As the real estate market begins to cool down after an intense first half of 2017, here are a few points to consider when it comes to purchasing a home with inflated purchase prices.
Mortgage Lending
Lenders will only fund mortgages based on the purchase price or value of the home, whichever is lower. That being said, here’s how it works.
You see a home listed at the reasonable price of $299,900. This home checks all the boxes on the list of ‘must haves’. Convinced this is the home for you, you decide to put in an offer of $305,000 which is within your budget and the amount you were pre-approved for by your mortgage broker. You receive a call from your Realtor explaining that there is another offer on the table and they ask if you want to change your offer. You are determined to purchase this home so you increase your offer to $310,000 – still within your pre-approved amount but is stretching your budget a bit. You wait to hear back. You wait some more. The phone rings – it’s your Realtor – the seller has accepted your offer! Congratulations! Time to celebrate!
Your broker gets the ball rolling with financing and the first item the lender requires an appraisal on the property which your mortgage broker requests on your behalf. A few days go by and you receive a phone call from your mortgage broker. Not good, really not good. The appraisal of the property has come in low – considerably lower than anticipated, at a value of $285,000. Oh no.
To reiterate, the lender will only lend on the value of the home, in this case, the amount of $285,000. You are left with the decision to make up the difference between the purchase price and value of the home or walk away from the deal. Its a $25,000 difference – which is probably a lot more than your anticipated 5% down payment of $15,500. To purchase the home you’ve pictured yourself moving into, it’s now going to cost you more. You are required to come up with a total of $39,250 (the difference of $25,000 plus your 5% down payment of the appraised value, being $14,250) and an additional $4,275 in closing costs by the closing date, making for a grand total of $43,525.
Regardless of having those funds in a savings account or not, it will be a scramble to get the appropriate paperwork required and get the funds as a gift from an immediate family member, if needed.
Equity
Another factor you may want to consider if you are purchasing a home with an inflated purchase price is the equity in your home. If you purchase a home for an inflated price you run the risk that the other homes in your neighbourhood won’t sell at inflated prices leaving the value of your home the same as when the appraisal was initially done.
This leaves you at a disadvantage with your investment. You may be paying your mortgage, which increases the equity in your home, but because of the inflated purchase price it may take you longer to get to reach your financial goals with your investment. Your idea of a 5-year home may become a 10-year home pretty quickly.
Risk
In a heated real estate market, the competition can be fierce. Buyers are putting in offers with little or no conditions – the two biggest conditions being financing and home inspection.
These buyers run the risk of not being able to obtain financing, or potentially purchasing a ‘lemon’ of a home. This leaves them unable to walk away from the purchase without penalty, should they need to. They risk the loss of their deposit (which, at closing, is used towards the down payment of the home) and in rare circumstances, any potential legal consequences that may arise from backing out of a legal commitment.
If I can offer any advice, do your own due diligence before your purchase. Research the area to ensure the purchase price is reflective of the value of the home; use the judgement of your valued Realtor; have a trusted home inspector in to give you an honest opinion on the condition of your home; do whatever it takes to ensure you will be happy with your purchase.
My biggest fear as a mortgage broker is that my clients have any buyer’s remorse when it comes to making, what is most likely, the biggest purchase of their lives. I want them to enjoy the process of purchasing and moving into a new home.
Like any large purchase, beware of what you’re getting into to avoid future disappointment!