Can Appreciation Bail You Out of a House Purchase You Can't Afford?

November 6, 2006, February 22, 2007

"I have been offered a tremendous deal…A house that appraises at $364,000 that I can buy for $294,000, with 100% financing and the builder will pay all my closing costs…I can afford the payment for only 6 months, it will take all my savings, but the broker says that I will be able to do a cash-out refinance in 6 months based on the appraisal and net about $60,000, which will cover the payment for another two years…"

You need a reality check. If the builder could sell the unit for $364,000, he would not be offering it to you for $294,000. Appraisals done for builders usually produce the numbers the builders want. That this particular builder, in addition to offering the "bargain" price, is also willing to pay your settlement costs, is a reflection not of his generosity but of his desperation to sell the house.

Further, the probability that you will be able to do a cash-out refinance in 6 months is vanishingly small. Lenders won’t do a cash-out refinance in excess of your equity in the house. Since the true value of your house when you close is no more than $294,000, and your mortgages add to the same amount, you will have no equity. Payments of principal over the first 6 months will amount to about $1,000. The other $59,000 of equity you are looking for would require price appreciation of 20% over 6 months. That conceivably could happen in a go-go market, but the go-go markets are all gone.

What is distressing about your story is the willingness of the builder and broker to take advantage of your inexperience and naiveté. They rid themselves of what to them is a minor business problem by leading you into financial disaster. Don’t fall for it.

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