Tactics For The First Time Homebuyer To Maximize Net Worth

by Carl Pruitt - Date: 2006-12-16 - Word Count: 1408 Share This!

The great inventor and businessman Thomas Edison once said "Opportunity is missed by most people because it is dressed in overalls and looks like work." Because of a unique confluence of factors, there is a great opportunity for first time homebuyers AND sellers right now. Unfortunately, there is a lot of resistance to this opportunity from real estate and mortgage professionals because it requires them to spend too effort on that unpleasant part of the home buying process called negotiation. Going back and forth from one party to the next explaining how the numbers fit is far too much like real work to most of them. They just like to fill out the blanks in the contract and wait for the closing. When the average real estate or mortgage professional is required to think outside the box, they cannot just slap the deal together in a few hours and turn it over to an assistant to finish.

Two seemingly unrelated financial events have come together to produce a win/win opportunity for everyone involved in buying and selling homes. The only catch is that making this opportunity pay off will require just a little bit of extra work. We must think outside the box in order to take advantage of this opportunity.

The first building block of opportunity is the fact that several wonderful new conventional community lending mortgage products for first time homebuyers and others have recently come into the market. These programs allow first time homebuyers and other borrowers to get a mortgage and buy a home: with no money down; less stringent credit guidelines (in other words, some credit problems); greater flexibility in income qualifying guidelines; interest only terms and longer amortizations (35/40 year loans); lower mortgage insurance coverage; and the kicker that really makes the difference - seller contributions to closing costs and prepaid items that can be up to 6 percent of the sales price!

The second factor creating this opportunity is that the country is in the midst of a rare buyer's market in real estate. Sellers have had to lower the prices on their homes to get rid of them, resulting in falling home values in many areas. Mortgage rates have dropped, but buyers still remember a couple of years ago when those rates were insanely low. They all want a million dollar house with a $1500 payment. And even though rates have dropped, they are not THAT good.

Today's typical "inside the box" real estate contract has the the first time homebuyer using a standard 30 year fixed rate fully amortized mortgage to finance their purchase. The seller ends up dropping their asking price by 3 to 5 percent, and paying 3 percent or even less in closing costs for the buyer. For example, on home offered for sale at $310,000 lately, today's first time homebuyer is agreeing to pay $300,000 for the home with the seller contributing 3% of the sales price towards the buyers closing costs. Even financing 100% of the sales price, this typical transaction still forces the buyer to bring $7000 or $8000 to close on the home. At a rate of 6.5%, the principal and interest payment would be approximately $1896.20. Throw in tax and insurance escrow payments of about $337.50 (in Georgia - many states are higher), and the mortgage insurance payment of $240 and you have a total payment of about $2473.70. Now add the more stringent credit and debt ratio limits (ratio of total payments to income) for this type of 100% financing and you have a perfect recipe for dramatically reducing the total market of buyers who can qualify for this property!

I started my journey in the real estate/mortgage business at a time when mortgage rates had just dropped to about 14%, so a payment like that for 100% financing on a $300,000 home still doesn't shock me all that much. But the average first time homebuyer today - who has lived through some of the lowest interest rates in history, and who was an infant when rates were high doesn't believe the houses they can buy for $300,000 are worth making that extra payment.

Now let's all step outside the box. What if, instead of dropping the price on the house all the way down to $300,000, the sellers agreed to accept the same net bottom line BUT they do it by agreeing to pay all the buyer's closing costs and all their prepaid expenses (such as hazard insurance, prepaid interest and setting up escrow accounts) and they put the rest toward discount points to buy down the borrowers interest rate!

Here is how that might work. The sellers accept a sales price of say $312,600 and pay 5% of the price towards closing costs, discount points and prepaid expenses. Sure they could go with the full listed price and contribute a little more, but lowering the accepted sales price helps satisfy the basic human need in the buyers to negotiate the price down at least a little bit.

Next, instead of applying for that standard 100% loan to value conventional loan (known in the business as a Fannie Mae FLEX100), the borrowers apply for a 40 year loan with a 10 year interest only payment period! This is one of the newest programs being offered under the FNMA MyCommunity loan program, which is wonderful for first time homebuyers. In the present market, the extra seller contributions in this transaction would most likely be able to buy down the interest rate on that mortgage down to 6.25%.

Now we have our first time homebuyer purchasing the house without having to bring any money at all to the closing AND they have an interest payment of $1628.13. This is $268.07 less than their payment would have been at the lower price. It gets even better. Add on the tax and insurance escrow payments of about $351.68. Then add on the mortgage insurance of $153.70. (MyCommunity loans require less mortgage insurance coverage than regular conventional loans.) Now our buyer has a total payment of $2133.51. This is approximately $340 per month less than the payment on the original lower sales price!

I know what you're thinking right now though. This is an interest only loan. Surely the buyer would be better off in five years if they had the fully amortized loan and their loan balance was going down. However, remember that extra money the buyer would have had to bring to closing on the 30 year conventional option? When you count the money the borrower had to bring to closing, and even figure in the effect of paying down the principal with the 30 year option, as well as the higher sales price on the 40 year loan, at the end of 5 years the 40 year loan will still have cost the buyer $6,096 LESS than the 30 year loan. This happens if our borrower does nothing beyond just making the payments and blowing the closing money on a vacation. In real life, by five years most buyers will be selling the home in order to trade up.

However, let's say the intelligent and frugal first time homebuyers in our case take that $7,000.00 in closing money they did not have to use and put it into an investment account at 6%. Then they take the $340.00 they are saving on the payment every month and drop it into the same investment account. Even when we account for the appreciation of the home (which will be almost the same regardless of the loan program), at the end of 10 years our buyers will have increased their net worth by approximately $27,116.00 MORE than they would have by making the exact same payment for 10 years on the 30 year loan program.

I must warn you that there are some limitations. These numbers will not fit every scenario exactly. The MyCommunity loan has income restrictions. However, in my experience the limits in most metropolitan areas are sufficient to qualify for homes in this price range. Interest rates may change. The numbers I have used are for example purposes only. There are other similar programs available for creative mortgage and real estate professionals to use when the building blocks of the transaction are different. When all the parties involved in a real estate transaction work just a little harder at analyzing the numbers and negotiating, sellers have a larger potential market for their home and buyers can use smart mortgage planning to vastly increase their net worth.

Related Tags: mortgage, buyers market, first time homebuyer

Carl Pruitt is a 21 year veteran of the mortgage/real estate industries. He helps first time homebuyers with credit problems get into a home with no money down and low rates. Free mortgage reports and advice, including more information on comparing costs, are available at http://24hourmortgageinfo.com

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