Traditionally in real estate, when sellers put their home on the market, they can consider many buyers and sell to whomever they want. But when an option contract is introduced to the mix, that all changes—the buyer gets the exclusive right to buy the property but is not obligated to do so. Here’s how real estate option contracts work.

The basics of real estate option contracts

A real estate purchase option is a contract on a specific piece of real estate that allows the buyer the exclusive right to purchase the property.

Once a buyer has an option to buy a property, the seller cannot sell the property to anyone else. The buyer pays for the option to make this real estate purchase. The option usually includes a predetermined purchase price and is valid for a specified term such as six months to a year. However, the buyer does not have to buy the property, whereas the seller is obligated to sell to the buyer within the terms of the contract.

Options have to be bought at an agreed-upon price. If the buyer doesn’t buy within the time frame, the seller keeps the money used to buy the option.

Advantages for the buyer

A real estate purchase option can be great for buyers. For example, if you want to buy a lot of land to build a new home, a purchase option can be used to keep the lot available for a certain amount of time, until you have funding.

The landowner cannot sell the plot to anybody else during the term of the option. At the end of the term, the landowner must sell the land at the price agreed upon, even if property values have risen in the interim. However, some option contracts may include terms that put a cap on the property’s price, or include other factors to determine the final price.

Advantages for the investor

Investors can use real estate options to secure high-profit investments at relatively low risk.

Here’s an example: An investor notes that a specific plot of land is in a prime location for further development such as subdivisions or a shopping plaza. Instead of purchasing the land outright and then selling it to developers, the investor purchases exclusive rights to the land through an option.

With the option in place, he approaches investors and developers, offering them the land at a much higher price than his locked-in option purchase price. Once his higher offer is accepted, he either sells the option itself for the purchase price or purchases the land and then flips it to the developer, pocketing the difference.

Lease options and their risks

Tenants interested in buying a rental property can use a lease option, also known as a rent-to-own arrangement. A lease option can be tricky and technical, so it’s in your best interest to get a lawyer to go over it.

A lease option allows the renter to purchase the property after a predetermined rental period, which the buyer pays to obtain. The lease option could determine a purchase price or state the property will sell at market value. A portion of the rental payments—which will likely increase due to the addition of a new premium—can be applied to the future purchase. All of these terms will be in the lease option contract.

You will lose money on a lease option if you don’t buy the property. The owner can pocket the additional rent premium and rent option costs if you don’t buy. For this reason, you should carefully review and weigh your options. In addition to a lawyer, meet with a financial planner to make sure you will be able to buy the property before the term ends.

The post What Is a Real Estate Option Contract—and Do You Need One to Buy a House? appeared first on Real Estate News & Insights | realtor.com®.

So you’re zeroing in on your very first real estate investment purchase: a home with potential that you’re planning on flipping. Congrats! But now it’s time to get to work.

Just be aware: Even if you spend weeks, or months, getting your investment property ready to sell, these efforts don’t necessarily guarantee profits. To give yourself a greater chance of making money off of your flip, you’ll want to avoid the following mistakes.

1. Hanging on for too long

For professional investors, flipping a home should be seen as a short-term process.

“I’d rather take a shorter profit in a shorter period of time than a marginally bigger profit over a longer period of time,” says Joshua Jarvis, CEO of Jarvis Team Realty, in Atlanta. Why? It can interfere with your year-end goals of making more money on flipping other properties. If your money is tied up in a project, you can’t invest in a new one.

“A 10% per annum return on a three-month investment is fantastic, but that same return doesn’t look so hot if it takes three years to come to fruition,’ says Nick Schlekeway, founder of Amherst Madison Legacy, in Boise, ID.

2. Over-renovating

Time is of the essence when flipping a home, and the quicker you can make it look good and sell it, the better. Any additional time spent on over-renovating it or obsessing over minute details can cut into your bottom line.

Patrick Freeze, owner of the Bay Management Group, in Baltimore, advises investors to “make the necessary repairs to your property but don’t over-renovate.”

The longer it’s not getting sold, the more potential revenue you miss out on. Plus, sinking money and labor into additional features can also mean you’ll make less money at the end of the deal.

So to make sure your house will fit in with comparable properties in the neighborhood, look for trends. In your neighborhood, are there McMansions stuffed with high-end appliances, or are most of the houses from the ’70s with modest updates? Figure it out, and play it close to the medium.

3. Not having an emergency fund

Experienced investors will consider this house flipping 101, but we cannot stress enough how important it is to have plenty of cash on hand in case of emergencies. What if your contractor finds asbestos and you have to pay additional money to eradicate it? What if there’s a downpour on the day you’re supposed to paint? Not having an emergency fund set aside can badly derail your project and put you in the red.

“The larger the fund, the better you are and the longer you can handle any risks,” says Jeff Tomasulo, CEO of Vespula Capital, an investment firm in Greenwich, CT.

To figure out how much you need, add together your overhead per month—mortgage, taxes, insurance, your lawyer, leasing agent, accountant, etc.—and multiply that by six for at least a half-year cushion, Tomasulo recommends.

4. Pricing yourself out of the market

Are you holding out for a higher sale price? You’re doing it wrong. The main reason houses sell fast is because they’re priced right for the market they’re in. That’s why it’s important to look at the comps in your neighborhood and speak to local real estate agents when deciding on a price for your investment property.

I’ve seen many new investors try to get $5,000 or $10,000 more than they should on lower-end homes. When it doesn’t happen, they spend the rest of the time chasing the market, Jarvis says.

His bottom line? “Price it right in the beginning, and get it sold.”

The post 4 Money Missteps to Avoid With Your First Home Flip appeared first on Real Estate News & Insights | realtor.com®.

If you need a mortgage to buy a house but lack the funds to make a 20% down payment, you might end up paying an added fee called private mortgage insurance, or PMI.

So what exactly is PMI? In the same way homeowners insurance protects you in case of problems in your home, PMI protects your lender in case you default on your loan.

Who needs private mortgage insurance?

There are two types of mortgage insurance: private and government. If you have a government-backed loan, such as an FHA loan, you pay mortgage insurance to the government. If your loan is not government-backed, you pay private mortgage insurance (PMI) to a corporate entity.

Lenders typically require PMI of home buyers if they put down less than 20% of the home’s value. The reason: Lenders see buyers with less money invested in a property as more likely to default on their mortgage and go into foreclosure, so these lenders are trying to protect themselves from that. It’s the trade-off for being able to buy a home with as little as a 3.5% down payment (which is the minimum required for an FHA loan).

In case you do default on your mortgage, PMI pays benefits to your lender to cover the loss.

How much private mortgage insurance costs

Expect your PMI payment to range from about 0.3% to 1.15% of your home loan. The most common way to pay PMI loan premiums to your lender is in monthly installments, but you may also be able to make your PMI payments in an upfront cost at your home closing, or roll it into the cost of the loan. Ask your lender for its PMI options. Then do the math for both the long term and short term, and compare it with your homeownership plans.

How to get rid of private mortgage insurance

Once you have at least 20% equity in your home, you can ask your lender to cancel your PMI. Once you have 22% equity, the lender is required to automatically cancel the coverage.

However, if you have an FHA loan, mortgage insurance payments will last the lifetime of the loan. But these payments last that long only if you keep the loan through its entirety—you can still refinance out of an FHA loan into another PMI-free mortgage when you have at least 20% equity.

How to avoid private mortgage insurance

If your loan isn’t government-backed, PMI payments are not necessarily an absolute. You may be able to avoid PMI payments by doing the following:

• Paying a higher interest rate. This is known as lender-paid PMI. Keep in mind this can’t be canceled and you’ll need to refinance to get a lower rate.
• Using a piggyback loan to cover all or part of the down payment. Piggyback loans come with a higher interest rate, so use caution and do the math.
• Reappraising your house if you think property values and updates have boosted your equity (be aware you’ll need to foot the appraisal bill).

Finally, some lenders may not require PMI for certain loan programs even if the buyer has less than a 20% down payment. These loans usually require sterling credit and other requirements. Consult your lender for more details.

A note on private mortgage insurance tax deductions

PMI has been tax-deductible since the Mortgage Forgiveness Debt Relief Act of 2007—and it’s still tax-deductible today! Yes, you’ll have to itemize your deductions; but if you do, here’s a ballpark figure of how much you’ll save: If you make $100,000 and put down 5% on a $200,000 house, you’ll pay about $1,500 in yearly PMI premiums—and cut your taxable income by $1,500.

Updated from an earlier version by Laura Sherman

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