Should I buy move in ready or fixer upper? $$$$$

Question

Hey everyone,

I'm having a huge problem. My wife and I are shopping for a house. Originally we started out to find a distressed property to fix up so we could get an awesome deal and have everything we want. Then we started looking at listed homes and I thought we could get a deal going with a short sale or Reo. None of that seems to be working because it seems like when agents are involved we end up at fair market price. Now we're looking at a home that we love but its at fmv. This is a beautiful home but not our dream home which we want to buy in 6-8 years and we're getting an FHA loan. I'm just worried that we're buying this place too high. Should I switch plans. The realtor is telling me theres a good chance the neighborhood will go up. It's definitely one of the nicest but what do you guys think. Is this the way to buy a house?

Jon Holdman · Answer

You say several things that lead me to think you should not buy any house right now and should not buy this house in particular.  Transaction costs on buying and selling are exorbitant.  Two percent, roughly, on the front end and 8% on the back end, in good times.  In bad times, like now, add another 3% for concessions to the seller.  If you plan to buy then sell in 6-8 years, you need to get at least 10% appreciation to just break even.  And you'll certainly have some amount of fix up and maybe updating when you sell.  You should evaluate for yourself if you think this will happen.  From 6-8 years ago to now that's certainly not the case.   Maybe things will get better in the next 6-8 years, but anyone who accurately predicted where we are now back in 2004-2006 was called an idiot.

Lots of folks managed to do the property ladder during the boom. Even not during the boom in specific boomy areas like LA and SF.  Buy one house, live there a while, sell at a significant profit and roll the profits into a bigger and fancier house.  I think that gravy train has left the station, even though there are many people who will try to convince you it hasn't.  And there may well be areas where its still possible.  But there are many areas where I think prices will be minimally higher 6-8 years from now.

So, my advice is that you shouldn't buy anything right now because you aren't able to buy (for whatever reason) your "dream house".  You say you're getting an FHA loan, so I assume that means 3.5% down.  If you don't get at least 8% appreciation by the time you sell you'll have to bring cash to closing to sell.  That will certainly impact your ability to buy your "dream house".  I would guess getting 20% appreciation in the next 6-8 years would be the top end of possible expectations, unless there's something you know that's going to happen in your area to drive that level of gains.  Are you counting on significant appreciation to roll into the dream house?  What's keeping you from buying that now?  What's going to change to make it possible in 6-8 years?  You actually don't have to answer those questions for me, but you should answer them for yourself.

The other thing you say is "its one of the nicest".  Do you mean the house or the neighborhood?  The nicest house in a neighborhood is not the best candidate for appreciation.  The less nice houses will always be a drag.

If this is a house you see living in for a long time, I'd say go for it, even if you're paying close to retail.  A house is nothing but an expensive doodad, same as a boat or car.  Buy what fits your needs and your budget.

Keep in mind that in many areas renting will net out to being cheaper than buying.  Do the math.  Renting for 6-8 years may well give you a better path to that dream home down the road.

Alan Mackenthun · Answer

I was calling out that buying a home is more than an investment, but undoubtedly it has to be considered an investment.  It shouldn't be expected to have a huge econonomic return, but it's a big purchase and nobody I know is buying a home expecting to live there the rest of their lives.  I was minimizing it as an investment and in no way implied it should be anyone's biggest investment.  At some point you're going to want to sell it and you'll be hoping it's worth more than you paid.

Answering your question about why not go FHA - because an FHA mortgage has more fees than a conventional mortgage and you'll have to pay PMI (private mortgage insurance).  These costs can be avoided with a 20% down payment so if it can be afforded, I'd recommend putting this much down.  With a 6-8 year timeline, I'd go with a 15 year mortgage or a 7-1 ARM as your timeline isn't expected to go much longer than 7 years.

Jon Holdman · Answer

I'll have to respectfully disagree with Alan Mackenthun that a house you live in is an investment.  If its an investment, its often just as crummy an investment as your investment in your car.  It only looks like an investment when you can say "hey, I paid $100K for this house 30 years ago and now its worth $325K".  Yes, that's 4% annual appreciation.  But in that 30 years you've paid a bunch of interest, taxes, insurance and no doubt done a bunch of remodeling and maintenance.  The cash you've put into your "investment" very likely totals over the $325 its worth.  OK, I guess that is better than a car, but its still not much of an investment if after putting in cash for 30 years you have the same amount you put in.

It would be far more honest to say "a home is the biggest purchase you'll ever make" than the "a home is your biggest investment".  Given the cash you need to retire, you need something more than a paid for house.

What a house is is a place to live.  That's a combination of both needs and wants.  Nobody needs stainless steel fridges or granite counter tops or 1000 sq.ft. per person (or more).  But it may well be something we want.  If it fits your budget, go for it.  If you're putting 20% down and you can pay it off it eight years, you're definitely in a strong financial decision.

Account Closed · Answer

Great advice Jon,I always appreciate your perspective. This house is gorgeous, the school system is great and it's near everything we want. Our dream home is going to be a mansion(mini) huge lot, basketball court maybe gated, etc. we have plans for that house but we want to build and expand our business before we buy this home. It's not dependent upon us being to make money on this house but we don't want to have to pay to move. (I don't want to struggle to get what we paid for it)
Also what benefit is there to us by putting 20% down. Our goal is to pay off the house in 8 years using my bonuses from work and some business profits. I just don't want this house hurting me down the line because we bought at fmv. Please let me know if I'm missing something or if there's something I'm not considering. Thanks guys

Account Closed · Answer

Thanks Alan. I appreciate that input. We definitely love the house. The question for me would be how much money can I save(which will help if the market slips and/or when we sell) by buying a foreclosure or reo. Is it worth it?

Alan Mackenthun · Answer

The age old question.  It sounds like you've looked around to know what's available on the market and approximately what you can get for your money.  'Deals' are harder to find in my market as inventory is down and buyers are out, but really, deals are based on perspective.  In reality, real estate is a reasonably free market.  A home is worth only what someone will pay for it and only that if someone is willing to sell at that price.  Fixer uppers can be a good deal as most people estimate high on repairs, though if a home is in real trouble repairs can be quite expensive.  Short sales can offer 'deals', but there can be a lot of uncertainty and it's not always appropriate for a home buyer, especially 1st time buyers.

A home you're going to live in is an investment, but that's not the only consideration.  If you love the home and it's fairly priced then I'd say go for it.