Archive for February, 2011

Before you make your first offer as a real estate investor, it would help to become familiar with the language of real estate. Forthwith, here are some terms that are important for you to know.
Adjustable Rate Mortgage (ARM) : The interest rate of the mortgage is tied to a financial index, and the monthly payment can go up or down over time with the index.

APR: Annual percentage rate (interest plus fees you‘ll be charged, expressed as an annual percentage).

Appraisal: A report made by a qualified person setting forth an opinion or estimate of property value.

Balloon Payment: A large payment due at maturity on a long-term mortgage.

Closing: The final meeting, usually with your real estate agent, sellers and a closing agent or attorney where you sign the necessary paperwork, make the monetary transaction and take possession of the house immediately, or in a designated time period shortly thereafter.

Closing Costs: The fees associated with processing the paperwork necessary to complete the real estate transaction.

Comparables: Homes with similar square footage that recently sold in the area.

Contingencies: Conditions which must be met for the purchase contract to be executed.

Counteroffer: The counteroffer is the seller‘s response to a buyer‘s offer.

Credit Report: A document completed by a credit-reporting agency providing information about the buyer‘s credit cards, previous mortgage history, bank loans and public records dealing with financial matters.

Debt to Income Ratio: Compares the amount of monthly income to the amount the borrower will owe each month in house payment (PITI) plus other debts. The other debts may include but not limited to car payment, credit cards, alimony, child support, and personal loans. This ratio is commonly used to see if the borrower has the capacity to repay the debt.

Deed of Trust: A legal document that conveys title to real estate to a disinterested third party (trustee) who holds the title until the owner of the property has repaid the debt. In states where it is used, a Deed of Trust accomplishes essentially the same purpose as a Mortgage (Washington is a Deed of Trust state).

Down Payment: A percentage of the cost of the home that is paid upfront.

Earnest Money: The deposit you make on the home when you submit the offer. This money is intended to show the seller that you are serious about wanting to purchase the property. Earnest money goes into an escrow account, and if the offer is accepted, the earnest money amount will be applied to either the down payment or closing costs. If the offer is not accepted, the buyer will get the money back.

Escrow: An account where money is held, either for earnest money or by the lender for fees due for taxes or insurance.

Equity: The difference in what you owe on the home and its fair market value.

FHA: Mortgages that are extended by private lenders, but insured by the Federal Housing Administration, often requiring a significantly lower down payment and lower incomes to qualify.

Fixed Rate: The interest rate stays the same for the mortgage term.

Foreclosure: The legal process by which an owner‘s right to a property is terminated, usually due to default. Typically involves a forced sale of the property at public auction, with the proceeds being applied to the mortgage debt.

Hybrid Mortgage: A loan that starts with a fixed rate period and then converts to an adjustable rate.

HUD: U.S. Department of Housing & Urban Development

Interest: The payment you make to the lender as a percentage of the money you borrow.

Interest-Only: A loan in which the borrower pays only the interest on the principal balance for a set period. Mortgage: The written instrument used to pledge a title to real estate as security for repayment of a Promissory Note.

Mortgage Insurance: Insurance written in connection with a mortgage loan that indemnifies the lender in the event of borrower default. In connection with conventional loan transactions, this insurance is commonly referred to as Private Mortgage Insurance
(PMI).

Mortgage (Promissory) Note: A written promise to pay a sum of money at a stated interest rate during a specified term. It is typically secured by a mortgage. Net Income: The difference between effective gross income and expense including taxes and insurance. The term is qualified as net income before depreciation and debt.

PMI: Private Mortgage Insurance.

Pre-Approval: A process in which a customer provides appropriate information on income, debts and assets that will be used to make a credit only loan decision. The customer typically has not identified a property to be purchased, however, a specific sales price and loan amount are used to make a loan decision.

Pre-Qualification: A process designed to assist a customer in determining a sales price, loan amount and PITI payment for which they are qualified. A prequalification is not considered a loan approval. A customer would provide basic inf ormation (income,

debts, assets) to be used to determine the maximum sales price s/he could offer. 

Principal: The amount of your loan that you actually borrow.

REO: Real estate (bank-) owned properties. Short Sale: When the seller‘s lender accepts less than the amount owed to release the mortgage in a sales transaction.

Title: The evidence to the right to or ownership in property. In the case of real estate, the documentary evidence of ownership is the title deed, which specifies in whom the legal state is vested and the history of ownership and transfers. Title may be acquired through purchase, inheritance, devise, gift or through the foreclosure of a mortgage.

Underwriting: The process of evaluating a loan application to determine the risk involved for the lender.  It involves an analysis of the borrower‘s creditworthiness and the quality of the property itself.

VA Loan: Loans administered by the Department of Veteran Affairs for Americans who have served in the armed forces.

About the author: Wendy Ceccherelli is the volunteer membership coordinator for REAPS.  She has been a fulltime real estate investor for the past five years and is the designated real estate broker for Home Land Investment Properties, Inc.  Prior to her career in real estate, she spent twenty-five years as a government arts funder.  I welcome your feedback. More information on a variety of real estate topics may be found at www.HomeLandSeattle.com.  I can be reached at [email protected]

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Gone are the days of overpaying for a property only to see it appreciate and realize a profit at closing thirty days later.  Nowadays, overpaying can mean cutting your profits by thousands…  sometimes without even knowing it!  What is an escalation clause? In short, an escalation clause is an addendum to an offer to purchase a property. It gives permission to increase your offer to an amount you specify in increments you also set forth in the event another offer exceeds yours.  In the current recession, you can harness the strategy behind escalation clauses to increase your profits, while helping to keep from overpaying for a property.

Here‘s an example:

A house priced at $360,000 suddenly drops to $300,000. After seeing the house, you decide it‘s a deal and begin writing up an offer. Persons B and C are also writing up offers. All persons know there will be multiple offers. All offers will be reviewed together. Sound familiar?

So… how much should you offer?
This situation is actually a common-value auction. Here, each person can only estimate the true value of the house; all they know is their own valuation of the property. If each person knew exactly how much the house was really worth, no one would offer any more than that amount, and a multiple-offer situation would never occur in real estate.

Let‘s say individual valuations are as follows:
YOU (Person A): $340,000
Person B: $310,000
Person C: $325,000

If each person makes an offer equal to what they believe the house is worth, you would end up overpaying by $15,000. Instead, you can avoid the ?winner‘s curse? by asking a fundamental question:  If no other offer will be higher than mine, how much should I offer if I think this house is worth $340,000?

It is advantageous for you to “shade” your offer to avoid overpaying. Since you can never know how much B and C value this house, you must assume you value the house the most. If you don‘t, you are likely to overpay.  You can always write up an offer for $300,000. After all, an offer like that would be immediately rejected by the seller, and it is far below what you think the house is worth.  To “shade” by this much is not necessary, especially if you believe Persons B and C value the property over asking price.

By using an escalation clause in your offer, you can offer $300,000 and automatically raise your offer by specified increments (let‘s say $1,000) until you reach your valuation of $340,000.  This ensures you do not overpay.  In this scenario, you would actually have bought the house for $326,000, thereby making $14,000! You won, and you won big.

You‘re probably wondering, “Sure, but what if someone else ends up offering more?  I‘ll lose the deal!”  That will happen… a lot.  In fact, it is not likely that you will have the highest valuation. More often than not, your offer will not be accepted in a multiple offer scenario. But remember, your valuation is the maximum amount you should be willing to pay.  Convincing yourself to pay more than your valuation means you may win the deal, but you will end up paying the very most to get it. Not a great feeling is it?
Not all real estate deals involve multiple offers, but by using escalation clauses to “shade” your offers and keep you from overpaying for a property is a great strategy when faced with such a scenario.

Happy strategic investing!

Elsie Huxtable is a Partner with Pacific Investment Partners in Seattle. PIP purchases fixer houses, assignments, and other debt instruments in King and Snohomish counties.  She is also a Realtor with Keller Williams, exclusively representing investors in strategic buying and aggressively selling their rehab projects. To learn more, visit www.pip-seattle.com.

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