclosures were up 35 percent from December 2005 to December 2006. This is according to RealtyTrac.com.

The biggest culprits for this prediction of increased foreclosures are the combination of resetting ARMs and slowing home sales. Many Adjustable Rate Mortgages (ARMs) have reset in 2006 and will continue to reset in 2007. This is forcing homeowners with these loans to pay increasingly higher mortgage payments because of the ARMs’ increasing interest rate. The slowing real estate market makes it more difficult for these owners to sell their homes before foreclosure sets in. Many of these homeowners are even unable to refinance into new ARMs because of credit issues, lack of equity, or an inability to qualify for today’s higher ARM rates.

This is creating new opportunities for foreclosure investors, but you will definitely need to do your research. The foreclosure market is very different from the generic properties listed by a seller’s agent on the MLS. Properties on the MLS for the most part are in good condition. There are standard contracts with contingencies that can protect the buyer if the property turns out not to be exactly what they thought it would.

As for foreclosures, the buyer has a huge disadvantage. The contracts are usually created by the seller (which is the lender) and it is written totally in their favor. The seller wants to get rid of the property and usually will not allow many, if any, contingencies that will allow the buyer to back out of the deal without losing their deposit. It is very important to hire a seasoned foreclosure real estate agent and attorney to take a look at the contract before committing to it.

The seller wants the transaction to occur as quickly as possible and that is why they try to control all aspects of the transaction. As the buyer, you must perform your due diligence and have a good settlement company, lender, and real estate professional with experience in foreclosure sales in your area. This will help you wind through the process and avoid potential costly mistakes.