We often hear that one’s home is one’s castle, but how true is that? It’s always been part of the American dream to own real estate, whether a single-family residence (SF), townhouse, or condo. Traditionally, we get the impression that investing in and holding property will make us wealthier. Indeed, stories go around telling us that most billionaires built their wealth from owning properties on a large scale. So, as a homeowner, it may be worthwhile knowing the ins and outs of property ownership and its chances of making a nice nest egg for you down the line. Read on.
The statistics tell a tale.
Zillow shows that the average residence in the US appreciated from $163K to $312K over something like ten years. The SF category over the same period went from $186K to $362K – around 5.4% compound growth. SFs in Birmingham, Alabama, beat the national average trend, rising by slightly more than double from an average of $58K to $118K (i.e., 7.4% compound growth, and 37% above the rest of the country). So, bottom line, real estate is a great asset to own. The question is, then, what derailed homeowners’ dreams despite this when we see so many foreclosures over the years?
It’s not real estate but leveraging that’s at fault.
What do I mean by “leveraging?”
It refers to how a homeowner relies on mortgage funding to acquire the asset. Few of us can think of buying a house without financial assistance, generally around 70% of the real estate’s appraised value. Over the last few years, the interest rates have thankfully been low, hovering between three and four percent. So, for example, if a Birmingham married couple bought a home for $100,000 back in 2011 with a 70% mortgage, they only had to invest $30,000. The bank funded the rest with the property secured as its fallback in case the borrower defaults.
Now watch this:
- Let’s suppose the couple paid 4% fixed interest annually (interest only) or $2800 x 10 years = $28,000.
- Supposing they sold the house ten years later after it appreciated at the average (i.e., 7.4% pa) for a fair value of $202,000.
- How did they fare on the deal?
- Well, as a start, they pay back the bank’s loan – $70K.
- Additional closing costs (paying realtors, lawyers, the title company, etc.) of $20K leave them with $110K net value for their original investment of $30K.
- Indeed, the leveraging arrangement magnified their wealth by more than tripling the investment (i.e., around a 13.3% compound return – nearly twice the asset appreciation rate).
From the above, you may conclude that the leveraging effect is fantastic, and borrowing bank money is the optimal route to becoming wealthy. But is this too good to be true?
There’s a downside to leveraging.
- An assumption that interest rates stay low is a lethal tripwire. During the Carter presidency, inflation went crazy, and double-digit interest rates ruled the day. That’s why savvy borrowers lock in a low rate when they can secure it. Those that don’t may pay a heavy price down the line.
- Property appreciation doesn’t always travel in a steadily upward direction. The financial crisis of 2008 taught us that a recession can slaughter capital gains in the blink of an eye while simultaneously erasing jobs left, right, and center.
- When homeowners get caught in a financial crunch, the home’s value could drop below the loan commitment. It’s called “being underwater.”
- Also, with insufficient income to pay interest, the bank will zone in and foreclose on the home. In that event, the total principal (in our example, $30,000) dissolves to nothing. The couple would have to leave their home and lose their original input to boot.
- In the recent COVID-19 crisis, many people lost their jobs and began slipping behind their mortgage obligations.
- Those who invested in residences relied on their tenants’ rent to pay the mortgage costs. However, landlords couldn’t eject defaulters (and there were many), barred by the CARES Act provisions. The latter forbade it for over a year to ease people’s pain.
- The bottom line was this: No rent + Continuing interest payments = A likely track to real estate bankruptcy.
- These disruptions can occur even in a vibrant property market, spelling disaster. To be clear, it’s not failing asset appreciation that’s necessarily the culprit, but more frequently leveraging pressures overwhelming the homeowner.
Indeed, leverage is a double-edged sword that can cut both ways, and the wrong side of it can get pretty hairy if it takes one by surprise.
Events that turn leverage against you.
It can happen to anyone, and trouble knocks at the door regularly in times of turmoil. You’d think that there’s an easy exit if the market is buoyant, but consider the following:
- Perhaps you are stuck with erratic tenants who also neglect the residence, thus deteriorating the home’s value. It results in a triple whammy issue because:
- No buyer wants to take on tenants who can’t pay
- A damaged and unsightly structure doesn’t help salability.
- In the meantime, the mortgage company is threatening to foreclose.
- You’ve lost your job, mortgage arrears are mounting up, and disrepair is creeping in every day.
- You don’t have the cash flow to renovate.
- You need to sell quickly, but poor curb appeal and internal defects detract from your MLS competitiveness.
- Your house is in excellent shape, but interest commitments are heavy after a job layoff. On top of this, you’re in the middle of a divorce.
- You can’t get an agreement to sell the marital home, let alone the other investment properties.
- The bank doesn’t care, and foreclosure looms here as well.
Many life circumstance examples like the above can bring your dreams to a screeching halt. For instance – sudden illness, a breadwinner’s uninsured death, moving out of state in a hurry – all sorts of things.
Pressured homeowners’ remedies
Trying to sell traditionally through a realtor with a 6% commission coming off the top, showcasing the house to get noticed, and being patient are not deal drivers you can cope with right now. One thing’s for sure; time isn’t on your side. You have to act quickly to get the bank off your back and lien holders (like your HOA for unpaid assessment fees). Your head is spinning with dilemmas on all sides.
A suggested viable solution
You need a home cash buyer that routinely resolves most of the things listed above with expertise. There’s no commission in the mix as a start, and they can generally look past poor aesthetics without severe penalties. Yes, the home cash buyer is in it for a profit, but all things considered, you can get a reasonable offer with net cash in your pocket inside of seven days (versus six weeks on average the traditional route). Angry estranged spouses often calm down when they see a viable way out. So, don’t despair when the landscape looks overly problematic. Companies like Home Buyers Birmingham – professionals with a capital P – may have a solution that resonates with you. They know how to appraise, account for disrepair reasonably, and pay off liens at cents in the dollar. You could come out of it fast in a hot or cold market, irrespective, with a great result and money in the bank.
Home Buyers Birmingham
1821 11th Avenue South Suite #55331
Birmingham, Alabama 35205