Here is a hypothetical conversation to help illustrate the relationship between price and financing.

BUYER:            “Hello, I’m a first time home buyer. I’m very interested in purchasing the super-low-priced house you have listed for $100,000.”

BROKER:           “Ma’am, let me show you the virtually identical house next door I have listed for $125,000.  I think you’ll find it more affordable.”

BUYER:            “Are you a moron?  I want to buy the cheapest house! Why would I buy the identical house next door for more money?”

BROKER:        “Unfortunately, the lower-priced house doesn’t qualify for FHA financing, so if you want the cheaper house you’ll have to bring in a 20% down payment.”

BUYER:          “I don’t have $20,000.  I was planning on getting an FHA loan with a 3.5% down payment.”

BROKER:        “If you don’t have $20,000, then let me show you the more expensive house next door that does qualify for FHA.”

BUYER:            “But the houses are identical from the outside! Why would one house qualify for FHA and one wouldn’t?”

BROKER:        “The lower priced home needs a new roof, so FHA won’t lend on it.” (send an email to david at HasslefreeCashflowInvesting dot com to request a free FHA property inspection check list)

BUYER:            “Why doesn’t the seller replace the roof so the property becomes eligible for FHA financing?”

BROKER:        “It’s owned by a bank, and the bank isn’t interested in doing the repairs.  The bank will just keep lowering the price until someone buys.”

BUYER:            “I’d like to buy the cheaper house and fix it up myself, but I don’t have a 20% down payment.  Can I make the repairs first and then buy it with FHA financing?”

BROKER:        “Maybe if it were owned by a regular seller, but the bank doesn’t work that way.  The bank doesn’t want the liability of you doing construction on a house they own.”

BUYER:            “Hmmm…. if I buy the more expensive house my down payment is $4,375, but if I buy the cheaper house my down payment is $20,000 plus the cost of a new roof.  What about my mortgage payment?”

BROKER:        “Your mortgage payment on the more expensive house will be $611 and your mortgage payment on the cheaper house will be $546.”

BUYER:            “Sixty-five Bucks!!! Is that all?!?!  I spend more than that at Starbucks!  If the loans are $40,625 different, why is there so little difference in payment?”  

BROKER:        “The cheaper house will financed by a local bank at 7.25% and the more expensive house is financeable by FHA at the subsidized interest rate of 4.5%.”
                ($125,000 x 96.5% = $120,625 x 4.5% 30yr amortization = $611 payment versus   $100,000 x 80% = $80,000 x 7.25% 30yr amortization = $546)

BUYER:            “I see what you mean.  Financing can have a larger impact on affordability than price!”

BROKER:        “If you want the more expensive house, we should write an offer today.  It just came on the market and I think it will go into escrow this weekend.”

BUYER:            “You’ve got to be kidding me!  The media says real estate is dead and average days on market for houses in this zip code is over six months.”

BROKER:        “You are only partly correct.  Very few people qualify for current bank financing, so if a property doesn’t qualify for FHA financing the property isn’t selling.   However, lower priced homes that qualify for FHA are selling fast and with multiple offers.”

BUYER:            “WOW, the newspaper lumps all the data together by zip code and it’s really misleading.”

BROKER:        “My phone has been ringing off the hook with people interested buying in low priced houses, but the buyers can’t get FHA financing because the properties need work.”   

BUYER:            “If you could get a handyman special for $20,000 down or a brand new house for $4,000 down and $60/month more which would you choose?”

BROKER:        “Exactly!”

INVESTMENT TAKEAWAYS:  Most people don’t buy on price; they buy on payment!   The ability for a customer to buy on payment increases the price a customer is able to pay.   Easy and cheap financing is one of the main reasons why real estate prices went up so fast in the last cycle and tight financing is the main reason why prices subsequently came down so fast.  More people currently want to buy real estate than can get financing. This is creating a pent up supply of buyers (and tenants).  As financing starts to loosen (the US Government is trying everything possible to help this) there will be a flood of buyers into the market.  The question is whether there will be enough buyers to consume the pent up inventory, and that is a very marketplace specific question.   If you are a professional ‘fixer upper’ investor and you can purchase with all cash, there is definitely an opportunity to make a home FHA ready and resell it for a fast profit.  The trap here is experience and hassle!!!  There is usually a fairly small profit margin in fixer uppers, and if you don’t have the right team and experience you’ll eat up your entire profit margin in unexpected repairs and transaction costs.  

In most of the US, the housing market has turned positive and is slowly appreciating!  The macro data will be slow to show this because the published data is usually 3-6 months old before you read about it.   If you would like to talk with a real estate professional about what is happening in today’s investment real estate market, please give me a call!  You can schedule a phone appointment with me by using my online calendar:

David Campbell
Real Estate Investing Strategist
Office: (866) 931-9149 Ext. 1

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3 Responses to Understanding this financing loophole can make you a lot of money…

  1. Great article. We see this here in the Hilton Head real estate market as well. We have some older homes that could use/really need to be fixed up. Many buyers are interested in a fix n’ flip however few take the time to really run the numbers in detail…as you say it comes to experience. The guys that are set up to move quick, get the work done right by an establish set of subs or employees and have a network of agents and buyers can do very well.

  2. Chuck Barnes says:

    Great post, I operate on the Gulf Coast in both a resort market and an in-town residential market and we are starting to see a smidge of appreciation… The foreclosures have continued to decrease and we are starting to wonder how much pent up bank inventory there really is. The resort market just might start to recover more quickly than the in-town residential market just due to higher demand.

    Also I posted a recent article that may interest you regarding the recent Fiscal Cliff Bill and the Real Estate Provisions that are involved, here is the link:

  3. This scenario is playing out all over the country. Unfortunately in many cases there isnt that home next door, at least here in Florida. Inventory levels are drastically low and the buyers only have the distressed home to consider.
    However, like you, I am in the business of educating. Another scenario for that buyer would be FHA 203(k) financing, purchase and renovate, buy the distressed home for $95,000 and and include $20,000 in renovation money, at rates under 4% fixed for 30 years (in most cases).
    And, I have not found a conventional loan that would permit purchase of a home with a bad roof either, so I am guessing the 20% down scenario above at 7.5% was a private lender. A conventional renovation loan would also work, as low as 5% down owner occupied 20% down investor, rates high 3 low 4%…

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