PURCHASING YOUR FIRST HOME WITH LIMITED FUNDS

Should I buy a fixer-upper house? Reasonable financing, types of loans, building inspection, home style, and location play a large part in the purchase of a home. Home ownership proves independence, possible financial gains, tax deductions, creative opportunities and satisfaction, possible reduced commuter and entertainment travel, and a chance to be closer to old friends and make new friends.

Home Preferences: Are you looking for a new home (new development or the only new home on the block), an upgraded used home, a well-maintained home with no upgrades, or an non-maintained home that requires upgrades? Do you like the ranch, cape cod, colonial, or modern style? Should the house be brick, wood, or vinyl-covered? How many beds and baths do you need? Do you need a basement, a large kitchen, or an open layout of rooms? Is a garage, carport, or off–street parking desired? Is a deck or screened porch a high preference? Do you like trees? Is landscaping a big deal? Can you live with or do you prefer a streetlight, aboveground electrical equipment, or a fire hydrant at your front door? Is a fence necessary?

Property Location: A great location raises the price. However, what is a great location for one person may not excite another. Is the house close to work, friends, major highways, local public transportation (bus and/or subway), shopping, hospital, and recreation?   How much travel time can be saved by this location? In the Washington, DC area, we measure distances by minutes, not miles! The time of the day and week, traffic, and road construction can vary the travel time from 20 minutes to an hour. Does the community have a swim club, playgrounds, and schools? Is a park and/or hiking/walking trails nearby? Is the view from the house terrific or is the lot adjacent to a nuclear waste site? Does all the rainwater on the street run across the property with some remaining in the backyard after each rain? Is there a spring on the property? Are there 12 unruly kids living next door? Does another neighbor supplement his income with a dog kennel? Is a fire hydrant within 1000 feet of the house (for safety purposes and lower home insurance premium)? Are there odors on the property coming from a nearby sewage treatment or a manufacturing plant, or maybe, the neighbors do not clean up animal wastes in their yards? Old-stuffed furniture in the neighbor’s front yard is not a good sign.   What is that strange noise?

How much home can you afford? Many mortgage company web pages indicate their loan requirements. You should obtain a pre-approval loan before you begin the search for your new home. This gives you a great advantage when a home becomes available in which you have interest. In the Washington, DC metropolitan area, homes have been placed on the market on Friday with the notice that bids will be taken until Monday at 2:00pm. Sometimes there are over 10 bids above the asking price! Without the pre-approved loan, bids are not accepted.

What is a fixer-upper house?

This is an older home that has not been maintained and has few, if any, upgrades. Usually, many repairs are required to make the fixer-upper house livable. It is offered on an “AS-IS” basis, which means the seller is not responsible for any portion of the property that does not work or does not meet current building, electric, and/or plumbing codes. These items include heating, air conditioning, plumbing, and electrical systems; water heater; roof; gutters; fireplace; flooring; doors; structure, foundation and wall problems; drywall system; painting; insulation, asbestos; driveway and sidewalks; flooding (in house and lawn); and landscaping. Other problems may include strong odors from animal wastes, mildew, or backed-up sewers.

Depending upon repairs required and buyer competition, the purchase price of a fixer-upper house is approximately 10-25% less than the average price for a house in the neighborhood that sold without the “AS-IS” clause. All systems in the average neighbor’s home have mostly been maintained, are suppose to work, and usually there are some upgrades.

Should you buy a fixer-upper house?

Limited Budget: The boom in housing demand, resulting mostly because of extremely low interest rates, has placed a hardship on the first-time buyer of a new or used home. Today in many areas, it is extremely difficult for a young single person to afford a new house or even an average-priced used home. In the Washington, DC metropolitan area in January 2005, there were few used detached houses below $275,000.   The January 2005 average price of a home in Montgomery County, MD is $444,000. Three-bedroom detached houses with some upgrades (new kitchens appliances and cabinets and some painting is the norm) begin above $300,000. Townhouses and condos were at least $200,000. New homes began at the $500,000 level and were located some distance from downtown Washington.

I purchased my first new detached home in 1966 in the Maryland suburbs of Washington, DC with 5% down and a 6.00% first trust for 80% of the purchase price and a 6.00% second trust for 15%. Mortgage insurance was not required then. The rule of thumb was a person could afford the monthly payments and utility costs for a house going for 2.5-times one’s salary. I was able to meet this requirement on one salary. Today, the banks and mortgage have so much money they stretch the 2.5-times rule. If not, there would be few borrowers! Loans also are currently available for more than the house purchase price. See “Financing” below.

To obtain a 95% loan ($15,000 down) on a $300,000 house, an income of $114,000 would be necessary with the 2.5-times rule. In most areas, this $114,000 income is rare even with two salaries. A $500,000 house with 5% down would require an income of $190,000.

Can you make many of the repairs?

Major Items: Unless you very skillful, I recommend a contractor for new kitchen appliances and cabinets, electrical supply to and including electrical panel, heating and air conditioning equipment, gas water heater, roofing and gutters (falling off the roof will hold up your other repairs), and major concrete work.

 

Installing drywall sheets requires much strength and patience. Doing the joint work and final plastering requires a skill. I choose to use a contractor to install the drywall system.

The major building supply companies offer free construction training: such as laying vinyl and ceramic floor tile; installing doors, windows; plumbing fixtures, They also sell How-To-Do-it manuals and rent tools.

You may wish to have an electrician do all the electrical work. Electrical codes and How-To-Do-It manuals guide you through basic electrical work. With patience and nerve, you should be able to add circuits, replace and add receptacles, add new lights, add switches, and add circuit breakers. The first rule of electrical work is to turn off the circuit breaker. However, in old houses, it is sometimes hard to determine what is on a circuit. Test all receptacles and light fixtures and list their location at the circuit breaker. You may be able to group as “Living Room and Half bath Lights”, etc. Test each working site before touching any wires to be certain you avoid shock.

Do you need everything corrected immediately?

For a single person or couple, the basic living requirements are a good roof, new door locks, one clean functioning bedroom, one operating bath, a kitchen with a small refrigerator, a sink, and something that will cook food, and a working furnace (if in winter). The bedroom requires paint, lighting, receptacles, privacy, and heat access. The bath room requires paint, bath tub/shower, water closet, lavatory, lighting, receptacles, and heat access.

The next preference could be the laundry with a washer, dryer, laundry tub, electric and/or gas supply, lighting, and receptacles. Drywall, paint, flooring, ceiling, and door could be added later.

In a four-bedroom house, the update of at least two bedrooms can wait several years. An air-conditioning system can wait until spring or later. Work on the lawn can be the last update unless soil is needed to drain rainwater away from the house.

Financing

100% Loan: Least upfront costs. Pay only closing costs (varies but at least $3000). Requires excellent credit report. Usually this has the highest interest rate, but search around.    This selection keeps more money in your pocket for house remodeling. Property Mortgage Insurance is necessary for the 20% gap between 80% -100% loan.

95% Loan: 5% down plus closing costs. Requires excellent credit report. Higher interest rate, but less than for the 100% loan. Property Mortgage Insurance is necessary for the 15% gap between 80% -95% loan.

80% Loan: 20% down plus closing costs. An excellent credit report is not necessary, but an excellent credit report would result in a lower interest rate.

Less than 80% down: Same as for an 80% loan. However, you are not using your money in the most efficient manner. If you have enough money for this option, buy a new house!

 

Property Mortgage Insurance: PMI for a $200,000 loan is about $115 per month. The PMI can be later eliminated when the equity increases to 80% of the appraised value. The value of the house will increase due to the improvements, inflation, and buyer demand. The appraisal cost is about $150. If interest rates have reduced after the appraisal, you may elect to refinance.

Refinancing: If interest rates drop below the rate you are currently paying and the equity in the home has increased enough (your equity is at least 80% of the home value), you should consider refinancing . If you have also obtained a home equity loan, both loans may be combined into a new first trust loan. However, a refinance requires closing costs charges again and you may have to pay closing costs on the previously obtained home equity loan.

Home Equity Loan: With excellent credit, banks will provide a home equity loan to match the money you put down to purchase the house. Home equity loans require a minimum monthly payment to match the interest owed on the loan at an interest rate based on the prime rate. Some lending firms offer a
loan at ¼ to ½% below prime. This loan is usually for a set period, such as 10 years. Monthly payments are not required on the principle, but is due at the end of the loan period. For most home equity loans, there are no closing costs if you retain the home equity loan for three years.   As you increase the equity obtained by your labors and inflation, you can increase the loan with the same bank without incurring closing costs if more cash is needed. This is a variable rate, so the Federal Reserve can raise or lower this rate. Prime rate is 5.25% on January 1, 2005. Some think the rate could increase another 0.5% in 2005.

Property Taxes: Taxes will increase every year! At least it is deductible from your income taxes.

House Insurance: Many insurance companies offer a 15% discount on home and auto insurance if you purchase both policies from them. Insurance premiums will increase every year!

 

Financing Recommendations

Recommendations:

 

Select the 95% loan and 5% home equity loan. This will provide the most cash that will be needed for the repairs. As repairs are made and inflation works, your equity will rise. If more cash is needed, the home equity loan can then be increased at no cost.

Obtain credit cards from the local building suppliers, such as Home Depot and Lowes. They occasionally offer 10%-off deals and/or months with no payments or interest charges.

Income Tax Break: Loan interest, taxes, and points are deductible. Add contributions, state income taxes, miscellaneous expenses, and if unlucky, medical expenses. Compare to the taxes you were paying as a non-home owner. Visit IRS for tax publications and forms

Inspection

If you are not familiar with house construction and building, electrical, and plumbing codes, a professional inspector is recommended. Determine the minimum that has to be done to move in; what you can do; what repairs require a contractor; make a list of projects to be completed as you get the time and money; and estimate costs. Expect problems you do not see and future preference changes to add about 25% to your estimated costs.

INSPECTION LIST

Address:

Asking Price:

Year Constructed:

Date of Inspection:

Condition

Age

Material

Brand

Immediate Estimated Repair Costs

Future Estimated Repair Costs

Foundation

Furnace

Air Conditioner

Duct System

Insulation

Water Heater

Humidifier

Laundry Tub

Washer

Dryer

Stove

Refrigerator

Sink

Disposal

Building Exterior

Roof

Front Porch

Back Porch

Deck

Garage

Carport

Driveway

Sidewalk

Lawn

Trees & Shrubs

Fence

Mailbox

Size (LxW)

Flooring

Lighting

Electrical Receptors

Drywall

Paint

Doors

Fireplace

Windows

Ceiling Fan

Immediate Estimated Repair Costs

Future Estimated Repair Costs

Type

Condition

Type

Condition

Interior

Exterior

Living Room

Kitchen

Bedroom 1

Bedroom 2

Bedroom 3

Bedroom 4

Bath 1

Bath 2

Bath 3

Recreation Room

Laundry

Storage Room

Stairs

Notes: 

Condition: OK, Replace, Update, or Future.    

Flooring: Carpet, Ceramic, Hardwood, or Vinyl.

Lighting: Recessed, Florescent, Bare Bulb, Ceiling Light Fixture, None.

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Updated: 1/7/05