Tuesday, January 18, 2005

The Appraisal Contingency – It's a Good Thing

The appraisal of a property's value has become a regularly used residual service by homebuyers in the real estate process. However, it can become a tool that is tossed by the wayside in a hot market -- and that's not very wise when it comes to the largest investment most consumers will ever make.

The appraisal serves various purposes in a transaction for several people. It acts as a financial compass, as it were, for everyone that has a monetary stake in the property value -- the seller, the buyer, the lender, and the insurance company.

If you're looking to use mortgage financing, it's hard to overlook an appraisal. Now, many buyers, trying to compete with other purchasers, may waive the appraisal contingency, but they will still have to have an appraisal to get financing. It just means that once the appraisal is completed, regardless of the final number, they will still walk toward the closing table. In my humble opinion, this is like handing over a blank check to the seller and telling him to just write whatever he wants for the house and empty your bank account.

Why would you write a contract on a house for $440,000 when a professional appraiser warrants that it's only worth $425,000? I've never met anyone who would buy a car or invest in stock in such a manner, but they'll throw all caution to the wind in the field of real estate. It's become so prevalent in some markets that Realtors even have a disclaimer form that they provide for buyers saying they have been informed of the dangers of waiving the appraisal -- and yet, buyers will sign it and move along.

The scenario usually works something like this -- a house is placed on the market at $400,000 and several offers come in immediately. Two require an appraisal, the third, offering $420,000, does not, so the seller goes with it. In addition, the contract has a $40,000 earnest money deposit. The lender requires an appraisal before they will lend $380,000 to purchase the house, and it comes in at only $400,000 -- revealing a $20,000 gap between the contract price and the value (and $20,000 more than what the lender is willing to provide to purchase the property).

Now, keep in mind, an earnest money deposit is not the same as a down payment, though it can be merged into the transaction as down payment money once the contract is ratified. The earnest money deposit is submitted to the seller as a means of saying, "We're really serious about buying this house." If the transaction goes south, however, the seller could demand to keep either a portion or all of the deposit if the buyer can't perform the contract.

That's why waiving the appraisal is a dangerous way to buy a house. If all goes well, then nothing bad happens. The buyer gets the house and thinks all this disclaimer stuff and warnings are from a bunch of nervous real estate agents who don't like to take risks.

But why don't you ask the buyer who exercised this type of offer that went sour? They lost half of their earnest money because the appraisal didn't come in high enough for them to even get the financing and the seller demanded the earnest money deposit to pay for the lost marketing time and the money he now has to put out for more payments, insurance, etc., to put it back on the market because the buyer wrote a contract he can't fulfill.

The result is either a lawsuit (and we're not talking small claims court); trying to renegotiate the sales price (good luck); moving forward by finding even more money to pay for the inflated price agreed upon (which is usually what happens); or taking the hit on your earnest money deposit and finding another house -- except, now, with less money in your pocket than what you had before.

If you wouldn't buy a business or invest in stock without determining the true value of the object of your purchase -- why would you purchase a house in such a manner? It doesn't make sense and it can cost you tens of thousands of dollars if your strategy fails. The road to homeownership is strewn with the carnage of unwise strategies -- throwing away the appraisal is one of them.

Budgeting For Household Expenses Means More Than Mortgage Payment

The new year has begun, and this is a great time to look at the true cost of your housing to see where you may need to budget extra spending for upkeep or be able to slice your budget. When a buyer shops for a house, the lender generally will take into account 28 percent of income to be used for the mortgage payment. Some mortgage plans allow more. A mortgage program I used had only one ratio, 41 percent, meaning that all my debt -- including mortgage, credit cards, etc. -- could not exceed 41 percent of my gross income.

Well, looking at your mortgage ratio shouldn't be confused with planning for your overall housing ratio. There's a lot more to housing expenses than just the mortgage payment. Nevertheless, let's start with that monthly payment and see how you can chop it up to save you money.


The mortgage payment, for most people, is made up by the principal, interest, taxes and insurance, or PITI. As you plan for budgeting this year, first look to see how you can rearrange these numbers. Have you been watching rates? They are well under six percent again. If you missed the huge refinance boom of the last five years, it may have returned for those who need to lower their payment. Bankrate.com reports a 30-year fixed for as low as 5.204 with 2 points from one lender. (Keep in mind, a point equals one percent of the value of the mortgage, i.e., a point on $200,000 would be $2,000.)

If you're looking to remove your mortgage altogether, then don't overlook the 15-year mortgage rates which at this writing stand as low as 4.710 with 2 points. If you're looking to refinance, look at the bottom line as much as the interest rate. The fees for getting into a mortgage can outweigh the savings garnered from the low rate and corresponding low payment. If it would take you 10 years to get your money back from the low rate because of all the fees you paid up front, it may not be worth the refinance. Check the fine print and compare the fees as much as the interest rate.


Here's another big part of your monthly household expenses that many homeowners don't really budget in the home expense category. Electricity, gas, water, cable/satellite, trash removal, even your phone expenses (wireless and land based) are all part of the utilities world now. How much are you spending? Is it within your means or are you overspending, taking away from being able to get out of debt. If your goal this year is to remove all debt, then start here -- economize the electricity, gas and water, cut the cable/satellite, and shop your waste removal vendors. I've seen some cable/satellite bills exceed $125 per month -- which could be used to hammer down credit card debt. The cell phone, as well, has become an expensive need/luxury for many families, when you consider that each kid has a phone with a $30 monthly bill attached to it.

Homeowners Insurance

Call your insurance company to find out if your coverage is up to date. You want to determine if you're carrying enough insurance to replace your home in case of an absolute loss. When you talk with a customer service rep, don't be surprised when the replacement cost figure they quote is less than the home value you ascertained from the appraiser. The insurance company is looking to only replace the house, not the land, thus the replacement cost will most likely come in under the market value. Shopping this policy could also save you a few hundred dollars per year.

Tax Bill

Are you being charged too much in property taxes? Tax offices across the country are moving their tax records online, making your search into your home's past a lot easier. Once you get to your record, investigate whether they have you listed for the proper number of bedrooms, baths, finished area, garage, etc. An improper designation on your record could mean you're paying way too much in taxes.

Maintenance Spending

This is a category we tend to forget to budget spending. Landscaping/lawn upkeep, paint, pest protection and weatherization can add up to hundreds of dollars per month. For some homeowners in larger properties, it may even be $1,000 per month.

Don't forget to include these expenses in your monthly spending plan:

Lawn/landscape care: Weed killer, seed, fertilizer, lime, mulch, perennials, annuals, fence repair, grass bags, tool maintenance (gas, oil, filing, replacement blades, etc.), equipment rental and anything else you may use to keep your curb appeal more appealing.

Irregular large expenses: Driveway repair, new gutters, roofing, window cleaning, deck/siding power wash, pest inspection and repair (termite, rodents, etc.), chimney sweep and other annual or biannual expenses.
Let this be the year you get a handle on your home care cost and control the spending so that you can begin investing.

The Investor's New Year's Resolutions

Okay -- you've been talking about doing it for years now, and today is a perfect time to put your plan into motion. New Year's Day is tomorrow, so let's not delay on your real estate investment plan for 2005.

Keep in mind that while you may not be ready to purchase a real estate investment in 2005, you can at least take steps with all the other things you need to do to get ready to invest. The steps are pretty simple, and include keeping up with your credit scores, reducing your spending, increasing your saving, building a team, determining your investment of choice, then getting out there and doing it. Here are the steps in detail:

I will check my credit report at least once a year, preferably twice. Checking your report consistently is an active, rather than passive, activity. Checking it actively prevents an identity theft from wreaking havoc on your ability to buy or invest in anything, alerts you to bad information being pumped into it by credit reporting agencies, and prepares you for a healthy credit picture in the future.
Here are the three major credit reporting agencies' websites:


I will get my financial house in order by spending less than I make, creating a spending plan (instead of a budget), paying off debt and beginning to save for a down payment. These steps adhere to what I call the G.O.O.D. principle -- Get Out Of Debt. The ONLY way to get out of debt is by creating a spending plan that pushes you to this goal. Deny yourself, provide for your needs and some wants, and use the rest to pay off debt or create a super-sized savings account. Here are some resources:

Yahoo's Finance Expense Manager
Dave Ramsey's Beat Debt…Build Wealth
Providian's Budget Calculator

I will create a real estate investing team. This starts with a mortgage professional (which could be where I bank or the company that financed my house), a good Realtor who understands the needs of investors, a settlement company, a home inspector, an attorney, an appraiser, an insurance company, a fix-it crew and a property management company if I'm not going to manage the properties myself. This may also include getting my own real estate license and affiliating with a real estate company so that I can maximize any commission dollars as part of my down payment strategy.

I will research the various real estate investing options and determine which one I will pursue. However, I will not be stricken with paralysis by analysis. The options available to me include: property for flipping, property for renting, residential rentals, commercial rentals, paper products (discounted notes, tax liens, second trusts, etc.), land (to rent out for agriculture, harvest timber, use of natural resources, renting for commercial advertising billboards or other uses, or hold and sell for higher profits later, etc.) and REITs (real estate investment trusts that are sold on the stock market), to name a few.

I will actually meet with the people mentioned above to get my investing on the go. Instead of reading yet one more article, buying one more book, searching out one more investor website, I will actually get out there and talk with the mortgage guy or gal so I know exactly what will be required of me when it comes to investing. I will meet with the Realtor to start seeking out that first property. I will actually attend a foreclosure sale so I get the idea of what it is I'm looking for. I will talk with a contractor about what it would cost to replace a roof, fix a bathroom and replace a furnace so I understand the up-front expenses of fixing up and maintaining a property.
Whatever you do -- don't do nothing. And remember, as you invest in real estate, also invest in yourself.

Protect Your Investment Through Timely Inspections

When the weather outside is frightful, it may be a little late to have your heating and air conditioning system inspected. Even for folks in warmer climates, there's nothing that could ruin your holiday time faster than an air conditioner that breaks down on a sweltering Christmas Day dinner.

Inspecting this system (meaning spending a little money each year) can save you a bundle on the backside. A number of heating and air companies offer a biannual inspection program where a technician looks over your system for wear and tear, leaks, and impending breakdowns.

I've carried this type of protection for several properties and it's always been worth the investment. While many homeowners seek out ways to lower their monthly expenses, this is not one of those places. Think about it -- the furnace-a/c is used nearly every day of the year and in the winter time, it is an absolute necessity for those in colder climates. For many homeowners it accounts for up to half of all utility costs, so we know it eats up a lot of energy. If you have an exterior unit, it is abused by the elements and we hope it keeps working 24/7 despite all the abuse.

Several years ago, I had a unit break down in February. I had a very chilly family and a backup on the waiting list for a technician. I found out I wasn't the only one with heater problems on this cold weekend and techs make premium money off those who want the heater working now. Thus a regularly scheduled maintenance program is your best insurance policy.

A qualified technician should take a look at the following elements of your heating-a/c system:

Check and adjust fan switch. If not operating properly a fan switch can waste energy and cause nuisance fan cycling.

Check air filters. We know we're supposed to change these all the time, but when was your last filter change? Dirty air filters increase your system's operating costs and cause undo wear on the system.

Inspect the heat exchangers. Heat exchangers crack and deteriorate with age. These cracks pose a risk of serious illness from the fumes.

Clean the burners and check all components. Poor combustion is caused by dirty burners or defective components, wasting precious heat as it "goes up the stack."

Clean/check ignition components. Failure of this one element of the system can cause ignition failure and shut the unit down.

Inspect unit wiring. Loose connections and/or weak fuses lead to motor or control failure.

Check safety controls. This is an obvious safeguard and if they are not operating properly, they can cause dangerous problems.

Clean blower wheels and lubricate motors. This one item of the inspection alone will provide longer life for the motor and more consistent temperature control.

Check fuel line/shut off valves. Undetected leaks waste energy and could become dangerous.

Inspect flue pipes. This is another area where pipe corrosion or leaks can cause a very dangerous situation.

Check/calibrate the thermostat. Defective or improperly calibrated thermostats increase operating costs while decreasing your comfort level.
For heat pumps, the technician will also check Freon levels and test for leaks in the system. If levels are low, this could be a sign of leaks in the system, which should be tested further. If none exist, then the system should be charged up with more Freon.

Maintenance, rather than emergency repair, is always the best move.

Resale Houses Find Stiff Competition In New Homes

As you place your home on the market, don't forget to look at the competition in your marketplace to help determine a price for your house. Some home sellers have found that while they have a "newer" home, the even newer homes (i.e., just built) have created havoc on the sale of their "previously owned" model.

This is especially true for those who live near a development that is currently under construction and in a community where the economy is slipping. One such case came to me by way of my Inbox the other day. The owner in Charlotte, NC, had already moved and was now faced with selling her townhouse. Her home was on the market for 5 percent less than what she had paid for it six years earlier.

Now she's wondering if she should keep the house on the market longer at the current asking price or consider dropping the price.

First of all, home sellers need to analyze what's going on in both the resale and new-home market as they place their house up for sale. Whether it's a hot or cold market, the properties in pristine condition will always sell quicker and for the highest dollar. It's just commonsense and human nature. If offered a $5 bill fresh off the press or one that is mutilated, muddy and ink-stained, most people will go for the new dollar bill instead.

If you find yourself up against new properties, look at following these steps to maximize your selling possibilities.

Check out the condition of the new house. What you find may either depress you or stimulate you to action. New carpet, freshly painted interiors and impeccable decorating is what you'll find and have to take into account when preparing your home for sale. Come back to your house and walk through it as you just did at the new-home development. Where should you start? Get to painting, replacing old flooring and decorating down (meaning make it more vanilla) so that buyers can visualize how they would decorate the home if they owned it.

What terms are you up against? Is the builder offering decoration choices? Free finished basement or deck? How can you compete with that? Can you offer up front a decoration allowance of $5,000? This might be more advantageous than dropping the price outright. Hang on to your price, but give the buyer an incentive to work with you in decorating the house the way they want it.

Get serious about the trends in your market place. Your local real estate market is exactly that -- a market. The Realtors don't control the prices -- the buyers and sellers do. If home prices are falling it means buyers are holding off on the higher prices they face. If prices are escalating there's not enough inventory to meet the demand and buyers are willing to move on up on the offer. While you may have done a lot to your house, those hours of labor and tender care rarely mean more money. It's primarily what the buyer is willing to pay for it, regardless of the amenities.

Check out the curb appeal. What can you do to seriously spruce up your exterior? A lot of buyers simply drive by and get the brochure out of the sign box if the house doesn't wow them right from the start. Builders know this and have the model with all the upgrades outside -- flowering plants, fresh mulch, great facades, good looking grass. What can you do to make your exterior look fantastic. One way to get ready to sell your house is to plan out a few months in advance. A drab yard can be replaced within one growing season if appropriately cared for.
Always remember -- the way you sell a house is not the way you live in it. Buyers want new, clean, fresh and unstained. For the highest price and terms possible, give them what they want.

Fair Housing: Everyone Is Part Of A Protected Class

A recent housing discrimination case from Texas reminded me that there are still landlords/investors who just don't get it in the arena of fair housing laws. My fellow investors, here are the rules in a nutshell: You must offer your property to anyone that has the financial wherewithal and credit rating who can afford the rental payments despite these seven characteristics: race, color, nationality, sex, religion, familial status or handicap.

Poor Mr. Johnny Brown allegedly doesn't get this law. He is the most recent target of a U.S. Department of Housing and Urban Development lawsuit for discriminating against Bennie Rogers, an African American who wanted to rent a unit at Mr. Brown's building. In short -- the leasing agent told Mr. Rogers that Mr. Brown "doesn't rent to coloreds." Mr. Rogers reported this discrimination to HUD and Mr. Brown is now defending himself against a suit for violating the Fair Housing Act. A subsequent investigation demonstrated that Mr. Brown had only rented to one person of color 10 years earlier and that person was connected to a biracial couple.

Each month, I teach a fair housing class. Periodically, a student will approach the front and try to finagle around this law. "But what if my landlord just doesn't like the way the tenant sounds or looks? Doesn't he need to feel comfortable about who he's renting to?"

Of course the landlord needs to feel comfortable who he's renting to -- so long as his comfort level has nothing to do with race, color, nationality, sex, religion, familial status or handicap. A landlord's investigation of a tenant should include all financial aspects of their background and this can be done by hiring a competent Realtor or property management company.

If you need help understanding who's covered by the Fair Housing Act, visit www.HUD.gov and click 'Fair Housing' on the left side of the page. In the meantime, let's get this straight. Here are the Cliff notes as to what protected classes mean:

Race: Caucasian, African descent, Hispanic, Asian, etc.

Color: "Red and yellow, black and white, they are all precious in His sight" -- and that works for landlords, too.

Nationality: If they've lived in any nation on the planet in the Milky Way at some point, you can't use it against them.

Sex: Male and female.

Religion: If they look above to the Creator or worship any of his creations (including Satan) you cannot use it as a means of discrimination. (Unless your property is distinctly a home for retired Baptist ministers, etc.)

Familial status: If they have one or don't have one, you must offer the property to them if they want it.

Handicap: You can't look at their physical challenges and decide you can't rent to them. You must, however, allow "reasonable accommodation" (meaning, you provide them a parking space closer to the door, etc.) and allow "reasonable modification" (if they want to widen doors, lower light sockets, etc., they can at their expense).
Depending on where you live, you may have other protected classes as established by your state or local jurisdiction, however, the local statutes cannot violate the federal statutes. Some other protected classes I've seen include:

Sexual orientation: heterosexual, bisexual, homosexual.

Age: too young, too old.

Elderliness: elderly.

Source of income: you cannot discriminate, for instance, if the person is on welfare or uses a Section 8 housing voucher to pay rent.

Ancestry: Osama's kid can rent from you if he can afford it.

Appearance: greasy hair is allowed.

Political affiliation: Republican, Democrat, Libertarian, Communist, etc.

Matriculation: students.
This is not an all-inclusive list, so do your homework as a landlord before making non-financial decisions on your tenant applicants.

What I really get a kick out of is when people try to define a protected class and even refer to protected class as "them." "Well, I doubt anyone in a protected class could afford my house, anyway," as one student told me. Get this down pat folks -- look at the above list -- we're all in a protected class, and that's the beauty of it.

Houses Drive Growth At The Local Level

When a new home comes on the market, it is another sign of how the real estate industry drives the economy. A house, unlike any other large purchase product, is a culmination of hundreds of products and services in one purchase, which explains partly why houses cost so much.

The Commerce Department reported last week that new-home sales across the U.S. unexpectedly rose 0.2 percent in October -- the third-highest level on record. At the current rate, builders will sell more than 1.226 million units in 2004. The median sales price of a new home is also on the up, standing at $221,800. The average price was $286,700.

As the economy continues its strengthening exercise, we should see even stronger demand for new homes in the coming months, especially if interest rates remain under 6 percent.

If you consider what it takes to build a house, you'll understand why a strong real estate market feeds the economy with such healthy financial nutrition. The builder isn't the only company finding work when you decide to buy a house from him. You would expect the builder to have his own construction crews -- and most do -- but then he may subcontract the finish work to other companies.

After the builder, there are the plumbers, electricians, drywall hangers, painters, window installers, siding installers and brick layers, and landscapers who will all benefit from the sale of a new home. Many of these folks don't work for the builder, but rather have their own companies.

Just in this group, you'll begin to understand how much product is being created for the building of one house, not to mention a whole development (with hundreds or thousands of homes) being constructed. If builders sell 1.226 million houses -- that means 1.226 million orders for flooring, hot water heaters, concrete orders, roofing supplies, electrical wiring, indoor plumbing, etc. For some manufacturers, it's an even larger boon to their business -- there aren't too many one-bathroom houses, thus the makers of bathroom items, such as commodes, sinks and vanities receive double and even triple orders when a house goes up; most homes have five major appliances -- meaning the 1.226 million homes interprets into 6.13 million washers, dryers, stoves, dishwashers and refrigerators.

Manufacturers of all the products put into your house benefit. Makers of bricks, siding, lumber, steel, electrical wiring, insulation, windows, roofing, flooring, concrete, asphalt, plumbing, just to name a few, all benefit largely when the new-home business is booming.

And while you have the specialty tradesmen who are employed for such a venture, you also have to take into account the people who deliver it -- the workers who load the trucks, the truck drivers and the mechanics who keep these trucks running.

Utility workers also get busy to wire the house for phone, internet, cable and satellite hookups -- 1.226 million orders this year (just for the new houses).

Once the house is built, then there are the inspectors who will determine that the house is in good shape, followed by a whole separate line of professionals involved in the sale of the house. Realtors start the marketing and sales process and once they bring in the buyers, mortgage, insurance, and title companies line up to help finish off the process.

But the economic impact isn't finished at the settlement table. New furniture, window treatments, more paint, wall paper, electronics, and all the gadgets that make a house a home get purchased as well.

Probably the final business to get in on the score are the credit providers. Once homes settle, credit card companies and home equity loan providers pull down the deed records to market to homeowners to see if they want to charge all of the residual purchases.

Yep, it's a great thing when the new-home numbers are up. It's a great thing, indeed.