If you’re preparing to buy a home or rental property, you have probably experienced feelings of doubt as you’ve considered all the possible things that could go wrong: the property going underwater, the rental income doesn’t cover all the expenses, or mortgage payments have become unaffordable.
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You are not alone if you have some reservations about buying a home. While those issues are just a few of the risks that are present when buying real estate, there are many more. Although these issues have been around forever, it’s only been recently that typical buyers have become better about doing their due diligence and taking the time, energy and effort to lower their risk on real estate.
The process is not overly complicated, yet it is time-consuming. We’ve put together a list of items that you should check off as your go through the home buying process to avoid some unwanted surprises.
Here’s how to lessen the chances of something going wrong with your purchase:
Understand the Home Buying Process
You should have a full understanding of the purchasing process from the start. Review the contract you will be signing early on and understand how to shop for the right property. You should understand different terms like: making an offer, contingencies, appraisals, mortgage financing, and when your earnest money deposit becomes “at risk."
Make Financial Sense
Investment Property: Start by penciling out the deal. You should determine the total cash you will invest and what “cash on cash” rate of return you project to earn. Bank CDs pay 1 percent, Bonds 5 percent, but real estate is riskier—so what should you earn? Five percent is the suggested rate. Value appreciation may come down the road and certainly will help, but be sure and count your cash first.
Personal Residence: Should you rent or own? There are some simple guidelines to follow here. If you plan to own for less than five years, you should remain a renter. You are not throwing away money renting and you will avoid a lot of stress. Buying for the long term is your best move. But don’t buy just to buy something—buy the property you “love” and that will make you happy.
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Hoping to snag that once-in-a-lifetime deal on a foreclosure or short sale? If you're trying to chase some “great” deal at the courthouse auction, or through a distress sale, it may only be a waste of time and energy with little chance at success. Be prepared. Buying a foreclosure or short sale is complex and the purchase can get held up. Try the more conservative approach and search for a traditional sale on listing websites.
Real Estate and Taxes
Buying to save money on your taxes? Most couples buying residences under $300,000 get little in net tax savings. People with higher incomes and more expensive homes get the biggest tax benefit. Surprised? Meet with your CPA to determine what, if any, tax benefits you will earn.
Getting a Fair Deal in Financing
It has become easier to get a “fair deal” in a mortgage because of new federal regulations. Regardless, you should understand your Good Faith Estimate (GFE) and how to dissect it to make sure you get that fair deal. Mortgages are for the long term, so take some time to interview a couple of lenders and understand your mortgage so you can make a good decision.
Homeowners Association (HOA) Condition
This is one of those items that most buyers do not even know to review. The finances and operations of an HOA are becoming a huge risk issue nowadays. If you do not understand and review them, you may get a surprise in the form of sharply higher fees or special assessments in the years to come. Meet with a knowledgeable person to help you decipher them. The goal is to avoid a community where the association is in really bad shape.
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Home Inspection and Fix Up Costs
Having a home inspection is one of the most important things you can do as a buyer. During the inspection you should be putting together a list of what needs to be repaired and replaced. Then you can take your list to a home improvement store to get a feel for the total costs to bring the property up to the standards you desire. This should help you negotiate any seller’s credits and/or terminate the deal if the costs are too much.
Insurance policies cover certain risks and have a maximum payout on any loss related to those risks. It is up to you to determine the maximum policy amount you want based on construction quality, cost to rebuild and your risk tolerance. The top issue is failing to increase coverage amounts over time as the cost of rebuilding increases. It’s suggested to meet with your agent and have a once a year checkup.
Title Insurance, Title Issues, and Lot Lines
This is another purchasing task that few people review. And while the risk of an issue is very low, the potential losses are huge. Taking fifteen minutes to review your title abstract and history as well as the plat or a survey of the parcel and then walk the property to verify the information. It could save you endless headaches and financial stress down the road.
Fixer uppers, flipping, vacation rentals, second homes, apartment buildings, condos, hotels, land or building a home also have significant risk issues that should be evaluated carefully, before you make the decision to take on one of these investments.
Taking the time to learn the risk issues and do the proper due diligence before you buy can significantly reduce your risk of something going wrong. And while it’s hard work, it is much easier than straightening out a “predicament” after you close escrow.
Leonard Baron, MBA, CPA, is a San Diego State University Lecturer, a guest blogger on Zillow, the author of “Real Estate Ownership, Investment and Due Diligence 101—A Smarter Way to Buy Real Estate”, and loves kicking the tires of a good piece of dirt! See more at ProfessorBaron.com.