Play by Play: Second Time Buyers, and Why an ARM Worked for Them

We had just started looking for our second home, and we weren't even sure what we wanted yet. I wandered into a Sunday open house, just for fun. And fell in love.

- Lauren

It was 2005. Lauren and Andrew had two young children, and were starting to outgrow their three bedroom, one bath bungalow in downtown Columbia , South Carolina. They were working with the same Realtor that helped them find their first home, where they had lived for five years. Andrew's income had increased significantly, but he had only been in his new job for about a year, which they knew would make it difficult to get a lower mortgage rate. Funny how with mortgage lenders, your very good intention to make more and more money doesn't count for anything! 

Lauren and Andrew knew how much they wanted to pay each month, so they would have money left over to furnish a larger house and pay a baby sitter occasionally. They knew they didn't want to be house poor, so they had already decided to borrow less than the bank offered them. (This turned out to be a wise decision, given what happened to the housing market a few years later.)

One day, Lauren wandered into a Sunday open house, and fell in love. She wasn't alone. The house had just gone on the market, and it was for sale by owner (FSBO). It was filled with prospective buyers who weren't saying a word, fairly common when they don't want other people to get excited about the property. Lauren called her agent, Rob, as soon as she left, before she even called Andrew, who went and looked at the house later that day. Andrew agreed that it was perfect for their family.

Lauren and Rob worked on an offer. The house was listed for $500,000, and the current owners had paid just $399,900 six months earlier. The sellers had planned to live there forever, and made some high end improvements, but decided to move when one of them got an unexpected job offer elsewhere that was too good to turn down. The owners were cooperating with agents, so Lauren's agent would get his commission. Lauren and Rob went over the details, ran the numbers again and again, and decided the house just wasn't in the budget. Lauren called the owner as a courtesy, because she had told him she was interested, to let him know that she couldn't do it, and he should take another offer he had received seriously. Then she cried. And slept on it.

The next morning, she called her agent and the owner and asked for a couple more hours. She called the mortgage broker she had worked with on their first house and talked over some options. As it happened, he was able to get them a slightly lower rate, putting the house just within their reach.

Here's how he did it:

1. Both Lauren and Andrew had a great credit rating. Over the last five years, they had paid off a student loan, paid all of their bills on time, and avoided running up any more debt. Their income had been steady, and they hadn't taken out any new loans. Their open credit accounts had aged, too.
2. Their LTV (loan to value ratio) on their first home was better than expected. The value of that home had gone up more than they thought it would, so they would likely be able to put more money down on their second home.
3. They decided to go with a 5 year ARM. Otherwise known as an adjustable rate mortgage, this is not always a great idea. In Lauren and Andrew's case, it wasn't a huge risk. Once he was self-employed for two years, with similar income, the couple would be eligible to apply for a fixed rate mortgage, probably at a lower rate. The ARM also had a cap -- the maximum rate it could go up -- and the payment would be doable for them, even at that interest rate, even if Andrew's self employment didn't work and he had to go back to working for someone else.

Lauren called the seller and told him an offer was coming, and she called her Realtor and let him know she was ready. Are you wondering why Andrew wasn't involved?

I hate doing stuff like that. Lauren enjoys it, and I trust her. She also buys all my cars. I like when she does all the research, then lets me in on the final decision.

- Andrew

Lauren and Rob hammered out an offer. They would offer $450,000, well below asking, but reasonable considering what the owners had paid, even taking into account improvements they made. Rob assumed, probably correctly, that they were putting it out there at a high price just in case they could get it. Lauren's heart was pounding as Rob drove the offer over to the owner. Her phone rang.

Hey, it's Rob. I'm almost over there, but I want to make a recommendation. To make your offer better than the other one, I think you should offer to skip the home inspection.

Lauren balked, but Rob explained that since it had just been done six months earlier, by a company he knew and respected, he felt good about it. Without the recent inspection, it would have been too big of a risk. The home, nearly 100 years old with wood siding, would still be subject to a termite inspection. Lauren agreed, and her heart pounded louder.

Later that day, she still hadn't heard anything, and decided to drive by the house after picking up her kids from school. Then she almost didn't because, totally irrationally, she wondered if the owner would see her, get annoyed, and take the other offer. As she drove by, her phone rang.

"Okay," it was Rob and he sounded serious. "I heard back from the owner. You and Andrew need to have a serious talk about how much you really want this house. You need to think about how much it's worth to you."

Lauren agreed and hung up, wanting to call Andrew and talk it out right that second. Her phone rang again.

"Hello?"

"Aren't you even going to ask what the counter offer was?" This time Rob sounded less serious. In fact, he was laughing. "They're accepting your offer, with one caveat: They want to hold the earnest money." Then he laughed harder. He was enjoying this.

Lauren was mad for a second, but she got over it. Why? Well, Rob is actually her dad, and her family messes with each other all the time, just to be funny. Also, she knew part of the reason they had been able to work out a deal was that he had no intention of taking any commission, and the owner knew that. She also knew they had gotten great advice, right down to the last minute decision to forgo the home inspection. The owner wanted a quick sale, and that made their offer a lot more attractive.

And the story gets even better: When Lauren and Andrew were first time buyers in 2000, they paid $134,000 for their bungalow on a large lot in a great neighborhood. In 2005, it sold in two days, in a bidding war. They listed it for $199,000, and ultimately got $210,000. So they were able to put a little extra into a down payment on their second home, lowering the monthly payment even more. Several years later, before the end of the five-year initial rate period, mortgage rates were looking good and Andrew's income had been consistent, so they refinanced to a 15 year, fixed rate mortgage. By the time 2008 rolled around, and the housing market crashed, they were in good shape, with a solid amount of equity.

In 2016, the home value is about what they paid for it. Though they took a risk in getting a 5-year arm, they mitigated that risk by being reasonably sure they'd be able to cover the mortgage no matter what happened, and by not over extending their budget. They also knew they'd most likely be in the house for a long time. (In fact, they're still there, and have since added another child. They still have plenty of room.) Life is full of calculated risk, and real estate is no exception!

Do you have a real estate story to share? This one worked out well, but we want to know when it didn't go so well, too. Did you sell to someone then have the offer fall through when they weren't approved for financing? Did you buy a FSBO and have a nightmare time negotiating? We want to know!

^* Names and identifying details have been changed.