Paying Over Asking Price For a House: Good or Bad Idea?

[00:00:00] Eric Brotman: This is Eric Brotman, the host of Don’t Retire… Graduate!: The podcast that teaches you how to advance into retirement rather than retreating. Welcome to Office Hours where we answer listeners’ questions about personal finance, retirement readiness, and more. We received a question from Matthew who asked, is it better to pay over the asking price for a house or to just rent?

Uh, and Matthew, that’s a terrific question. And one that a lot of people are grappling with right now. Um, the combination of soaring home prices and now increased, uh, interest rates have created a confluence, particularly for first-time buyers, that has become very, very difficult. So if you’re a renter currently, and you’re looking to buy your first home, we’ve had a ten-year period where that’s been really doable and now the pendulum is starting to swing against first time buyers a little bit, partly because of pricing and partly because of the cost of funds.

So I think in each case you have to look at number one, how much over asking are you really talking about? And number two, what is your down payment readiness? Because when you finance a home, you can only borrow money based on a percentage of the fair market value or the appraisal. You can’t borrow based upon the purchase price.

So that means if you’re, for example, buying a home, it appraises for $300,000 and you’re going to put down a 20% down payment, well that’s $60,000 of the 300. The problem is if you wind up offering more than the 300,000, and let’s say you offer 350,000, hypothetically, the 50,000 over asking cannot be mortgaged because it’s, there’s no equity to support it, therefore there’s no collateral.

So you would have to actually pay the over ask amount and then still put down 20%. So your down payment amount goes up dollar for dollar based upon the over ask. So if you’re buying a home for $5,000 more than it appraises, that might not be the end of the world, but if it’s 30 or 40 or 50 or a hundred thousand dollars more, uh, number one, I’m not sure you’re getting a good deal because who knows whether that house is ever gonna be worth what you’re paying for it, but just as importantly, you’re going to have to come up with an awful lot of money out of pocket upfront. And it’s not going to be on your balance sheet. It’s not going to build equity because the house isn’t worth what you paid for it. So, Matthew, I know you’re struggling with this, with this topic and rents are going up around the country too.

So there’s no panacea here. The cost of living has definitely gone up with inflation and with higher interest rates. And I don’t see that stopping anytime soon, actually. So if you already own a home and you’re looking to move, you might be able to sell your current home for a little bit more than it’s worth, and that can offset the cost of the next home.

But if you’re contemplating either continuing to rent or buying a first home, this is suddenly not a very good time to do that. Uh, now interest rates have been at unbelievable lows for a very long time. Right now, I think we’re at a 12 or 13 year high in interest rates. And historically they’re still low.

So if you can get a mortgage at five or five and a half percent, that’s still historically a spectacular deal. The problem is we all got very spoiled by two and an eighth or two and seven eighths or three and a half percent, which is almost free, it’s embarrassingly low. And so all of a sudden we’ve reset our own compass in terms of what a good interest rate is.

Five or five and a half percent is a terrific interest rate if you look back at the last 50 years. It’s a lousy interest rate if you look at the last 10. So I know I haven’t fully answered your question. There are pros and cons to renting, and there are pros and cons to buying a home. But when you overpay for a home, you put yourself a little bit over the barrel.

Not only because you need to come up with the extra down payment, but because you might not be able to afford to sell it. So what happens when you go to sell a home? Let’s say you, in that same example, you buy a house that’s worth $300,000. You pay $350,000 for it. You owe at that point because you made the down payment of the 50,000 overage and the 60,000, which is the 20% of the appraisal.

So you owe 240 on it. Let’s say for some reason the market reduces values of homes in various areas. And we’ve seen this before where housing prices drop certainly in 2008 and nine that that happened. And if it happens again, let’s say the house is now only worth 250. The problem is even though you only owe $240,000 on it, by the time you pay closing costs on the sale, you would actually have to come to the table, to the settlement, to sell your house with a check.

You would not only not get something for the sale, you would have to pay money to sell the house. And that is a perfect storm for, for folks that is not, not pretty. So if you are in a position where you have an ample down payment and the overage is not a big deal, then I don’t think you should let that stop you.

But if you’re looking at a significant pinch in terms of the amount you have to come up with, or if it means that you’re really going to be spending every last dollar and you’re not going to have other monies for other things you need to do, I would avoid it because remember when you buy a house you’re, you’re not just moving in and it’s ready to go. You’re moving in and then you have to not only furnish it, but you have to appoint it, you have to fix things. You’re going to replace some stuff. And you’re going to spend a lot of money when you get in the door. So it’s not enough in my opinion, to save a down payment and move anyway. Forget the overage. If all you’ve saved is the down payment and then you move in and you suddenly need a washer and dryer, you have a problem.

And if you’re going to be that close to the vest, you really shouldn’t buy a home. And I know that can be an unpopular thing to be told, but it’s in your best interest not to it. Because buying a house as much as people like to talk about real estate as an investment, and it can be, your personal residence is not an investment.

It’s a cost center. And while it’s possible that you could sell your primary home for more than you paid for it and historically we’ve seen that happen, that’s not why you buy one. You buy one to put down roots and to have your nest. And there’s lots of psychological reasons for it. But, you know, we’re even seeing seniors, Matthew, who, who can’t stay in their homes even though they have no mortgage because the real estate taxes have gone up so much and the cost to insure them.

So I don’t think it’s for everyone. If you’re close enough to the vest that this could be harmful to you, I would urge you to continue to rent, continue to build a down payment, and to maybe wait until the market’s a little cooler before you make that purchase. And I recognize fully that that could mean you’re getting a better price for the house, but you’re paying six or seven or 8% on it instead of five. Interest rates aren’t permanent. So if you have to finance a home at 7%, when rates eventually do get back to five, you can refinance it. On the other hand, once you’ve overpaid for a house and you’ve paid more than it’s worth, that money is gone. So I hope this has shed some light on the topic for you. It’s not an easy question, but it was a great question and I thank you for sending it to us.

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