Barry Choi: Real Estate Mistakes to Avoid

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The landscape has changed and you need to be aware when making decisions

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With inflation at record highs, the Bank of Canada has hiked interest rates much faster than many expected.

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Now that the cost of borrowing has increased, sales and prices in the real estate market are rising more slowly, and in some cases falling. This type of market condition hasn’t existed in Canada for years, and some people are caught making huge financial mistakes.

No consideration of market changes prior to sale

In a hot real estate market, homeowners looking for an upgrade would typically buy a new home before listing their current one. Because homes in desirable areas would sell quickly, most homeowners would be confident that they could unload their homes at the price they needed before their new home closed.

Given the current market conditions, buyers have become cautious. Soliciting multiple bids rather than asking is not as common and the sale may take longer. This poses a major problem for sellers who need the proceeds from the sale of their current home to finance their new one.

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Unfortunately there is no easy solution. Waiting is unlikely to make things better as markets will not turn overnight. Also, you have a deadline as you have to finish the house you have agreed to buy.

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You could simply accept the highest bid and try to find a way to make up the difference. For example, you could see if an alternative lender is willing to lend you more money. If you go this route, you would likely have to pay a higher interest rate because the lender is taking on more risk.

Alternatively, you could keep your new home deposit and walk away with the loss. However, this seller has the right to sue you for damages if they are unable to resell the house for the payment you agreed to. If the house sells for less than you offered, you could be legally hooked for the difference.

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To completely avoid this mess, you should include a financing term that gives you time to sell your current property at a set reserve price. Sellers may criticize this condition, but it is in your best interest to protect yourself as selling prices are no longer certain.

You will not receive a rating for your purchase price

Many lenders require an appraisal of the home you have purchased before approving the funds on your mortgage. Basically, estimates are based on current market values, not what you offered for the home.

In some situations, the appraiser may say that the property is not worth what you agreed to pay. Let’s say you paid $700,000 but the appraiser says your house is only worth $650,000. You would be missing $50,000 on your mortgage. Raising this sum is not an easy task.

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During a hot market, buyers often asked for another valuation. This might seem like a pointless exercise, but it wouldn’t be uncommon for new sales in the area to be higher than what you paid for. The new appraiser could then justify the price you paid, which could give you all the funds you need.

Given current market conditions, appraisers and lenders are likely to be more cautious. There is no guarantee that your review will be refunded at the price you paid. To minimize your risk, you should consider bidding well below what you were approved for. So if your lender says you qualify for a $1,000,000 home, consider bidding no more than $900,000 as that will give you a buffer to work with.

Pre-qualify for a mortgage instead of being pre-approved

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Almost every lender has an online calculator that you can use to estimate the mortgage you will be approved for. You can also use these calculators to adjust the interest rate to see how changes would affect your payments.

While this is a convenient and quick way to calculate affordability, it’s just a pre-qualification and essentially meaningless as you haven’t been approved for anything yet.

With a pre-approved mortgage, lenders officially fill out your numbers. They look at your income, credit score, debt load, and more to determine exactly how much they’re willing to lend you. They also share the interest rates they are willing to give you on fixed and variable rate mortgages. Because it is a formal approval process, lenders can hold the interest rate for 90 to 120 days. This way you can shop with confidence knowing you have the financing.

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Some people assume that pre-qualification is the same as pre-approval, but that’s just not the case. Pre-approval is basically a promise from the lender. The last thing you want is to buy a home and then find out you don’t have the financing. This could lead you to scramble to find an alternative lender.

Without taking into account higher interest rates

If you were looking to buy a home last year, it wasn’t uncommon to find a fixed-rate mortgage at around two percent. Let’s say you want to get a $700,000 closed-end mortgage with a five-year term and a 25-year amortization (payment) schedule. Your monthly payment would be $2,964.16.

In the meantime, however, interest rates for fixed-rate mortgages are around four percent. That would make your monthly payment $3,682.14. That’s more than a $700 difference. You could opt for an adjustable rate mortgage that changes depending on market conditions. At the moment you pay less interest than with a fixed-rate mortgage. However, if interest rates are expected to continue to rise, you may end up paying more than a fixed-rate mortgage in the long run.

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If you haven’t recently received a pre-approved mortgage or updated your budget, you may be shocked to see your monthly operating expenses at the higher rates. The amount you might have been able to afford a year ago might not be the case now. Because of this, many potential homeowners have become more cautious about bidding, leading to the current market slowdown.

While the real estate market will eventually sort itself out, it may be time to be cautious about all the money that’s at stake. That doesn’t mean you shouldn’t buy or sell property during this time, you just need to take a few extra steps to protect yourself from making a big financial mistake.

This article is informational only and should not be construed as advice. It is provided without any guarantee.

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