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How to Figure Cap Rate

by Ray Ault

How to Figure Cap Rate

Real estate investors rely upon a variety of type’s information when negotiating for income producing properties ‐ for instance, the desirability of the property's current location and/or any prospective changes in the neighborhood are two common factors. One crucial piece of information that helps investors make their decision is called the capitalization rate (or "cap rate"). The cap rate (expressed as the ratio of the property's net income to its purchase price) allows investors to compare properties by evaluating a rate of return on the investment made in the property. See Step 1 below to calculate the cap rate for your home!

Calculating Cap Rate

#1  Calculate the yearly gross income of the investment property.
The gross income of a piece of investment property will mainly be in terms of rent rolls. In other
words, when a real estate investor buys a home, s/he usually makes money from it primarily by
renting it out to tenants. However, this isn't the sole possible source of income - miscellaneous
income can also accrue from the property in the form of coin operated vending or washing
machines, etc.

For example, let's say that we've just purchased a house we intend to rent to tenants at a
rate of $750/month. At this rate, we can expect to make 750 × 12 = $9,000 per year in
gross income from the property.

#2 Subtract the operating expenses associated with the property from the gross income.
Any piece of real estate comes with operating costs. Usually, these are in the form of
maintenance, insurance, taxes, and property management. Use accurate estimates for these
numbers and subtract them from the gross income you found above. This will find the property's
net income.

For example, let's say that, after having our rental property appraised, we find that we can
expect to pay $900 in property management, $450 in maintenance, $710 in taxes, and
$650 in insurance per year for our property. 9,000 - 900 - 450 - 710 - 650 = $6,290, our
property's net income.

 Note that the cap rate doesn't account for the property's business expenses - including the
purchase costs of the property, mortgage payments, fees, etc. Since these items reflect the
investor's standing with the lender and are variable in nature, they adversely affect the
neutral comparison that the cap rate is meant to deliver.

#3 Divide the net income by the property's purchase price. The cap rate is the ratio between the
net income of the property and its original price or capital cost. Cap rate is expressed as a
percentage.

Let's assume we purchased our property for $40,000. Given this information, we now
have everything we need to know to find our cap rate. See below:
o $9000 (gross income)
o -$900 (property management)
o -$450 (maintenance)
o -$710 (taxes)
o -$650 (insurance)
o =$6290 (net income) / $40000 (purchase price) = 0.157 = 15.7% cap rate

Part 2 Using Cap Rates Wisely

#1 Use cap rates to quickly compare similar investment opportunities.
The cap rate basically represents the estimated percent return an investor might make on an all cash
purchase of the property. Because of this, cap rate is good statistic to use when comparing a
potential acquisition to other investment opportunities of a similar nature. Cap rates allow quick,
rough comparisons of the earning potential of investment properties and can help you narrow
down your list of choices.

For example, let's say that we're considering buying two pieces of property in the same
neighborhood. One has a cap rate of 8%, while the other has a cap rate of 13%. This
initial comparison favors the second property - it is expected to generate more money for
each dollar you spend on it.

#2 Don't use cap rate as the sole factor when determining an investment's health.
While cap rates offer the opportunity to make quick, easy comparisons between two or more
pieces of property, they're far from the only factors you should consider. Real estate investment
can be quite tricky - seemingly straightforward investments can be subject to market forces and
unforeseen events beyond the scope of a simple cap rate calculation. At the very least, you'll also
want to consider the growth potential of your property's income as well as any likely changes in
the value of the property itself.

For example, let's say that we buy a piece of property for $1,000,000 and we expect to
make $100,000 per year from it - this gives us a cap rate of 10%. If the local housing
market changes and the value of the property increases to $1,500,000, suddenly, we have
a less-lucrative cap rate of 6.66%. In this case, it may be wise to sell the property and use
the profits to make another investment.

#3 Use the cap rate to justify the income level of the investment property.
If you know the cap rate of properties in the area of your investment property, you can use this
information to determine how much net income your property will need to generate for the
investment to be "worth it". To do this, simply multiply the property's asking price by the cap
rate of similar properties in the area to find your "recommended" net income level. Note that this
is essentially solving the equation (Net income/Asking price) = cap rate for "net income".

 For example, if we bought a property for $400,000 in an area where most similar
properties have about an 8% cap rate, we might find our "recommended" income level by
multiplying 400,000 × .08 = $32,000. This represents the amount of net income the
property would need to generate per year to get an 8% cap rate, so we would set the
rental rates accordingly.

Tips

Always verify the income that is purported to come from the income property, as well as the
expenses, if possible. A condition associated with an offer to purchase the property should
include inspection of the lease agreements to verify the rent rolls. Expenses might be verified by
contacting third party suppliers.

When considering the value of a property, appraisers will look at comparable sales, the
property's replacement value as well as take an income approach to the property. The income
approach considers the required return on equity and debt.

Warnings

The cap rate doesn't reflect future risk. The investor cannot rely on the cap rate to assume that the
property will sustain its current income or value. The property and rents associated with it can
depreciate or appreciate. The expenses can simultaneously rise. The cap rate offers no prediction about
future risk.

1031 Exchange Issues

by Ray Ault

Our Lender Made us do it!

Generally it is recommended that no changes be made to the way title to property is held shortly before or after a 1031 Exchange. For example, if title to an apartment building is held by Lisa and Russell as husband and wife, title to the new replacement property should be held in the same manner. However, sometimes a lender may require a change in title (“vesting”) as a condition to providing a loan for the replacement property, such as requiring the couple to own the new property in only the name of the husband or wife. An IRS statute which created unlimited gifting between spouses exists, which may help address situations like the above, but this statue is dated and creates a gray area on current application. This situation could be problematic for spouses who have entered into a 1031 Exchange since appeasing the lender may invalidate their 1031 Exchange.

The last time the IRS issued a memorandum related to spousal vesting was in 1984. At that time spouses did not receive a favorable ruling. The IRS position was that each spouse is a separate taxpayer, therefore each owned a separate half of the jointly owned property (even if they file a joint return). In Technical Advice Memorandum (TAM8429004), the IRS ruled that where both spouses were on title to the relinquished property but only one spouse was on title to the replacement property, the other spouse was deemed to have gifted their portion of the proceeds, and must pay tax on 50% of the gain.

Later in 1984, Congress passed IRC section 1041. This law, which remains in effect today, created unlimited tax free gifting between spouses. Section 1041 hasn’t been revisited in a long time, which leaves us to wonder if the IRS would still issue the same ruling today as it did in TAM8429004. Since it is not clear, many tax advisors suggest the following with respect to the spousal title scenarios below:

Example A: One spouse is on title to the relinquished property but the lender wants both on the title to the replacement property:
  • Have counsel prepare an agreement that the co-signing spouse is doing so in trust for the other spouse; the replacement property is the separate property of other spouse and that no gift has occurred.
Example B: If there is no lender requirement – only the spouse on title to the relinquished property should be on title to the replacement property:
  • The property can be placed in a revocable living trust with the other spouse named as the beneficiary to protect from an untimely death until they can safely be added to title.
Example C: If both spouses are on title to the relinquished property and lender only wants only one on the replacement property there is not a clear answer:
  • The spouses may need to find a new lender or rely on the unlimited gifting provision of section 1041.

Taxpayers should always consult with a competent tax advisor for advice with respect to their individual situation.

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Economist: It's Not Easier to Get a Mortgage

by Ray Ault

Home sales are improving, so does that mean it's easier to get credit access for a mortgage? Not necessarily, writes Jonathan Smoke, realtor.com®'s chief economist.

Last fall, mortgage giant backers Fannie Mae and Freddie Mac urged lenders to ease their requirements and also introduced new 3 percent down payment programs for qualified buyers. The Federal Housing Administration also has lowered its insurance premiums.

The Mortgage Bankers Association's Credit Availability Index was at 122 in June, a 5 percent increase year-over-year in the expansion of credit. However, the index peaked at 869 in June 2004 – indicating that June's reading is still far from that peak or even a normal reading. 

Smoke says that the average FICO score on a closed purchase mortgage in June was 727. Average FICO scores for the past 24 months have hovered between 724 and 742. That represents above-median credit quality households, Smoke says. The average denied FICO score was 672 in June, down from 686 a year ago.

What that means, Smoke notes, is that "more lower credit-quality households are applying but not getting approved. Yet at the same time, the percentage of purchase applications making it to closing has risen from 64 percent last June to 69 percent this June. Times are still tough for those with tarnished credit."

On the other hand, wealthier households seeking a jumbo mortgage may be having an easier time. Lenders are showing signs of loosening up on jumbo mortgage requirements.

A more widespread change may be on the horizon for the market. A July Senior Loan Officer survey report from the Federal Reserve did show that over the past three months banks have been easing lending standards on several categories of mortgage loans. Smoke notes that those changes may start appearing in the closing averages in the coming months.

Still, "today's limited credit availability is at least partly to blame for the tight supply that's leading to higher prices and higher rents," Smoke writes. "Builders are not convinced that there's enough depth of demand to absorb higher levels of new construction, so they are holding back and focusing on their profitable growth instead. Meanwhile, a substantial percentage of today's home owners with mortgages underwritten years ago fear not being able to qualify for a new mortgage today, so they stay on the sidelines and keep their homes off the market."

Source: "Is It Really Easier to Get a Mortgage These Days? Well …" realtor.com® (Aug. 6, 2015)

 

Spring Bounce

by Ray Ault

Mar 30, 2014 9:00 PM PT

Donna Cicerone and her husband Paul want to put their three-bedroom home in Milton, Massachusetts, on the market. First, they have to find a house to buy.

The Cicerones live in the Boston area, where all but three weekends this year have had snow, sleet or rain. Bad weather has forced them to cancel house-hunting plans half a dozen times, they said. When they have found a house they liked amid a limited supply of properties, they’ve been outbid.

“The moment we sign a contract to buy, we’re putting our house on the market,” said Donna Cicerone. “We feel like we’re missing an opportunity because everyone says there are lots of buyers, but there’s nothing we can do.”

Frustrated shoppers and would-be sellers like the Cicerones are setting the pace for the housing market’s spring selling season, the March through June period when more than half of U.S. home sales take place. The market’s getting a late start this year because so much of the country has been in the grips of bad weather, said Dean Maki, chief U.S. economist for Barclays PLC in New York.

“There aren’t many people who want to drive around looking for homes in a blizzard, and there aren’t many sellers who can put their homes on the market unless they have some place to move to,” Maki said. “We’ve seen sales take a hit so far, lagging where they usually are, but we think the next few months will make up for it.”

Photographer: Matthew Staver/Bloomberg

 

Sales Fell

Home sales declined in February to the lowest level since mid-2012, according to the National Association of Realtors. The number of contracts signed with the intention of purchasing properties fell that month to the lowest since 2011, according to the Realtors’ group. While the numbers are seasonally adjusted, they can be influenced by unexpected events such as unusual weather.

Applications for mortgages to purchase homes dropped in February to the lowest since 1995, according to an index from the Mortgage Bankers Association that also is seasonally adjusted. By mid-March, the gauge regained about 12 percent from that low, while remaining about 17 percent below the level it was during the same week in 2013.

Most of the sales blocked by bad weather will happen in the next few months, Maki said. Housing forecasters Fannie Mae and the Mortgage Bankers Association predict 2014 home sales will be

‘Exaggerated Bounce’

“Because we’ve had a late start to sales, we expect a bit of an exaggerated seasonal bounce,” said Maki.

Sales of existing homes probably will rise to 5.14 million in 2014, up from last year’s 5.07 million, according to the mortgage bankers group. Mortgage lending for purchases probably will total $661 billion, near last year’s $652 billion, the trade group said.

Like many buyers, the Cicerones are eager to purchase a house so they can lock a mortgage rate before borrowing costs rise. The average U.S. rate for a 30-year fixed mortgage was 4.4 percent last week. A year earlier, it was 3.57 percent. By the end of 2014, the average rate probably will be about 4.6 percent, said Fannie Mae.

“We’re ready to pounce when we find the right house,” said Cicerone, 48. “We want to put our home on the market to catch all the buyers nervous about mortgage rates, and we want to find a house as fast as we can so we can lock in a good rate too.”

They may get some cooperation from the weather in April. Below-normal temperatures will give way to more seasonal weather in the eastern U.S. next week, according to Matt Rogers, president of Commodity Weather Group LLC in Bethesda, Maryland. The December through February period was the coldest in four years.

Fed Tapering

Borrowing costs have risen as the Federal Reserve continues tapering stimulus efforts that have kept interest rates low. Policy makers cut monthly bond purchases to $55 billion this month, from $85 billion last year. Fed Chair Janet Yellen said the program could end this fall and that the benchmark interest rate, which has been close to zero since 2008, may rise six months after that.

Tighter lending also is hurting the market, said Michael Hanson, a former Federal Reserve economist now working for Bank of America Corp. in New York. In January, the Fed issued a report showing 1.4 percent of banks had raised mortgage standards, the first increase since April 2012.

“We need more first-time buyers in the market so they can purchase the homes of people who want to move up,” Hanson said. “We won’t see a normal real estate market until they are included, and they are the ones most affected when lenders tighten standards.”

First-time buyers accounted for 28 percent of all purchases in February, up from 26 percent in January that was the lowest in data going back to October 2008, according to the National Association of Realtors.

Supply Differences

The supply of homes for sale is bigger than last year, according to the National Association of Realtors. At the current sales pace, it would take 5.2 months to sell the properties on the market in February, compared with 4.6 months a year earlier.

The markets in certain areas, such as Boston, Denver, and Houston, are leaner than during the 2013 Spring selling season. In Boston and Boulder, Colorado, the number of homes for sale in February was down about 30 percent from a year ago, according to Zillow Inc. in Seattle. In Houston, Dallas and Denver, the contraction is about 20 percent. The metropolitan New York and Seattle areas were up 1 percent.

That has made extra work for home-loan brokers such as Jonathan Sexton, a vice president at NE Moves Mortgage LLC’s office in Cambridge, Massachusetts. Each time people make an offer on a house, their mortgage broker prepares a letter showing they are pre-qualified for the amount of the bid. When supply shortages cause bidding wars, those letters are in greater demand.

‘Low Success’

“So far this year, I’ve seen an inordinately low success rate for bids because the supply of properties is so limited,” he said. “I wish I got paid in pre-approval letters instead of closed loans.”

Sales in the Boston area and other parts of the country likely will pick up speed as the market goes into April and May, said Bank of America’s Hanson.

“The housing market, like the rest of the economy, is on a gradual recovery path,” said Hanson. “In the next months, we’re going to see the Spring market come to life.”

2012 Awards

by Ray Ault

Today I was humbled by the owner and members of  Coldwell Banker C&C Properties when it was announced that I was the "Agent Of The Year". As many of you know it was a busy time in my real estate business for the last couple of years. But thanks to God and all of my wonderful clients I managed  preform at the highest level last year. I was awarded not only "Agent Of The Year" but "Top Producer of the Year", "Top Sales of the Year", "Coldwell Banker International Diamond Society" and "Top Producer of Year" with Coldwell Banker Mortgage.

It is a very humbling experience to receive these awards and a standing ovation from my peers. I am very thankful for all the kind words that were sent my way today. I appreciate the trust that my clients place with me when they are buying or selling one of their biggest investments. I plan to continue to work hard and earn your business in the future.

6 Things That Turn Home Buyers Off

by Ray Ault

Here are 6 big-time homebuyer turn-offs that make buyers cringe at the thought of your home, and action steps you can take to prevent your home from being an offender:

1.  Stalker-ish sellers.  I know you think you’re being helpful, walking the buyer through your home and pointing out the wagon-wheel light fixture you made with your own two hands, the custom mural of a stingray you paid top dollar to have painted across your living room wall and the way the sounds of happy schoolchildren running across the front yard of your corner lot to get to the school in the next block lifts your spirits.  However, the buyers might be trying really hard to ignore, minimize or figure out how to undo the very features of your home you hold dear.  They also may want or need to have personal space and conversations with their mate or their agent while they’re viewing your home - you being there, especially walking right alongside them while they’re in your home, prevents them from being comfortable about doing this, or discussing all the things they would change if the home were theirs. In my experience, the more nitpicky a buyer gets about a house and the more detailed their list of things they would change, the more serious they are about considering making an offer on this place.

What’s a Seller to do? Back off. Let your home be shown vacant, or leave the house when people come to see it.  If you need to be there, at least walk outside or go sit at the coffee shop down the way while prospective buyers view your home.  If the buyers have questions, their people will contact your people.

2. Shabby, dirty, crowded and/or smelly houses.  You already know this one. Yet, buyers constantly marvel. The buyers who come to see your home are making the decision whether to choose your home for the biggest purchase they’ve ever made during the worst economic conditions most of them have ever experienced.  Your job is to get your home noticed – favorably – above the sea of other homes on the market, many of which are priced very, very low. 

What’s a Seller to do?  Other than listing your home at a competitive price, the only tool within your control for differentiating your home from all the foreclosures and short sales is to show it in tip-top shape. Pre-pack your place up, getting rid of as many of your personal effects as possible. Do not show it without it being completely cleaned up: no laundry or dishes piled up, countertops freshly washed, smelly dogs (I have a couple who smell on occasion – no judgment – but don’t show your house with pet odors) or litter boxes cleaned and/or out of the house.

3.  Irrational seller expectations (i.e., overpricing).  Buying a house on today’s market is hard work!  On top of all the research and analysis about the market and situating their own lives to be sure they’ll be able to afford the place for 5, 7, 10 years - or longer, buyers have to work overtime to separate the real estate wheat from the chaff, get educated about short sales and foreclosures and often put in many, many offers before they get even a single one accepted.  The last thing they want to add to their task lists is trying to argue a seller out of unreasonable expectations or pricing.  And, in fact, there are so many other homes on the market, buyers don’t have to do this.  When they see a home whose seller is clearly clueless about their home’s value and has priced it sky-high, most often they won’t bother even looking at it.  If they love it, they’ll wait for it to sit on the market for awhile, hoping the market will “educate you” into desperation, priming the pump for a later, lowball offer.

What’s a Seller to do? Get real. Get out there and look at the other properties that are for sale in your area and price range. Get multiple agents’ take on what your home should be listed at, and don’t take it personally if their recommendation is low. If your home has much less curb appeal or space or is much less upgraded than the house across the way, don’t list it at the same price and expect it to sell. If you owe more than your home is realistically worth, you may need to reexamine whether you really want or need to sell, or consider a short sale, if you simply have to sell.  Don’t be tempted into testing your market with an obviously too-high price, unless you’re prepared to have your home lag on the market and get lowball offers.

4.  Feeling misled. Here’s the deal.  You will never trick someone into buying your home. If the listing pics are photo-edited within an inch of their lives, or your home is described as an “approved” short sale when, in fact, the bank approved another offer, now withdrawn, but will require a new offer to go through any sort of approval process (even a truncated one), buyers will learn this information at some point.  If your neighborhood is described as funky and vibrant, as code for the fact that your house is under the train tracks and you live in between a wrecking yard and a biker bar, prospects will figure this out.  If the detailed information about your home, neighborhood or even transactional position (e.g., short sale status, seller financing, etc.) is misrepresented, the sheer misrepresentation will turn otherwise interested buyers off.  If you authorize your agent to “verbally approve” the buyer’s offer, don’t go back the next day demanding an extra $5,000. In cases where the buyer feels misled, whether or not that was your intention, running through the buyer’s mind is this question: If they can’t trust you to be honest about this, how can they trust you to be honest about everything else? 

What’s a Seller to do?  Buyers rely on sellers to be upfront and honest – so be both.  If your home has features or aspects that are often perceived negatively, your home’s listing probably shouldn’t lead with them (like the ad I recently saw with the intro line: “this place is a mess!”), but neither should you go out of your way to slant or skew or spin the facts which will be obvious to anyone who visits your home.  Make sure you know what the listing of your home reads like, before it’s published to the web, and that a prospective buyer will not feel misled by it.

5. New, ugly home improvements.  Many a buyer has walked into a house that has clearly been remodeled and upgraded in anticipation of the sale, only to have their heart sink with the further realization that the brand-spanking-new kitchen features a countertop made, not of Carerra marble, but brand-new, pink tiles with a kitty cat in the middle of each one (I saw this once, people – no joke).  Or the pristine, just-installed floors feature carpet in a creamy shade of blue – the buyer’s least favorite color.  New home improvements that run totally counter to a buyer’s aesthetics are a big turn-off, because in today’s era of Conspicuous Frugality, buyers just can’t cotton to ripping out expensive, brand new, perfectly functioning things just on the basis of style – especially since they’ll feel like they paid for these things in the price of the home.

What’s a Seller to do?  Check in with a local broker or agent before you make a big investment in a pre-sale remodel.  They can give you a reality check about the likely return on your investment, and help you prioritize about which projects to do (or not).  Instead of spending $40,000 on a new, less-than-attractive kitchen, they might encourage you to update appliances, have the cabinets painted and spend a few grand on your curb appeal.  Many times, they will also help you do the work of selecting neutral finishes that will work for the largest possible range of buyer tastes.

6.  CRAZY listing photos (or no photos at all).  I’ve seen listing photos that have dumpsters parked in front of the house, piles of laundry all over the “hardwood” floors touted in the listing description, and once, even the family dog doing his or her business in the lovely green front yard.  Listing pictures that have put your home in anything but its best, accurate light are a very quick way to ensure that you turn off a huge number of buyers from even coming to see your house!   The only bigger buyer turn-off than these bizarre listing pics are listings that have no photos at all; most buyers on today’s market see a listing with no pictures and click right on past it, without giving the place a second glance. Photos are a sellers best tool to get buyers to have enough interest to want to make an appointment and come inside.

What’s a Seller to do?  Check your home’s listing online and make sure that the pics represent your home well.  If not, ask your agent to grab some new shots and get them online (and say pretty please, pretty please!).

NAR forecast anticipates quicker recovery for new homes

by By Inman News, Thursday, January 27, 2011

 

In its latest real estate and economic forecast, the National Association of Realtors anticipates that sales of existing homes, after falling 4.8 percent in 2010, will rise 7.9 percent this year, to 5.3 million, and another 4.5 percent in 2012, to 5.53 million.

The median price of existing homes, meanwhile, rose 0.3 percent in 2010 after a 12.9 percent drop in 2009, and is expected to rise 0.5 percent this year, to $173,800, and another 2.4 percent in 2012, to $177,900.

Sales of new single-family homes are expected to rebound faster, rising 17.7 percent this year, to 374,000 sales, after a 15.5 percent drop in 2010, and then rising 51.1 percent in 2012, to 565,000 sales. In an earlier forecast, released last month, NAR anticipated that sales of new single-family homes would climb 20.8 percent in 2011 and 30.9 percent in 2012.

The new-home median price rose 2.2 percent in 2010 and is expected to climb 1.8 percent this year, to $224,700, and 1.9 percent in 2012, to $229,000.

NAR expects that 30-year-fixed mortgage rates will average 5.1 percent this year, up from 4.7 percent in 2010, and rise to 5.9 percent in 2012.

Home Buyers are Ready to Move from the Sidelines.

by Ray Ault

News you can use to stay ahead of the curve.

August 30, 2010—Are more Americans positioning themselves for home purchase? Although May’s data showed that home sales were down 26.8% as the home buyer tax credit concluded, a new survey conducted by Relocation.com suggests some families are opting for renting while they research—cash in hand—for deals on a new, more desirable home in their area.

Among the key findings of the survey: Of the 60% of individuals moving into rentals, 24% were previous homeowners who are renting temporarily while they look for a new home to purchase. Underscoring this finding is the fact that for many of these families, foreclosure was not the reason for moving—in fact, the number of consumers who moved due to foreclosure dropped by 70%.

Furthermore, many of these families stayed in the area (one in three made a short distance move of 100 miles or less), opting to remain in a location where they already know their schools, shopping districts and prime neighborhoods.

“While the housing market continues to flux from month to month, we’re seeing strong, continued interest as consumers looking to move start their research with us,” said Relocation.com Chairman and Founder Sharon Asher. “These findings suggest that more Americans may be poised to re-enter the housing market this year.”

The Relocation.com survey was conducted in early June 2010 and is a continuation of consumer surveys conducted since March 2009 to gauge moving and relocation attitudes and behaviors.

Simple Rules

by Ray Ault
Much of the news this week has been about the great coach John Wooden who died last Friday at 99 years of age.  He was a hard working simple man who attained continued successes in his life.  He truly set a great example of being a great person.  John Wooden lived by three values: 1) Never use profanity; 2) Be on time; and 3) Never criticize a teammate.  Can you imagine creating such success by these simple rules?  I’ve seen this quote all week and thought it appropriate to share  "Do not let what you cannot do interfere with what you can do." I think we’ve all found out that there’s so much more we can do and learn when wee look at what we can do and no concentrate on the obstacles in our path. When you think about it, we’ve become better due to the adversity we’ve endured.  Now we can fine-tune our best qualities to reach our goals and to help more people into homes at eye-popping low interest rates!
Have a great day!

How foreclosure impacts your credit score

by Ray Ault

I came across this article tonight and thought it was worth sharing. You will most likely ask about this at some point.  

After foreclosure: How long until you can buy again?

By Les Christie, staff writer May 28, 2010: 7:58 AM ET

NEW YORK (CNNMoney.com) -- Walking away from a mortgage you can still afford to pay has consequences; everyone knows that. Your credit score is shot and it can be impossible to get credit.

Some homeowners, no doubt, believe that the credit score hit is worth getting out from a deeply underwater mortgage. They may owe, say, $500,000 when their house value is only valued at $350,000. And, they figure, there's no way it will ever be worth what they owe so it's better to get out from underneath the burden.

After default, they reason, they can raise their FICO scores by paying all their bills on time and eventually finance another home purchase.

Don't count on it.

While homeowners who default due to economic hardship, such as a job loss or divorce, normally must wait two to five years before buying a home again, walkaways may face double that time.

"It could be well over seven or eight years before [walkaways] are able to obtain a mortgage to buy a home again," said Jay Brinkmann, chief economist for the Mortgage Bankers Association.

 

How foreclosure impacts your credit score

"Credit scores are only one component of a complete credit decision," Brinkmann said. "[In these cases] credit scores are not a good indicator of their willingness to continue to pay their mortgage."

But future underwriters will scrutinize their records very closely, and if they find no precipitating factors leading to the defaults -- no job loss, no health issues --the repaired credit score won't overshadow the black mark of a walkaway.

"If you made a strategic decision to default on paying your mortgage, it will work against you," said Bill Merrell of the National Association of Review Appraisers and Mortgage Underwriters.

Merrell, who teaches underwriting, said banks are looking at several factors in determining whether to grant mortgages: the amount of money borrowers have in the bank; employment histories; payment history.  However, banks may be far more lenient if the default resulted from factors somewhat beyond the borrower's control, such as from local economic problems. "They'll give you more consideration if it's job related," he said. But, he added, banks look at strategic defaults "very negatively."

 

That said, it's not impossible to get a loan. Banks still want to make interest payments, so they might be willing to gamble with a walkaway.

"It might be a little more difficult for them to borrow, but [banks'] drive for market share -- to profit from making loans -- will trump that caution," said Keith Gumbinger, of the mortgage information publisher HSH Associates. "I don't think we'll see a full denial."

It's hard to foresee the state of mortgage lending six or seven months from now, let alone seven or eight years into the future. So lenders may look at applications from one-time strategic defaulters and say, "Yes, they walked away but it's a whole different market now," according to Gumbinger.

Even so, lenders may require more from borrowers who walked away than those who didn't.

"To the extent they could get a mortgage," said Brinkmann, "they can count on needing a heavy down payment."

The lenders may ask for 30% down or more. That would provide enough collateral cushion that the bank could get all or most of its money back in a foreclosure.

Strategic defaulters might also be charged higher interest rates, even above the levels other borrowers with similar credit scores would receive.

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Ray Ault
Coldwell Banker C & C Properties
2120 Churn Creek Road
Redding CA 96002
Mobile: 530-945-7807
Fax: 866-451-8072

Cal DRE Lic. #01236173