Could someone explain to me why this is a bad idea?

In your scenario here you let person "A" off fairly easily and I don't think their bank would be so kind. If they bought a $500,000 house on a traditional mortgage paying $50,000 up front and then, 2 years later they sold it for $250,000 they still owe the bank $200,000. The bank won't even release the house for clear sale in this case unless the borrower comes up with the cash at closing to pay off the mortgage note. Their downpayment is gone, any equity is gone and they still have a huge bill.

One of the problems with using a mortgage is that you can get "locked in" to a house that you don't want. If it's resale value drops below what you owe on it you are stuck making up the difference to sell it (this is what happened to my sister in the Hartford, CT area a few years back). For a lot of people that means you stay right where you are at until the resale value can cover what you owe.

Person B is in a much better position - they can take the loss if they want to or they can keep the house, rent it and use their credit to buy another house wherever they want to move to. When the market improves again in the long term they can sell the 1st house without taking a loss. In the mean time any rent receipts can cover maintenance and taxes.

See, I put disclaimers in for a reason. ;-)

Thanks for clarifying, fishin', makes sense.

From what I do know (slightly expanded by fishin's reply, still limited), if the point is to buy a house, buying it outright is much better than buying it any other way. If the point is to make a good investment, there are pros and cons.

I would feel uncomfortable making a blanket statement like that. I would say the idea of buying versus renting is generally a good idea, but again, it depends on your personal situation.

Real estate can be a bad investment. Keep these points in mind:

• Do your homework properly for the area you intend to buy. In other words, what areas is it not a good idea to buy in, etc.? In what areas are homes holding their values?
  
• Thoroughly go through the home that you intend to buy, whether it be an apartment, townhouse, house. Don't be afraid to look for hidden damage behind furniture, etc.
  
• When you are serious about a home and intend to buy, get it inspected by a professional. Yes, it costs a bit of money, but could save you a lot of grief down the road.
  
• Check how much the property taxes are.
  
• If you are buying an apartment or townhouse, look at one year's previous minutes of the council that oversees the maintance and bills for the complex. How much are the monthly fees, etc.?
  
• Don't let the real estate salesperson push you into making a quick decision on a sale.
  
• Check the sales contract over carefully. Has anything been missed? For example, if curtains are to be included, is there a subject for that?
  

I've probably left out some tips, but you get the idea. If you go blindly into a sale, you may regret it. Just to give you an idea, in our province, we have had a lot of problems with new leaking apartment buildings. Unfortunately, novice first-time buyers bought into some of these (in some cases) and were caught with very high "special assessments" later on to help pay to correct the damage. We're talking as much as $20-60,000 Cdn. So, the old adage, "Buyer Beware", is extremely true when you're buying into a home of some kind.

Another point is to have a bit more money put aside than you need to buy, in case of unexpected expenses. Don't budget so tight that you have potential financial problems once you move in. This is if you are paying for the whole amount or a monthly mortgage. If you do have a mortgage, budget for things like insurance, which you must carry. Also, lawyer's fees, etc.

Wow, thanks everyone for your input. This thread has been VERY informative. I'm hoping for even more people to put in their two cents.

Thanks!

It sounds to me like you are a first time buyer. If at all possible, when you are going ahead with looking at homes to buy, take someone with you who has bought one before. Their experience could ward off a lot of pitfalls.

If you're anything like me, when too much information comes my way, my mind goes numb and I miss a lot of important details. My wife (who is way smarter than me) and I always did important stuff like this together. What one misses, the other one often picks up on. This was especially true of going over detailed things like contracts.

You are right. I have looked at real estate many times in the past, but I would be a first time buyer. And I do tend to glaze over when too much information is presented to me. Thanks for the advice.

I was going to come back and say exactly what Fishin did, so I'll just second what he said.

A little thing I heard on CNBC a few months ago. The latest craze on the east coast by the well-to-do is to take out large mortgages and make money doing so. In the financial world its called arbitrage.

The scheme is basically this. You take out a large mortgage at 6% interest. You then invest the money in tax free municipal bonds that pay about 5%. You get the tax write off for the mortgage interest that more than makes up the difference between the interest on the mortgage and the bonds.

a $400,000 mortgage costs you about 24,000 in interest
you earn 20,000 in interest on your bonds
If you are in the 30% tax bracket (state and federal) you save $7,2000 which means you earn 3,200 a year.

2 things needed for this, you have to have the cash to put in bonds and you have to have the income to get the savings on your taxes. It does pay to be rich.

Buying a house outright may not be the best idea for everyone. It really depends on what you want. Consider these points (in no particular order):
1 your house will appreciate (or not) no matter how much money you put down
2 you cannot "spend" the equity in your home, you can only sell it or borrow against it.
3 given a long enough legnth of time, real estate will always appreciate.

If you spend "all" your money on the house, you will have no money left to "make money" with. That is a bad idea. You could easily make more money investing then you will spend on interest payments. Remember in business, spend someone else's money and "you could always get a loan unless you 'need' one."

If you are only buying a house for a place to live, and are not interested in making money (you already have a huge income or are retiring for instance) then it wouldn't be a bad idea. If the value of the house is only 10% of your net worth, then it isn't going to really matter.

oh yeah, the statement that real estate will always appreciate is a broad generalization. Do your homework and buy someplace unlikely to fall out of favor with people who would be likely buyers of your house.

Hey fishin', maybe in Connecticut but not in California.

If you put $50K down to buy a $500K house, and the market goes down to $250K ...
Person A can get rid of the house anytime (with no sales hassles) and still
only lose $20K of that down payment. Here's how.

You move out of the house, rent it out for $2000/month, and then stop paying the mortgage.
When the bank announces it is going to foreclose, haggle with them.
It's not their job to own a house, they don't want to own a house,
so they will offer smaller payments for a few "difficult" months.
Make a few smaller payments and when they've finally lost patience
with you, don't make any more.

The bank threatens you with foreclosure for a couple months, and
when they finally announce the date that they will auction it off, wait until
one week beforehand and then declare bankruptcy.
For three months they are not allowed to proceed with anything, and even
then it takes another month to refile auction papers and advertise it.

So four months later, when the bank announces the new auction date,
wait until one week beforehand, and
then give your renters 30 days notice to leave.

By the time the process is over, you've collected 15 months rent at
$2000/month ($30,000) while paying no mortgage or property taxes.

The bank auctions it off for $210k (after paying your property tax of $5000)
thereby losing $245k. Finally, after the auction is done, then the bank
gives your renters 30 days to leave.

You owe nothing, and continue to live wherever else you want.
In California, the bank cannot pursue you for anything more than
the real estate that's explicitly written on the mortgage. They cannot
seize anything else.

So, person A recovers $30,000 of their $50,000 down payment, losing
only $20,000 while the bank loses $245k.

Person B loses the entire $250,000 of depreciation, because they
assumed the entire liability of ownership.



The bankruptcy part is optional -- That only buys you another 4 months rental income ($8000).

Kicky ....... Whether it is a good idea to pay cash for a house would be something you would need to analyze by figuring out what rate you could earn on your cash investment - relative to mortgage rates. If it were me and I paid cash for a home, I would take what would have been my mortgage payment each month .... and find a place to invest that money.

Someone made a comment about home equity loans being cheaper than first mortgages. Not so. There are teaser rates out there. But most of these are tied to the prime rate. They are called heloc's. You can even get a 1st lien heloc these days. In todays environment it's not a good idea to have a variable rate mortgage tied to the prime rate. If inflation gets out of hand, these loans will kill your wallet. Not to mention you are paying interest only with nothing going on the principle. On average, you can expect fixed rate 2nds to run upwards of 2% higher than 1st liens. In the recent declining interest rate environment, heloc's were great.

Prime rate is 5.75% right now. I have been writing 30 year notes for 5.5% FIXED. :wink: And on the occasional dip, grabbing 15 year rates at 4.875 to 5.00% FIXED.

Anyhow ..... I have a 401K account at work. We are allowed to shuffle our money around into different entities at certain times. I have dramatically increased my account by doing a little homework and vesting into different things at certain times. It really helped when I vested in a certain stock that was rumored to split. It did...then the price ran back up eventually. WOW! It was a well paid off gamble on my part, because I put alot of eggs in that basket, that I normally would not have.

A friend of mine and her husband, have made a ton of money in real estate. That is my next avenue, hopefully. I have already been lining things up for it. They only do this part time - as they both work full time jobs. Last year they made over $90,000, just on the side. That was on 3 properties they bought, then sold. They buy properties well below appraised value. They do this by one of two ways for the most part. First by checking out foreclosures. You can call up the sheriff's office and get the actual pay-off on the property and sometimes win the bid by going a little over that. The banks are there to safeguard their investment and will buy it back themselves if your price is not their price. You would be wise to pay a lawyer to do a title search to check for liens, though. Sometimes you can deal directly with the homeowner and cement the deal with them before the day of sale. Someone else I know, did this and ended up with a home that appraised at 200,000 for 67,000. These kind of deals are far and few between though. If they can't get a home at a foreclosure sale, they look for REO homes. These are homes that the bank has taken possession of. They really do not want to hold them for a long period of time and will take a loss sometimes, rather then have to deal with the holding of the property. That means you get a deal! In my area, unemployment is low and Findlay is bursting at the seams in all directions. New industries are coming in. But Findlay is noted for being one of the fastest growing towns in the US. They even made the game show "jeopardy" a couple years ago, because of their growth. So real estate is very stable here.

Anywho.....there are alot of ways to make money. You just have to be money wise and willing to do your homework.

My mentor in college, when I was taking financial engineering taught me alot of things. I remember him telling me that knowledge is only as good as the person holding it. In other words, don't just learn it. Do it! You can know the short term direction of interest rates, simply by learning to read the bond market. That will help you to know when to tell your banker to lock in your rate, when you go to apply for a mortgage. Let him or her know that you aren't stupid and you know that short term rates are probably down a half, from what he might have quoted you over the phone when you talked to him the week before. :wink:

Anyhow.......I could go on and on and o-n , but I will spare you.

Good luck sweetheart!

Damn! A dumb blonde you ain't, Brooke! Thanks! Right now I'm not awake enough to even understand a lot of that stuff, but I'll re-read it later.

Thanks again.

One other problem with taking out a home equity loan when you run into financial issues is that you aren't necessarily considered a good risk by the bank and it isn't easy to get a loan if you don't have a mechanism to pay it back. The bank doesn't want your home.

A different option than a home equity loan would be to take out a home equity line of credit. It has an annual fee, usually around $50 to $150 dollars, but you get it before you ever need it. Then, you can use the equity you have in your home by writing a check and you don't need to get approved for a loan and you don't have anything to pay back until you actually write that check.

Another option is to take out a 30 year mortgage but make the largest payment you can afford each month (make sure there's no prepayment penalty). You aren't tied in to the larger payment of the 15 year mortgage but you get the tax benefit of the interest payments while paying off your mortgage years earlier. This works particularly well with adjustable rate mortgages that have a fix-term up front, such as 5-1 ARMs or 3-1 ARMs. Make double or even triple payments while the low introductory rate is fixed and then when it starts to adjust annually, your payments will actually go down rather than up with an increase in the interest rate. Keep paying the higher payment and the property will be paid off in 10 years or less.

If you have a ton of willpower and will actually invest the money you get from taking out a high mortgage, then you can come out ahead. Many people get caught in this scheme because they aren't dedicated enough to see it through and end up spending the money. I would never suggest someone declare bankruptcy. There's a long-term downside that complicates your life for many, many years.