Home Inspections: Avoiding the Money Pit

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picture of a money pit

Real estate prices increase over time. Look at this chart below of the Case-Schiller Index. Wow, that’s beautiful馃樆

case schiller home prices

Sure, there may be short term dips in prices, but if you simply buy property and hold it, the property will appreciate in value (and hopefully outpace inflation). This is why real estate is the most popular and biggest asset class in the world.

You can buy a home, even an overpriced home, but over time, that extra 10-20K won’t really matter.

The only thing we’re aware of that can actually seriously hurt your real estate investment is by buying a lemon. Buying a home that ends up being full of problems. A money pit.

Don’t buy a money pit!

De-Risking your Investment

From a purely financial perspective, a mortgage is a great leveraged instrument. You can buy a home using 20x leverage!

By putting down 5% (or less), you are using leverage, the bank’s money, to buy real estate.

  • 5K will buy you a 100K house.
  • 5k x 20 = 100.

To maximize leverage, you want to spend as little money as possible and then simply hang on for the ride as your property value and home equity increase over time.

But what if you find out that the home needs 10, 15 or even $20,000 worth of repairs?! Now, instead of 20X leverage, you only have 4X leverage.

  • 5K downpayment + 20K repairs = 25K.
  • 25K x 4 = 100K

Even if you get the seller to reduce the price by the cost of the repairs, you’re still using far less leverage to buy the home since you will have to spend money to fix it.

This is why it’s so important to get a home inspection.

the real estate money pit

Avoid the Money Pit

Ok, the term money pit has a strange origin. Let’s unpack what it actually means as it pertains to real estate.

Real estate is illiquid, meaning that it hard to get cash out. It’s easy to put money in, but not so easy to get money out of real estate. Part of it will remain trapped in your home so to speak.

Even if you do a cash out refinance or take out a home equity line of credit. Most lenders will require you to keep at least 10-20% of your money in the home.

When you make your mortgage payments on your home loan, part of the money goes towards paying your interest rate, and the other part goes towards paying down your principal balance/loan amount. This builds up your home equity.

Your equity is the percentage of the home you own. Back to the previous example, you may have 25K in equity on a 100K home after paying your mortgage for several years.

illiquidity in real estate
Credit: baona

The Illiquidity of Real Estate

Put it like this. You basically won’t be able to access the majority of the money that you put into your home for a long time. At least until you have 20% equity in your home, which could take awhile given that most of your mortgage payment will go towards paying interest in the first few years.

Therefore, you want to make sure you put in the least amount of money upfront to make sure that you always remain liquid. You always have access to your money.

Full circle – A home inspection covers your ass!

It makes sure that your home doesn’t have major problems that will make you dump a bunch of money into into it: The foundation, roof, HVAC, electrical, plumbing, and structure of the home.

illustration of home inspection
credit fix.com

Unless you’re buying in a high cost area like NYC or the Bay area where you may have to buy a fixer upper just to get in the game, you should run (don’t walk) away from a home that has any of the aforementioned issues.

Preserve your leverage.

You may fix the home up but you may never see that money again for another 5-10 years. Oh, and did we mention that the bank will charge you money…just to…access your own money!

Want a cash out refinance? Sure, just pay for a credit check, appraisal, and a bunch of closing costs as well.

We are loan officers and realtors so we understand that nothing in life is free, but we’re also consumers so we’re a bit annoyed as well.

Bottom line, why get a home inspection? To avoid the money pit!