To Buy…or Not to Buy
In the dim, dark past of perhaps 12 months ago, everyone bought into the myth that owning property was an inalienable right, and we all agreed it was an overall good thing. Lenders were only too happy to oblige: a ham sandwich could qualify for a mortgage. Banks and other lending institutions developed a thriving business in offering “products”—interest-only loans, variable rate loans, no down payment loans, stated income or low-doc loans, negative amortization loans—none of which were entirely understandable, all of which encouraged buyers to trade up to properties that they really couldn’t carry. We all know what happened then…
Banks have learned enough to totally reverse themselves. Now, loan applicants, qualified or not-so, are all experiencing the same intrusions, delays and humiliations by lenders and their “underwriters” (the department that actually verifies the information provided by the applicant). Lenders may have money to lend but they still don’t have uniform criteria in place to determine the credit-worthiness of applicants.
The current “buyer’s market” is the result of tight money mixed with desperate sellers who are either “underwater” (meaning that the market value of their property has dropped below the principal amount of their outstanding mortgage) or who can’t afford their mortgages anymore. So, the question is, “Should I buy now?”
Qualified buyers have an opportunity to make a good investment now. There’s inventory out there, owners offering their properties at concomitantly low prices. Sellers who are lucky enough to sell now, albeit at lower prices, are wise to purchase in the same market. First time buyers with steady, reliable, and verifiable income and some cash in the bank have lots of choices. Loans are available at historically low rates, especially “conforming” loans that are government-backed, although admittedly, they are harder to get.
Potential home and business property owners should take the first two steps simultaneously: first, put together a brutally realistic financial statement and budget; and second, consult with a reputable real estate broker thoroughly familiar with the neighborhood you’re interested in. Honest financial introspection will determine how much you can spend. If there is a lesson to be learned from the real estate crisis, it is this: don’t buy more than you can afford. Buyers made the mistake of shopping with borrowed money and plenty of optimism, but not with their own resources. A low initial interest rate, subject to reset five or seven years down the road, allowed buyers to commit to larger loans on the assumption that their incomes would increase. They didn’t foresee high unemployment levels. Interest-only loans, without any payment toward principal, relied on market value increases to develop “equity,” that is, ownership. They didn’t foresee plunging market values. Borrowers just assumed that they would be able to sell at a profit when the loan readjusted or if their payments became burdensome. They didn’t foresee a glut of bargain-priced properties.
Now that prices are significantly lower and interest rates are favorable, buyers may still think they can afford “more.” Savvy buyers, who understand recent history, should resist shopping at the top of their budget. Instead, develop an honest budget, project what you can afford to pay each month, and then reduce that by 10 percent or more! Make sure you factor in cash reserves, so you can carry your property for six to 12 months, even if the worst happens.
Be aware that real estate brokers charge a percentage of the purchase price as commission: the higher the price, the higher the commission. The seller, not the buyer, pays the commission to both brokers, and buyers’ brokers have the professional obligation and responsibility to get the best possible price from the seller. But there’s always the temptation to get a “good buy,” “go for quality,” put in a “low-ball bid” on a property that’s too costly for your budget, in short, to spend more. Be specific and disciplined about how much you are willing to spend, and don’t be talked into looking at properties above that amount.
Instead, try to put more cash into the purchase. Your life savings should not become a 10 percent deposit, if it could be 40 percent of the purchase price. Let your broker know how much cash you want to put toward the purchase price. More cash means a stronger negotiating position. More cash means it will be easier to get a mortgage at a better rate. More cash means more equity, which means more of an asset. This is especially important if it’s a business purchase.
Unless you’re prepared to pay all cash for your purchase, the next step is to qualify for a loan. Now the issue is, mortgage broker or banker: what’s the difference?
A mortgage broker does your shopping for you. Brokers aren’t affiliated with any single lending institution, so they have access to a variety of sources that the consumer doesn’t, out-of-state lenders, for example, or even private funds. Typically, the mortgage broker will assess your qualifications and match you up with a loan. A bank’s mortgage representative will match you up with one of the bank’s products. If your loan is “hard to place” and the bank won’t tailor a loan program for you, the bank will turn you down.
Mortgage brokers aren’t miracle workers—ham sandwiches no longer qualify—but they have the flexibility to find a loan when a retail bank can’t. Of course, there’s a price to pay for the individualized services performed by the broker: commissions and origination fees, known familiarly as “points” because they are calculated as fractions of the purchase price, may add significantly to your closing costs. Some lenders pay the fees, many don’t, so you need to ask specific questions and read the “good faith estimate” carefully before you decide whether to go with a broker.
Legal fees may also add to the cost of your purchase, even if lawyers don’t play a starring role in the real estate transaction in your state. In some markets, there are more lawyers at the closing table than a meeting of the county bar association. In most, title companies handle the actual settlement. In all real estate transactions, however, lawyers should be consulted, especially if the purchase is for business purposes. Contracts for the purchase of real estate may be written with English words, but they should be interpreted and explained by an expert, fluent in legalese.
Even before looking at a contract, a lawyer should look at the background of the property you are contemplating. This is “due diligence” and necessary for you to make an informed decision or negotiate further with the seller. No one wants to commit to a long-term debt and give up years of savings just to be surprised by a leaky roof or defective heating, tax increases or questionable ownership, zoning restrictions or expired certificates of occupancy. As you hire an engineer to inspect the property, so must you retain a lawyer to review any paperwork that exists or can be recreated. You may decide to ask the seller to make repairs or cure defects in title, or you may decide to buy even if the property needs renovation, but at least you’ll know what you’re getting into. The seller has no obligation to disclose any conditions, and you won’t have recourse against the seller after closing, unless the contract says so.
Ask your lawyer to analyze and explain the tax impact of your purchase (and eventual sale) and the desirability of taking title as a single person, married person with your spouse, in a trust or business entity.
But the most important part of the process—the part that kind of gets lost in the technicalities—is choosing the right property, not just the best buy. Once you know how much you can spend, you can become a knowledgeable shopper. You don’t have to rely on your real estate broker or limit yourself to one broker; buyers with access to the internet can become very well educated, very easily.
If you’re thinking of “picking up” a distressed property, however, or a bargain at a foreclosure sale, you probably should engage the services of a local broker who is knowledgeable about bank sales. Once you’ve identified such a property, you need to speak to your lawyer, because there may be title issues or other issues like tax liens or open permits that will cause problems at closing.
In this market, finding a property in your price range that suits your needs isn’t nearly as challenging as dealing with paying for it. Sellers will welcome an “all cash” offer, even if it’s lower; that way they avoid the risk of making the sale dependent on whether the buyer can get a mortgage. But if you can’t buy without a mortgage, or if you would like the tax benefits of a mortgage (interest is tax deductible) you must be upfront and demand a “contingency clause” in the contract of sale. That means that you don’t have to go through with the sale if you can’t get a mortgage. Make sure you negotiate sufficient time to secure the loan, typically 30 days, but in today’s market often 45 days, and don’t forget to specify “business” or “calendar” days. Make sure you understand how much time you have under the contract to get a “commitment letter” from a lender, otherwise you may be in default and liable to lose your deposit.
How likely is it that the seller will “keep” your deposit if something unanticipated happens? No one intends to default on an obligation or breach a contract, but circumstances change unexpectedly. In this uncertain climate, both buyer and seller are vulnerable and eager to protect themselves. A seller seeking redress for a buyer’s breach is required to give notice of default and an opportunity to cure before attempting to retain the deposit. The buyer may just need more time, or a price adjustment; the seller may be content to retain a part of the deposit instead of the whole thing as a condition for the buyer’s withdrawal. Let your lawyer handle the negotiations.
All real estate transactions require the advice of an expert. Retain counsel as soon as you decide that this is the time to buy.