Movin’ on Up

How first time homebuyers can exponentially their grow wealth

Nearly 50% of current home sales are going to first time home buyers, the majority of which are under the age of 30. New homebuyers, especially young ones, tend to shop for homes that are in perfect or near-perfect condition because they don’t have experience with home maintenance and minor repairs. Simply put, homes that need various repairs often scare new homebuyers. But as we will see in this article, homes with various imperfections should encourage their potential owners because they provide unparalleled financial opportunity.

Sweat Equity

The term sweat equity is used to describe the value increase of a home when an owner makes improvements to it. Creating sweat equity is a cheaper and faster process than creating long term equity by paying a home’s mortgage down over many years. This catapults a “sweat equity homeowner” into a higher net worth years before an individual who pays down their mortgage diligently every month. First time homebuyers who opt to shy away from a home that needs some work are losing out on a great opportunity to create instant sweat equity by doing repair work themselves. Most first time homebuyers want to move right in to a clean, updated home that needs no work at all. This is a convenient choice; but homes that are in move-in condition often come with a higher price tag as compared to a foreclosed home that needs paint, flooring and landscape.

Retail vs. Wholesale

Usually the price of a house reflects the condition it’s in. A homebuyer can pay retail price for a perfect product, or they can pay half price for a product with “nicks” and “dings”. In the case of a house, the difference in price ranges in the tens of thousands of dollars. This is a very important fact to note for first time homebuyers who want to be on stable financial ground as time goes by. Houses are like savings accounts. Generally, a home’s unused equity can be tapped in the future for things like a new car, a daughter’s wedding, a college education or unforeseen expenses. Equity can be created quickly by purchasing an ugly home under market value and making timely improvements to it.

Someone who pays full price for a house is accepting the fact that their paycheck will be going into paying the mortgage down over time, creating equity in the long run. The problem with this scenario is that in the early years of a mortgage, there is little money going towards the payoff of the house; most goes to the mortgage provider in the form of interest. However, in the case of a homebuyer that buys wholesale, their paycheck will be going into a much smaller mortgage payment because their house is initially worth much less. This genre of homebuyer will have to spend time and money renovating the house to their liking, but they will have a house that has decades of equity built into it in a matter of months, versus the retail priced buyer who is burning their money on mortgage interest.

The 1:3 Rule

A potential homeowner can tell if a house that needs some TLC is priced right by remembering the 1:3 Rule. Generally speaking, a good deal on a house is when one dollar spent on fixing something that is visually unattractive or is in ill-repair, yields three dollars of sweat equity. For example, a 1,000 square foot house that is on the market for $100,000 needs drywall repairs, paint and new hardwood floors. These repairs are very simple to do and require no expertise. Premium materials for this job would cost about $7,000 and take about 4 weekends to complete. If the house is correctly priced at $100,000, then $7,000 in rehab work should yield a house worth $128,000. The 1:3 Rule simply indicates the pricing to base an offer on for a particular house. Keep in mind that the 1:3 Rule is a simple gauge designed to protect prospective homebuyers from spending too much on a home that needs some work.

All prospective homebuyers should become familiar with the values of neighboring homes of similar build style (ranch, cape cod, condominium, bungalow, colonial etc) and similar square footage as compared to the home they’re thinking of placing an offer on. The best way to get this information before making a purchase is to work hand in hand with a reputable real estate agent who can provide records of recently sold homes. Try to work with a real estate agent who has done rehab projects before; they can offer timely advice. Never buy a house needing repairs unless you are certain the price of the house will allow for sweat equity creation after estimated repairs are completed. In areas where real estate is always in demand, a 1:2 equity creation ratio based on property upgrades is fine. The goal is to just make sure that the eventual purchase price plus rehab costs fall tens of thousands of dollars short of what the home can easily be sold for. In the case of my own house, I spent $25,000 on repairs and created $50,000 in equity which was a 1:2 ratio of rehab expenses to equity creation. My home is in an area of very high demand so cashing the equity in when I decide to sell will justify my expenses.

What to look for

There are certain things to look for which allow for price breaks on a house and are also easy to fix. First time homebuyers who are looking to fix up their first house will want to stick to visual problems such as:

• Low curb appeal/landscape
• Paint/visual interior remodeling
• Holes or cracks in walls
• Flooring (tile, hardwood, laminate or carpet)
• Outdated or missing trim (crown molding, floor trim etc.)
• Minor mechanical issues such as broken door handles, missing handrails or cracked window panes
• Broken light switches/covers, outdated light fixtures
• Outdated or unattractive plumbing fixtures

Just about anyone can make home improvements like the ones presented above. Larger problems involving roofs, plumbing, siding, foundations, cracked or uneven pavement, outdated windows or mold problems will require skilled laborers working for reputable licensed contracting companies. First time homebuyers should probably stay away from homes that require work they cannot do themselves unless they personally know reputable contractors and have a pricing guarantee.

Funding the Deal

Obviously buying a house that needs some work will take some financing. If you have a nice nest egg or are able to work out a deal with family or friends to help fund the project, then you’re off and running. Just be patient and place many low offers on homes that interest you; soon enough a great deal will come to fruition with the eventual acceptance of an offer. Homebuyers that don’t have cash or personal acquaintances willing to help fund the deal will have to secure a mortgage with built in rehab financing. If the house is in move-in condition and just needs some updating then a conventional bank loan will suffice.

Mortgage lenders will usually not create a mortgage for homes that require significant. There are however, exceptions. First time homebuyers will want to gravitate towards a FHA 203K loan. Details of this loan product can be found at:  

Another option that is becoming more prevalent is to purchase a home on a land contract from a private seller. This is commonly called seller financing because the seller is acting as a mortgage lender, accepting payments from the buyer every month like a bank would. Purchasing a home on a land contract usually requires a small down payment, a small monthly mortgage payment and the buyer makes all repairs. When the buyer’s credit requirements are met, a traditional mortgage is obtained, paying off the seller. Everyone wins, just as long as the house was priced right.

Hypothetical Rehabs

Before embarking on your journey to create sweat equity, select some houses with the help of your real estate agent and make a list of all potential repairs that you are capable of doing. Then go to your local home supply store and price out the materials. Talk to some contractors for the repairs that may be out of your reach and get some general estimates. Estimate how long the repairs will take and when you can fit them in to your schedule. This fun exercise will help you to determine what your offers should be placed at for the houses that pique your interest. Creating estimates like this also protects you from overspending on the purchase of the home. Don’t get discouraged along the way. While other homeowners are throwing their money away in the form of mortgage interest, you’re building a solid financial foundation in a matter of a few months.