In today’s fast-paced seller’s market, it’s not uncommon for prospective buyers to find themselves in a bidding war over a house. And while it may appear an innocent move (after all, the lucky bidder gets the house!) there can be dangerous downstream affects.
For example, the Petrees are in a bidding war for the house they really want and are willing to give the seller his inflated selling price of $195,000 (market value is more like $189,000) plus cave in to his demands to pick up $500 of his closing costs.
It’s obvious that they’ve thrown money away in the $500, but that’s just the tip of the iceberg. By overpaying for the house, it costs them more money for the down payment on the mortgage, more in closing costs (since many mortgage costs are based on a percentage of the mortgage), not to mention thousands of dollars more in interest over the years due to the larger mortgage. All toll, overpaying for the house could cost the Petrees an additional $10,000 if they own the house for ten years.
But there’s more. Because they purchased at an inflated price, their equity buildup is off to a slow start. And if they’re forced to sell before the house can realize some significant appreciation, they may have to bring money to closing—all brought about by overpaying for the house.
If you’re tempted to pay a premium price, it’s good to keep in mind my favorite home buying adage, “You don’t make money in real estate when you sell, you make money when you buy!” Sins like overpaying, over-leveraging, and overspending on closing costs will come back to haunt you later in low equity coupled with fewer selling and repurchasing options.
What can you do if you’re compelled to overpay for a house? There are two potential antidotes: 1) Know why you’re overpaying; and 2) Make sure the overpayment factors into your game plan based on how long you’ll keep the house. If you know you’ll have to pay more upfront (due to competing buyers, etc.) but have a game plan to quickly recoup your losses, overpaying for your home could make sense.
Say you’ve overpaid for a property that has several extra acres that can be divided off and sold at a substantial gain. In fact, you believe the acreage sale could fund an entire remodel for your home. It’s probably a good case of overpaying (provided you’ve gathered the proper planning and zoning research information upfront.) Overpaying for a property should not be isolated from other facts of the purchase. For example, overpaying for a house in a stable, appreciating neighborhood may not be as dire as spending too much on a house in a deteriorating subdivision or on the edge of a warehouse district.
Buyer emotions, stiff competition from other buyers—even feelings of losing out on the home you want challenge buyers to overpay. Keep a cool head, have a buying game plan (and stick to it) and make money when you purchase the house.
That’s where the extra profit is found.
Written by Julie Garton-Good