Now, that said, I think the FHA-insured mortgage can be a viable option for those of you who are rebuilding your life after divorce, or a financial setback such as a long layoff. Those are circumstances where a poor FICO credit score is not a sign of a lack of financial responsibility, but rather an indication that you have undergone a disruptive life event beyond your control. But even here I ask you to stand in your truth. I would feel so much better if you waited until you had the money to make a down payment of 10 to 20%. Being able to save that much is a sign that you have the strength and tenacity to make the right financial choices. And with a more sizable down payment you will be that much closer to the 22% home equity you need to have the 0.90% insurance fee dropped from your payment.
Special Buying Rules for Condos and Co-ops
If you are considering buying a condominium or cooperative, please be very very careful. In some of the most overdeveloped markets that have been hardest hit, condo prices can, at first glance, look like an incredible steal. But when you purchase a condo or co-op you are purchasing more than four walls; you are buying a piece of an entire development, and that means you have to make sure the development itself is a good investment. Here are the questions to ask:
•
What percentage of the units are owner-occupied as a primary residence?
Lenders and the FHA are becoming increasingly cautious about offering mortgages for properties that are in developments full of vacation or investment-property owners. And if a development is full of renters, that can impact your future resale value as well; unless it is a hot market for investment properties, you might have a hard time selling at a top price when everyone else around you is renting out their units. My advice: Stick with developments that are at least 90% owner-occupied.
•
How many units have been foreclosed on in the past three years?
If the answer is more than 3%, that is a sign of potential trouble, if you ask me; if there are more foreclosures you will likely see your home’s value drop.
•
What is the homeowners’ association or condo fee for each of the past five years?
You do know that in addition to your mortgage payment, you also will owe a monthly maintenance or common charges fee, right? I am asking because I am surprised at how many people come up to me so excited about a great condo deal, and then when I ask about the common charges they give me a blank stare. These monthly fees go toward paying the general maintenance costs of the development or building—landscaping, security, etc. And a portion of your monthly fee should also be set aside in a longer-term reserve fund that is tapped when the development needs to make an assessment for a major repair or upgrade, such as a new roof. I would be very wary of any development whose association fees have increased more than the general rate of inflation—about 3.5% or so. That’s a sign that the development doesn’t have a good grip on its costs, which would likely mean more big adjustments going forward. I also think you need to be extremely careful about buying into a development with many unoccupied units; if those units aren’t sold or rented quickly it’s likely the existing owners will be stuck with higher monthly fees.
•
What percentage of current owners have not made their monthly condo/association fee payments in the past three months?
If it is more than 3% take that as a warning sign that everyone else—including you—may be asked to make up the shortfall.
•
How large is the reserve fund?
All the owners, collectively, are on the hook for any big-ticket repairs or upgrades to the development. Ideally, you want to hear that the condo’s roof is 15 months old, not 15 years! You must insist on reviewing the financial statements for the development, including how much money is currently set aside in the reserve fund. At a minimum, at least 10 percent of a condo association’s annual operating budget should be set aside for the reserve fund. For older developments that are more likely to need maintenance, it would be great to see even more dedicated to the reserve fund. It’s obviously your best bet to focus your sights on developments in good physical shape, but if you have your heart set on a unit in a building that will likely need a new roof or other capital repairs in the next few years, be sure the reserve fund can handle that cost. Otherwise you could be hit with budget-busting special assessments that can cost you thousands of dollars.
Now, if all of that checks out, I then want you to do a full 360-degree inspection of your unit. Look, you are going to be living with neighbors quite near. So you better make sure you will be content amid all that closeness. Spend some time walking around the development and talk up as many residents as possible; are they effusive or complaining? You also want to do a noise check: If it’s a multilevel unit, I would ask to have someone walk around the unit above you; I personally would never go near a place where I could hear my neighbor’s every move. Same goes for any attached units nearby. Are the walls soundproof? And if you are highly sensitive to cigarette or cigar smoke, try to find out if neighbors you will be sharing ventilation systems with are smokers; in many buildings that smoke could end up wafting into your unit. And be sure to visit at a few different times, especially a weekend night. If you enjoy peace and quiet, it is better to know now if your neighbors tend to be more outgoing—and noisy—party types.
WHERE TO COME UP WITH THE DOWN PAYMENT
As discussed in “Stand in Your Truth,” the way to save for capital purchases is to create automated savings accounts so you can add to your dream funds every month. Set up a separate account for your down payment. The money should be kept in a stable bank or credit union account; money you expect to need within 10 years should never be invested in stocks.
DO NOT TOUCH YOUR RETIREMENT SAVINGS
In the past I have given first-time buyers the option of taking money out of their retirement savings for a home down payment. There is indeed a special rule that allows first-time buyers to withdraw up to $10,000 from a traditional IRA for a down payment, and be exempt from the 10% early withdrawal penalty levied when you are younger than 59½. (Though you still will owe income tax on the withdrawal.) Roth IRAs are another down payment source; you can always access money you contributed to a Roth without any tax or penalty, and first-time buyers can take $10,000 of earnings without paying the early withdrawal penalty. Income tax is only charged if the account is less than five years old.
However, I do not subscribe to that advice anymore. Given the struggles so many of you are having saving for retirement I am going to insist that you leave every penny of your retirement money invested for retirement. If that means you need to spend a year or two saving up for a down payment, that’s the truth I am asking you to stand in. Remember, the New American Dream is not just about sensible homeownership, but about retiring with security as well.
I also do not advocate borrowing large sums from your family for the down payment. This is primarily a lesson in personal accountability. I want you to be responsible for what likely will be your single biggest investment ever. For a 20% down payment I do not want your family chipping in more than one-quarter of that amount, or 5%. And it is your responsibility to make sure your family members are standing in their truth. They must never give you money if it compromises their own financial security.
MAINTAIN AN EIGHT-MONTH EMERGENCY SAVINGS FUND
In late 2010, more than 40% of unemployed Americans had been out of work for at least six months. That statistic alone should make it obvious why I insist you have ample savings set aside so you can continue to cover your mortgage and other housing costs in the event of a layoff or furlough. In fact, mortgage lenders will be looking at your savings when evaluating your application. Without at least four or five months’ worth of mortgage payments saved up you may find it hard to land a deal.
OPT FOR A 30-YEAR FIXED-RATE MORTGAGE
As I write this in early 2011, a 30-year fixed-rate mortgage for a well-qualified buyer is below 5%. I can’t tell you how seriously great that is. When you can lock in a low rate and you never have to worry about it changing, you must grab that deal. Yes, I know five-year and seven-year adjustable rate mortgages have even lower rates, but they also come with risk as well. Haven’t we all learned the risks that come with adjustable-rate mortgages? Many of today’s foreclosures came about because people took out adjustable mortgages during the bubble that they assumed they would be able to refinance out of before the rate adjusted. When that didn’t pan out as expected the troubles began. And given that interest rates are currently at historic lows, the trend going forward is for rates to rise, not fall. All the more reason to lock in a safe-not-sorry 30-year fixed-rate mortgage.
TIP: Consider a 15-year mortgage if you are at least 45 years old
. As I explain in the retirement chapter, I think one of the best retirement strategies is to get your mortgage paid off before you retire. So if you are purchasing a house today that you anticipate you will retire in, and retirement is within 15 to 20 years, I want you to consider taking out a 15-year mortgage. Yes, that means your monthly payments will indeed be higher, but at today’s super low interest rate—4.0% as of early 2011—a 15-year is incredibly affordable. If you have the income and savings to be able to handle the higher monthly payments you will save tens of thousands of dollars in total interest payments as well as arrive at retirement mortgage-free.
And if you are confident you can afford the higher required payments with the 15-year loan, it is the better strategy than just settling for a 30-year mortgage that you intend to pay off in 15 years. The interest rate on a 15-year mortgage is typically about a half a percentage point lower than the rate on a 30-year loan. That helps keep your overall interest costs lower. The website
Bankrate.com
has a calculator that will walk you through the math of a 15-year vs. 30-year mortgage.
UNDERSTAND THE RISK OF DISTRESSED PROPERTY
In most parts of the country, foreclosed homes and homes that are listed as short sales account for one-quarter or more of the homes for sale. These so-called distressed properties often sell for below-market rates, but you need to be extra careful if you are considering bidding on either type.
A
short sale
is when a lender agrees to let a homeowner sell a home for less than the current balance left on the mortgage. The lender is essentially agreeing to take a loss on that shortfall. As a buyer you must understand that you have two sellers in a short sale: the homeowner who is listing the home, and the lender. When you make a bid, even if the seller accepts, you then must wait to hear if the lender agrees to the terms. That can take months. And if the seller has a second mortgage on the home the process becomes even more difficult; the sale can’t go through without the approval of the second-mortgage lender, and that is not something that happens easily or quickly.
A
foreclosure
is when a lender has already taken back possession of a home from a borrower. Sales of foreclosed homes can move much more quickly; once the bank puts the property on the market it is eager to make a deal. But I don’t have to tell you about all the problems rocking the foreclosure market; as I write this in early 2011 we are dealing with revelations that many lenders may have foreclosed on homes without going through the proper steps. More troubling is the concern that many lenders lack the proper documentation to prove they in fact have title (ownership) of the home. What seems most likely is that this will clog the foreclosure process for months as banks—prodded by regulations and lawsuits—will have to scramble to prove their paperwork is in place. Given the turmoil in the foreclosure market I advise you to think very long and hard and ask yourself if you are up for navigating your way through the maze. It can take months. And you must work with a real estate agent with experience in foreclosures, as well as a real estate lawyer well equipped to review all documents. You need legal proof that a title search has been conducted and that you will indeed have free and clear title to the property.
TIP: Title Insurance on Foreclosed Homes
. If you are purchasing a foreclosed home and you anticipate making sizable renovations to the property, ask your title insurer for a policy that includes a special rider that would cover not just your purchase price, but also the future value after renovations as well. In the event the foreclosure documentation mess escalates and your ownership is questioned in the future, you want to know at the very least that your title insurance policy will provide ample reimbursement for the renovated value of your home. I recognize that there are some seriously great prices available on foreclosed properties, but I want you to be very careful if you decide to focus on foreclosed property. The buying process can be lengthy and full of pitfalls, and the current legal issues swirling around add a dose of uncertainty. Please stand in your truth: Maybe paying a slightly higher price for a home that is not a foreclosure is in fact the better deal for your family.
LESSON 4.
WHAT TO DO IF YOU ARE UNDERWATER
The steep fall in home prices in many parts of the country means that many homeowners who purchased a home during the bubble—often with little or no down payment cushion—currently have a mortgage that is higher than the market value of their home. According to housing data firm CoreLogic, more than 20% of homes with a mortgage in the third quarter of 2010 were underwater. Arizona, California, Florida, Michigan, and Nevada have the highest concentrations of underwater homeowners.
In this lesson I want to address separate strategies for two very different types of underwater households: those that can’t afford their mortgage and those that can. If you can’t afford your mortgage and you are in fact underwater, I want you to stand in the truth that walking away may in fact be the right and honest move for you and your family.