Risk #1: The Risk of Foreclosure. The risk of losing a home has only recently moved to the front of our collective national consciousness. Foreclosure was once a very, very rare event, seen as an unlikely worst-case scenario. But it became a vivid nightmare come true for an all-time high number of home owners during the recession. The risk and fear of foreclosure is largely due to this increase in foreclosure rate over the past few years, and to the vivid, catastrophic nature of the event. Also, almost everyone knows someone who either lost a home or had serious mortgage distress, so it seems like a very common occurrence.
When we take a look at the facts behind this risk, we realize that the risk of foreclosure appears to be much higher than it truly is. There are roughly 76 million owner-occupied homes in the U.S., according to the Census Bureau. Earlier this year, real estate data firm CoreLogic revealed that there had been 3.4 million foreclosures since 2008. That would mean only about 6 percent of homes in America had been through a foreclosure – and this, through the very worst recession of most of our lives.
The more probable risk is the risk of ending up underwater, which more than 25 percent of American homes were at some point during this past 5 years.
The fact that home values rise and fall cyclically is not a risk or a probability – it’s a fact of the real estate market, and one that you can’t do anything about. Your aim should be to manage and minimize the risk of serious mortgage distress (i.e., struggling to make the payment) or foreclosure. And you have the power to manage these risks by:
- Making smart mortgage choices. Buying at a price well within what you can afford, selecting a mortgage that your household finances can sustain over time, and not overleveraging by borrowing cash against your home equity for things like cars, clothes or ready cash.
- Making smart financial moves over time, including building a cash savings cushion you can turn to if a job loss or disability interrupts your income.
- Buying a home in as desirable a location as you can afford – and in an area with strong prospects for economic and population growth.
- Making small, extra payments to bring down the principal balance on your loan, if and when you can afford to.
Risk #2: The Risk of Overextending Yourself. This is a very real risk – more real, even than the risk of actually losing a home. Home buyers can overextend themselves when they take loans that give them falsely low upfront payments;. This was common in the subprime era that many believe led to the recession, but is less likely with today’s tighter lending guidelines and narrow loan programs.
That said, it’s still possible to overextend yourself by taking on more of a mortgage than you can truly afford taking into consideration things that your lender doesn’t include in their estimation of you can affordable, like:
- what you need to put aside for savings and investments
- childcare and college or private school tuition
- the costs of fixing, maintaining or upgrading your home.
There’s only one way to 100 percent manage your risk of overextending yourself when you buy a home, and throughout the time you own it: run your own financials! No matter how much you hate math or hate the thought of restricting your spending, it is irresponsible to buy a home (or be a home owner, for that matter), without regularly running your own monthly spending budget or plan or audit or program or whatever you need to call it to encourage yourself to sit down and do it! You have got to know with specificity what comes in and goes out every month in order to avoid getting in over your head.
Doing this math – on paper, not just in your head – is critical with almost everything you do as a homeowner, financially speaking. When you decide to remodel, buy things for your home, upgrade your bathroom, or refinance the place, create and honor the habit of making a written budget – even a super simple one -and doing the actual math to get a clear picture of what it will cost and whether you can afford that.
Risk #3: The Risks of Overpaying and/or Leaving Money on the Table. The night a buyer and seller agree upon a purchase price, one thing happens in both of their households, almost 100 percent of the time. The buyer wonders and worries that they might have paid too much. “Would the seller have taken less?” they ask themselves. And the seller fixates on the reverse, worrying whether they could have gotten more cash out of the buyer. “Would they have paid more?” the seller wonders (and often, asks heir agent).
There is one essential truth about home purchase prices that applies to both buyers and sellers: you can never know, with 100 percent certainty, whether the other side would have paid more or taken less. The answer to that question exists only in a hypothetical world in which you didn’t offer or take the price you did, in fact, offer or take. So, it simply makes zero sense to fixate on the issue. It’s a drain of time, energy and enthusiasm for an agreement that made enough sense for you to ink, so your best bet is to stop worrying about it.
That said, there are smart strategies buyers and sellers can and should take to minimize the risk of making poor decisions as to purchase price. Buyers should work with their agents to focus on the recent sales prices of comparable homes as a primary driver, along with their own personal budgets, of the price they offer for any given home. In cases of multiple offers, buyers should make their best offer knowing that you have to offer more than everyone else to “win” the home, by definition . And you should decide, in advance, not to worry or wonder whether a lower price would possibly have worked, if you do turn out to be the victorious buyer.
To avoid leaving money on the table or missing the ‘right’ buyers for their homes, sellers must prepare their homes to the very best of their ability (with advance inspections, repairs and staging, as their agent recommends). Then, price them in accordance with the comparables and their motivation level. The aim should be to price it low enough that the home looks like a compelling value to online house hunters, compared to the competition, but not so low that you miss out on the buyers who are seeking homes like yours – and also not so low that you would be upset about accepting an offer at the full asking price.
Risk #4: The Risk of Buying a Lemon. Ever see the Tom Hanks film The Money Pit? It’s a vivid rendering of every buyer’s fear: that the home of their dreams will turn out to be a nightmare, requiring years of surprise, costly repairs and causing many a daily crisis when this pipe explodes or that roof caves in. Every home has flaws – even brand new ones. But this is a risk that is often overrated in my experience, especially by first-time home owners who have simply not had to maintain a property before.
The reality is that this risk is relatively simple to size up for a given property, and to manage, via inspections and home warranty plans. Talk with your agent about which inspections to order for a given property, but it’s extremely common to obtain at least pest, property and roof inspections for a single family home before buying it. Standard practices for your area, the specific features of a given property and the findings of the other inspectors might suggest that it’s prudent for you to obtain any number of additional inspections or repair bids, ranging from a sewer line inspection, to the inspections of a structural engineer, general contractor, electrician or chimney specialist. Best practice is for you to personally attend as many of these inspections as possible, and read the written reports – as well as asking follow-up questions until you feel comfortable that you understand and are okay with the home’s condition.
The other best practice here is to obtain a home warranty plan at close of escrow to cover the unavoidable, eventual breakdowns of things like furnaces and water heaters. Your agent will help you secure a policy before close of escrow, but it’s your job to keep the home warranty in place every year when it expires.
Risk #5: The Risk of Losing Your Deposit. In most home buying contracts, there is a window of time after the contract is signed in which the buyer has contingencies: the right to bail out of the deal for any number of negotiable reasons, like if the loan falls through or the inspections reveal insurmountable concerns. While a buyer may have made a deposit at the very beginning of the contract, it is standard in many areas that the deposit is increased (meaning the buyer puts in more money) and rendered non-refundable at the end of the contingency period. After that point, if the buyer backs out of the deal, many contracts give the seller the right to retain the deposit money.
The specifics of contingencies and deposit money refundability vary, sometimes widely, state-by-state and contract-by-contract. For example, in the standard real estate purchase contract forms used in California and many other states, the buyer must expressly submit a written form that exercises their contingencies or removes them, telling the seller they are moving forward – the deposit cannot be retained by the sellers unless the buyer first removes their contingencies in writing, then backs out anyway.
In other areas, there is an objection period, so that if the buyer says or does nothing (i.e., fails to “object” to the transaction proceeding), the deposit automatically becomes non-refundable when the objection period lapses. Almost all bank contracts for the purchase of foreclosed homes follow this passive objection period arrangement, rather than requiring the buyer to actively remove their contingencies for the deposit to be rendered non-refundable.
No matter what the specifics of your contract’s deposit refundability guidelines are, there is almost never a good reason for you to forfeit your earnest money deposit. The way to manage this risk is to sit down with your agent before you write your offer and discuss deposit refund, contingency and objection period guidelines. Make sure you ask every question you have and fully understand the guidelines and timelines, as you move through the phases of offer; counter-offer(s), if any; and contract acceptance.
Then, when you do get into contract, work with your agent to get a clear understanding of when your contingencies and/or objection periods expire, and put these dates on your own calendar. Throughout the transaction, operate as though time is of the essence when it comes to obtaining inspections, responding to your loan officer’s documentation requests and the like, because it truly is of the essence. Finally, make sure you are vigilant about requesting an extension of time for your contingency or objection period(s) if needed.
Your agent will undoubtedly help keep you reminded of what dates are coming up, but you are ultimately responsible for ensuring that you collect the information you need in the time you have to gather it and make a final decision on a given property without forfeiting your deposit funds.
Risk #6: The Risk of Getting a “Bad” Loan. Because the world of mortgage and finance is an area that causes many people fear and trepidation, the idea of getting a so-called ‘bad’ loan strikes fear into the heart of many a home buyer and refi-er. What makes for a bad loan is different for different people. Depending on where your head is at, it could mean anything from a loan with a higher interest rate or fees than you could have gotten elsewhere to a tricky loan program that has big, bad surprises in years to come, à la balloon payments or scary payment adjustments.
The risk of getting a bad loan was much greater during the subprime era, when there were loads of low-down payment, adjustable loans with big prepayment penalties and skyrocketing interest-only payments. These loans are largely extinct right now (though they might not be forever). Fortunately, you have much more control than you might think over whether you wind up with a ‘bad’ loan.
Exercise that control by:
- Working with a mortgage loan officer that your friends, family or colleagues refer you to – and rave about – rather than simply walking into some branch of some bank off the street or working with the shiniest, slickest someone who promises they can “trick” the banks into giving you a loan.
- If you have a bank you like or love, consider obtaining a loan quote from them and one from your referred mortgage loan officer, then ask both loan officers to help you compare them.
- Taking the most plain vanilla home loan product you can. It’s very difficult to be surprised with a basic 30-year fixed-rate mortgage, where the payment stays the same until it’s paid off. The more complexities you add in, the more potential for surprise you open yourself up to.
- Reading and understanding every line of your good faith estimate – and aggressively asking every question you have in your head until you completely understand it. Do the same with your loan documents at closing. In fact, I recommend asking your loan officer to make sure you can review your loan documents at least a day or so in advance of your appointment to sign them, so you two can walk through them together in an unhurried manner before you’re sitting at the closing table.
- Understand that property taxes and insurance costs do vary over time. Talk with your real estate and mortgage pros to try to wrap your head around the future trajectories of these costs. It’s not overkill to work with a financial planner as you move into the home owner stage of your financial life.
Risk #7: The Risk of Being Duped. Related to the fear of buying a lemon of a home, many a home buyer, seller and mortgage borrower has asked me some version of this question over the years: “How do I know they’re not lying to me?” And for the word “they,” you can pretty much fill in the blank with “my agent,” “the other agent,” “the seller,” “the buyer,” “the mortgage broker,” “the inspector/contractor” – you name it. There are several ways to assess and approach the risk of being duped in the course of a real estate transaction, no matter who you fear might be doing the duping.
First, recognize that most people are more likely to be honest than they are to lie, as a general rule. Does this mean no one has ever lied to a buyer or a borrower? Of course not – but it does mean that the risk of you being lied to is actually far lower than the risks involved with failing to fully read the disclosures a seller or lender has provided, in my experience. This is especially true when it comes to professionals who have their credibility and livelihoods on the line, and sellers, most of whom would rather over-disclose than be sued later.
Second, work with professionals who have been referred to you and vouched for by people you know: your friends, relatives, colleagues, or the other real estate professionals you already have and trust.
And finally, whenever possible, get a backup source of information – don’t rely 100% on one individual’s word, if you don’t have to. Get inspections to give you a fuller picture of the home’s condition, beyond what the seller says. Pull the home’s file with the city building department to learn more about how it’s been modified over time, if your contract and the real estate law of your area allows. Talk to the neighbors about their experience of the neighborhood – they’re often more than happy to share. Your agent can tell you what is and isn’t allowed under your contract.