If you want to fix and flip houses, it’s very important for you to know who your buyer is. Your buyer is the the person you are flipping the house to. And in many cases, this will be a first time home buyer.
If you are buying a house, fixing it and flipping it to a first time home buyer, then it’s very important for you to understand that buyer, because they are essentially your customer (the person you are selling the house to).
A first time home buyer is typically a millennial, and they are more likely than not to be using an FHA Mortgage. First time home buyers need to get “pre-approved” by a mortgage broker who reviews their income, their debt and their expenses. The mortgage broker issues a pre approval letter which shows the maximum amount that they can afford to spend on a house. This is the maximum amount that a mortgage company is willing to lend them.
Another key thing to understand is FHA loan limits. For example currently in Palm Beach County Florida, the FHA loan limit is $557,000. So FHA would be willing to loan up to that amount. But would a buyer qualify? The answer for most first time home buyers is a definite no.
The Median Household Income in Florida for a single wage earner family is $60,429. Most mortgage lenders have a maximum allowable ratio of mortgage to debt of 28%. This means that the average one wage earner family in Florida can afford to spend no more than 28% of their gross income on a mortgage payment. This works out to be $16,920 per year or $1,410 per month.
Mortgage lenders also look at the Debt to Income Ratio or DTI. They want to make sure that after they add up all of your expenses (including the potential mortgage) that your payment does not exceed 36% of your gross income. This means that even if you had no car payment and no credit card debt, you would only be able to afford a maximum mortgage payment of $21,754. This works out to be $1,812 per month. Remember that this maximum amount for the mortgage payment must INCLUDE property taxes, insurance and any PMI and HOA fees.
When you understand this, you can reverse engineer current mortgage rates, to see what the maximum amount of a home that that borrower could afford would be. And that is where there is a major issue. Since rates have increased from 3% to over 8% it has created a serious situation for borrowers.
Let’s say that the borrower wanted to be approved for a $300,000 loan. At today’s FHA rate of 8.5%, a $300,000 loan would work out to a monthly mortgage payment of $2,307.
Add to that monthly payment a 2% property tax of $5,000 per year ($416 per month), PMI of 1% per year ($250 per month) and insurance of $4,000 per year ($333 per month), and the total mortgage payment ends up being $3,306.
However in order to afford that $300,000 mortgage, the borrower would need to have a gross income of $9,183 a month ($110,000) a year. So at current interest rates, the borrower would have to find a more affordable home since he cannot afford that payment. The problem is that there are no more affordable homes.
A quick search of www.realtor.com shows just 14 listings for 3 bedroom 2 bathroom homes under $300,000 in Palm Beach County. And all 14 homes are not in very good neighborhoods. So the dilemma facing that first time home buyer is that not only can they not find a home they would be approved to buy (based on their income) but there are no homes that they would even want to buy in that price range.
This creates an issue where the potential buyer has to either keep renting, or be willing to move to a more affordable market.
How affordable? Well remember we spoke about the single wage earner household where the wage earner earned $60,429?
That individual, even with zero debt could only afford to pay $2,307 per month. That is an “all in” amount including property taxes, insurance, PMI and HOA.
What would the price need to be in order for them to be approved at prevailing rates? The answer will shock you!
A 200,000 loan at 8.5% will be a monthly payment of $1,538
Assume $3,000 per year ($250 per month) in property taxes, $3,000 per year in insurance ($250 per month), and $2,000 per year in PMI ($166 per month) and a home in a community with no HOA fees.
The total for that mortgage payment is $2,204. That’s what he can afford. The problem is that there are no houses in that price range. So the borrower would have to keep renting, or they would have to move to a more affordable area.
What would payments be on that $300,000 house if interest rates were 3% and not 8.5%. The answer is the monthly payment would be $2,264 instead of $3,306. That’s $1,042 a month less!
And the income required to qualify for that mortgage is only $75,000 versus $110,000 at 8.5%
Either prices have to come down, or interest rates have to come down.
For now, it’s cheaper to rent than it is to buy. There are many people looking to rent, which means It’s a great time to own rental properties!
Learn how you can start fixing & flipping houses or how to find your first rental property at my Fixing & Flipping Houses Boot Camp!