Why you shouldn’t buy a house in a declining market
November 19th, 2006 by KenricI really want to move from my current residence on the westside of Phoenix over to Scottsdale. I drive 37 miles to go play basketball on Wednesdays, 34 miles to play softball of Fridays and 52 miles to play Hold’em at the casino on Sundays. These are one way distances! I want to move closer to where I go do stuff!
However, I can’t find a good reason to buy a home in Scottsdale! I know it sounds crazy, but I just can’t justify purchasing a home there. In fact, I don’t think that this is limited to Scottsdale, AZ, but in any market where rents are well below the mortgage needed to purchase the same house.
Scottsdale is currently a declining market. I can rent a decent home in a good neighborhood for $1500/mo. I can buy that same home for $400,000. Alot of homes for sale are also available as rent-to-own or lease options. I can’t figure out why anyone would buy a home if there is an a lease option available.
Let’s say I buy a $400,000 home. I get a 100% loan at 7.5% and assume that HOA is $50/mo, Insurance is $50/mo and taxes are $200/mo. My monthly payment would be $3100/mo.
My other option would be to lease option this house at $400,000. In this scenario I’d probably pay a small option price of $5,000 and rent it for $1500/mo. I would try to negotiate some sort of rent credit as a bonus.
So let’s see how the lease option would pan out. The most obvious difference is that I am living in the same home for $1500/mo vs. $3100/mo. I am saving $1,600 a month! I also have less repair responsibilities than if I had purchased the house with regards to repairs. Most lease options have a repair price limit so that it’s the owner’s responsibility to pay for the large repair bills such as roof, AC, furnace, etc…
What happens if the market continues to decline? In two years, if my house is worth $350,000 it’s pretty obvious the lease option was a much better option than buying. Did I lose $50,000 in equity? No. I can just choose not to exercise the option and move to a different house. You can say that I lost my $5,000 option, but I see it as saving me $45,000. I also saved $1,600 a month for 24 months.
What happens if the market goes up? What if my house is worth $450,000? Great, I win again. I controlled this property for $5,000 and $1,500 a month, vs. paying $3,100/mo.
What happens if the market stays the same? The lease option would come out ahead too.
Here is the main difference between lease options from two years ago and today. Two years ago, people were inflating the option price based on projected appreciation. In the hot market, the option price of a $400,000 house would be $450,000. This made lease options a horrible deal for the tenant buyer because if the market did not go up to $450,000, the tenant buyer lost his option price and rent credit.
In today’s market, sellers are pricing lease options at today’s selling price. So the lease option works the opposite way now. It’s better for the tenant buyer. It protects the tenant buyer against a declining market. You get to lock in today’s price for a few thousand dollars, live in the house for cheaper and then decide if you want to buy it based on the market price in two years!
So my question is, why are people buying houses that also offer lease options? Can someone tell me?
Posted in Real Estate | 3 Comments »
Stumble it!
Why would you want to lock in “today’s price” in a declining market? There is no reason to either buy the house or to lease/option it. The best option all around would be to rent it.
Once a market starts falling, it takes years to reach the bottom. You will see a lot of false bottoms and “dead cat” bounces but the real bottom is years away.
By UBU50 on Nov 20, 2006
UBU, the reason I personally would do a lease option is because I want control of the property that I’m living in. I want the sole option of buying the house at a later time.
If I could time the market perfectly, I’d just rent and rent until the bottom and then lease option a home at that time. But I can’t time it perfectly, so how would I know when to lock in my price? One the market starts going up its too late to lease option, lease options will not be priced at market anymore.
By Ken on Nov 20, 2006
Sounds like a good deal! Best of both worlds.
People who want to buy either aren’t aware of these options or have been brainwashed that rent is throwing money away or think the market can’t go down…. Or just don’t think.
By moom on Nov 20, 2006