Buying real estate right is an important skill to master in your wealth-building journey. Always remember that time is your best friend. Never rush into the purchase of a property, because the worst deals happen when you are desperate. Give yourself time to get qualified for the right mortgage. Identify the right property. And make the necessary improvements to the property (if necessary) before you start using it. This principle is true whether you are buying your first home or your fiftieth investment property.
There are three things that you will always do when you buy real estate – it is important to do each one of them the right way.
For most people, getting qualified means that a financial institution determines how much money it is willing to lend you for a mortgage. Creditors do this by looking at your income, your assets, your employment, and your credit. They use the combination of these components to decide the maximum amount of money you can borrow and at what interest rate.
In my book, The Wealth Cycle, I go into greater detail about why they learn about you from each of the components, but for the purposes of this article, I want to focus on what you do once they give you pre-approval. Your mindset about the pre-approval is critical to taking the right actions when you are purchasing the home.
The first thing to note when you receive your pre-approval is that the number on that document is the maximum amount of money they are willing to lend you. Therefore, instead of taking that as your starting point with the real estate agent, take a moment to figure out what your true house budget should be.
I have a simple exercise that can help you with this.
Determine the monthly payment that the mortgage would translate to (estimate taxes and insurance in this calculation). Then compare that amount to what you currently pay for rent. For example, if the mortgage monthly payment would be $2,500 and you currently pay $1,500 in rent, your new housing cost would be increased by $1,000. To figure out if that mortgage payment will work in your budget, try and save the difference between the mortgage and your rent today (in the example, this is $1,000) for six months. The amount that you can comfortably save over and above your rent for those six months is your true ‘pre-approval’.
So, if you were only able to save $500 for the six months, you should only look for houses where your total monthly payment is $2,000 (your rent + what you were able to save).
Once you have determined your true housing budget, the next step is identifying a property. There are three types of property that you can buy:
If you were to go into this process without any guidance, chances are you would find the turkey property most attractive because it requires the least work and hassle. If you are following The Wealth Cycle principles, however, the light renovation and total makeover properties are much smarter buys. This is because you have a lot more negotiating power to get a good deal when there is stuff wrong with the house that you can point out.
Finally, when you have determined your true housing budget and included non-turnkey options in your search, make sure to have an investor’s mindset so that you can buy smart.
If you look for property the way most people do, you probably list out all the things you want in your ideal house or investment property (like they do in those ‘house shopping’ shows on TV), and then pick a list of areas you find attractive to purchase in. There is nothing wrong with this approach, especially for your primary residence, but if you want to build wealth, you have to ask yourself a different set of questions in addition to the ‘house shopping show’ questions.
Expand your search to locations that are not yet the hot place to buy but are likely to develop in a few years. You can determine which areas have this profile by looking at trends surrounding the area. Are there plans for a new shopping area or stadium near that area? Is there a mix of newly built homes and homes that need fixing up? Is it an area that had a lot of foreclosures but still has a good school system and is accessible for commuters? What other major development plans have the local government discussed?
When you start asking yourself these kinds of questions, you begin to look at your real estate portfolio in a whole new light. And opportunities that others have not yet capitalized on become available to you. The more you can find these types of opportunities, the better your chances of buying an undervalued property that will appreciate in the future and increase the value of your real estate portfolio.