As more and more Millennials and Gen Xers start families and begin accumulating significant savings, the prospect of buying a home becomes more and more real. Purchasing a home is one of the most impactful financial decisions you and your family ever makes. After all, you’re most likely buying a property which costs more than your net worth. Therefore, I implore you to purchase your home like a pro, and not make these mistakes.
A lot of the data I reference in this article comes from the book “Zillow Talk.” The founders of Zillow wrote this book to discuss how to use big data (they have a lot of housing data as you could imagine) to make the best real-estate related decisions. I checked a copy out at my library, but it is also for sale on Amazon and other websites.
Without further ado, let’s talk about some costly mistakes for home purchasers that you can avoid!
1) Not Shopping for Realtors
Real estate is one of the few industries which has not faced tremendous price compression over the years. The 6% of home value commission used during the 1970s is still very much alive today.
But, like in my industry, a few disrupters are entering the marketplace offering more favorable pricing models. Type into Google “flat-fee realtor” or “discount realtor” and you will see realtors which have much more reasonable pricing. Clever and Redfin come to mind. If you use one of these realtors when you purchase a home, you normally receive a credit back toward your closing.
One caution, however, which is you may wind up getting what you pay for (less, in this case). This especially applies if you work with an a la carte realtor, where you only pay for specific services. If you’re a tech savvy individual who is fine negotiating, searching for homes online, and have expert knowledge of the area in which you are buying, a discount realtor is probably a good idea. If you’re moving to a new area or require specialized knowledge from a subject matter expert (i.e. you’re buying a multi-family home or a foreclosure), paying extra for a higher level of service may be a better choice.
2) Getting a Mortgage at Your Local Bank
Remember when millions of people decided to stop paying for cable and satellite TV because there were new, significantly cheaper services (Netflix, Hulu, etc.) that allowed them to stream their favorite content? That industry changed; the mortgage lending industry has changed too.
When you go to a bank, you apply to get a mortgage with that bank. No competitive pricing exists because the bank doesn’t show you what competitors charge.
Go onto Bankrate.com or OwnUp.com and see what options you have. You can usually find some significantly cheaper options in the form of lower rates or lower lender fees. Costco’s mortgage program also offers very attractive pricing and service with major discounts on loan origination fees. The caveat with most of these – you work virtually with a mortgage broker, which means lots of the paperwork is done online. Some people may be uncomfortable with that process. The better pricing versus brick-and-mortar banks though often results to at least $20,000 in savings over the life of most mortgages.
3) Not Considering Variable Rate Mortgages
Life is full of change. We change jobs, on average, at least twice per decade. The average marriage lasts eight years. We expand our families and have children. And yet, when we purchase a house, we don’t question signing up for a loan with a fixed payment for the next 30 years.
Because peoples’ lives change frequently, I usually recommend getting a variable rate mortgage. The way these mortgages work is for the first several years, you have a fixed rate. After that, the rate can adjust based on prevailing interest rates. 5/1, 7/1, and 10/1 variable rate mortgages correspond to a rate which is locked for five years, seven years, and ten years before they can adjust higher or lower.
The initial rate on variable rate mortgages is normally lower than that on fixed mortgages, which means lower monthly payments. And, since many people don’t expect to live in a home for much more than a decade, there is generally little need to be concerned about the prospect of rising payments. All considered, variable rate mortgages are great money-saving tools for those who expect to live in their home for less than ten years.
4) Buying a Foreclosed Home in a Strong Economy
The prospect of buying a foreclosed home, fixing it up, and selling it some day for a higher price than you paid is romanticized. After all, wouldn’t it be fun to flip homes like they do on HGTV? It seems like an easy way to make lots of money. It’s not.
The reason why so many people became wealthy buying up foreclosures between 2007 and 2010 was because there were simply so many foreclosures, and not enough buyers to purchase them. Therefore, the banks owning these properties had to pick amongst the relatively few buyers, to sell their repossessed home to. The few buyers demanded bargains. Over a decade later, and with a healthy housing market, foreclosed homes are actively sought after and banks can sell their homes for much higher prices.
We often talk about the “foreclosure discount” – the difference in price between a foreclosed home and a comparable non-foreclosed home. In 2009, while the economy was tanking, it was 23.7%. In 2012, it dropped to 7.7%. Today, it is likely even lower. This discount doesn’t take into account the condition of foreclosed homes, which is often poor. Therefore, the cost of improvements and sweat equity don’t make buying a foreclosure worth it in a strong economy.
That said, if a 2009 real-estate bust happens again, I’ll be first in line to buy some investment properties.
5) Buying in a Depressed Area Hoping for Values to Increase
I’ll be brief on this one, but following the wisdom of “buying the worst house in the best neighborhood” and buying in bad neighborhoods in hopes of a turnaround are surefire ways to lose money. Zillow data shows that these types of homes are often cheap for a reason, and underperform other, more desirable homes over the long run. If you really want to try and bet on buying a home in an up and coming area, Zillow suggests purchasing in areas which have low home ownership rates, older homes, and close to Starbucks coffee shops (yes, I’m serious).
6) Using Your Home to Build Wealth
When thinking about buying a home, we dream about the potential of owning a place to live in, but there is a hidden agenda. That is, everyone who purchases a home hopes that someday they can sell it for a much higher price than they bought it for. Even though the latest housing boom has made homeowners a pretty penny, don’t count on your residence to fund your retirement. A paper from the St. Louis Federal Reserve discusses how home equity, historically , only appreciates about 1.5% above the inflation rate per year. A diversified stock portfolio has returned closer to 7%, adjusted for inflation. Therefore, while your return on home ownership is better than your checking account’s, don’t expect simply owning your personal residence to make you rich.
7) Forgetting to Accurately Factor Taxes into Your Payment
When I lived in Pittsburgh from 2018-2020, everyone praised how cheap housing was. It was true. I lived in a four-bedroom house with a finished basement in a great location and its price was $320,000. My mortgage payment was $1200/month. I initially figured that adding in my property taxes would probably make my total payment $1500/month. Nope – Pittsburgh is notorious for extremely high property taxes — I failed to research that. The end result, my monthly mortgage payment was $1200, and my monthly tax payment was another $800. In other words, a cheap sticker price doesn’t mean that real estate is cheap once you factor in taxes.
8) Buying a Home When You Shouldn’t
Going back to point 3, a lot of people don’t live in the same place for very long. This is especially the case for younger people with more job and life changes. Buying and selling homes is expensive. Nerdwallet’s rent vs. own calculator suggests a 4% of property value closing cost to buy a home and a 6% closing cost to sell one. In other words, when you commit to purchase a home you have already lost 10% of its value in transaction costs (this doesn’t include transfer taxes, which can amount to an additional 5-8% of home value depending on where you buy). You can make up those costs easily by staying in a home for a longer period of time (at least 5 years usually, depending on geography). Moving shortly after purchasing a home though is a costly endeavor. Therefore, if you foresee your current residence as only temporary, you should consider renting.
Buying a Home is a Big Decision – Do It Right
Buying a home is one of largest purchases you will ever make. Avoid these common mistakes so you can minimize your chance of buyer’s remorse after you close. Or, if you want a more in-depth analysis of your upcoming major purchase, schedule a free call with us by clicking here.