March 27 brings us the Motley Fool Answers podcast's monthly mailbag show, which Alison Southwick and Robert Brokamp dedicate to providing their best advice and insights in response to listener questions.
Our podcasting duet learned something last month: Having Ross Anderson, certified financial planner from Motley Fool Wealth Management -- a sister company of The Motley Fool -- along for the ride makes it so much easier.
In this segment, they unpack the complicated situation of a couple who bought a townhouse they thought they could afford -- until the HOA threw a wrench in the works. Now they are staring ahead to the day when the interest rate on their ARM starts rising and trying to reassess their plans. But never fear, the Fools have some insights that ought to help -- and some advice for people who might be looking at buying in a neighborhood with a muscular homeowners association.
A full transcript follows the video.
This video was recorded on March 27, 2018.
Alison Southwick: Our next question is kind of a long one, so bear with me. It's from John. About two years ago, we moved into a townhouse. We took out a five-year ARM knowing we didn't want to stay there long. The HOA fees were really high, but we felt it was still a good deal, since buying the HOA implemented a special assessment totaling roughly $12,000 over five years. Not happy about that. Our mortgage plus HOA and assessment fees will surpass the proper percentage of our budget.
I'd like to stay in the house for as long as possible considering it's an area that is going up in value, plus we will have sunk $12,000 into the community; but that time when our mortgage rate will adjust is approaching and with rates going up we're going to have to stomach that.
Here's the question. Do we get out soon and incur the cost of moving to avoid current and future high fees, or do we stomach the high fees for the next three to five years? Any thoughts on finding cash for a down payment on our next house and maybe this house as a rental or is that unlikely given our financial situation now, but maybe?
Robert Brokamp: I feel like John's not quite sure how he feels about his townhouse.
Ross Anderson: First of all, it's a loaded question. There's a lot, here. But for the folks that are listening, the first thing I would tell John is if you are looking at a community that has a condo board or an HOA, ask them before you buy for a reserve study.
All these condo boards, all these HOAs on about a five-year basis should be doing what's called a reserve study, which is where they have an expert come in and look at how well capitalized is the association, what expenses they think are coming up, and do they have enough money in the bank to cover it?
That is a huge indicator of whether you're going to be facing things like special assessments. Like rising dues. I mean, it's very common for the dues to rise over time, anyway, just because things do become more expensive with inflation, etc., but [you may have] a board that has been neglecting that reserve fund [they haven't been putting enough money into it because it's typically unpopular every time they do a special assessment]. Every time some president raises the rates on people, they typically get ousted because they're like, "Well, I don't like that guy. He made us pay more." It's funny how that happens.
That would be my first piece of advice. If you're going to buy in a condo or a home community that has one of these, make sure you see if it's well capitalized, because if they're responsible for things like roofs and parking lots, these are big expenses, and so if that comes up, you're going to be dealing with it.
Now, the second thing I would say. There's a lot of competing language in John's question. We got in because we wanted to get out quick, so we went with this short-term, five-year ARM, which means the rate is going to adjust on him in three short years. Then he says, but we'd like to stay in the home as long as possible or maybe even rent it out, which would mean that you're a long-term owner and you're going to convert this into an income-producing property. Those are not really together.
Southwick: Get your story straight, John!
Anderson: If you think that this is going to be long-term property, and that you might be able to come up with the cash for a down payment without liquidating the property, I would refinance it as quickly as possible. Really, we're in a rising-rate environment. We've already seen the Fed increase rates this year. They're projecting to do it a couple of more times, so I think that this is going to get much higher on you.
The other thing is if you're going to buy a different home, you may consider accelerating that, because your purchasing power decreases as rates go up. So, the amount of house that you can buy elsewhere may decrease over the next three years with the same amount of payment, so it might be time to accelerate this.
I think really assessing whether you want to be in the home long term is critical, and then if you're going to treat it as an income property, you've got to lock it in and start thinking long term about the asset and how you've got it leveraged.
The assessment is tough. It's probably going to hurt your selling value if somebody else comes in and they realize that they're going to have this special assessment to pay, or you're going to have to absorb that, somehow, and build it into your purchase price. There's a couple of creative ways that you could maybe structure that. I think it is going to hurt your sale value a little bit, but the good news is maybe you spin it to say, "Well, whatever is causing that assessment has already been fixed. We've already paid for it, so it won't happen it again." Hopefully that helps you, there.
In terms of finding any cash for a down payment, I think that's kind of impossible to answer without knowing more about John's financial situation and just what his assets look like. I can't really touch that one but think hard about what you want to do. Do you want to be a landlord? A lot of people don't actually want to be a landlord. The idea of income from a property sounds really attractive. The idea about getting calls in the middle of a night because a pipe burst sounds less fun, and if you're paying a management company to not deal with those things, a lot of your profit goes right out the window. It will be a long time before you break even. All that fun stuff comes with being a landlord.
I don't know if I helped John, but those are some things I would think about if I were in his position right now.
Brokamp: And to a certain degree, it comes down to the budget. You're right. I think you have to assume that when the ARM resets, it's going to be at a higher rate. Can you afford that as well as this assessment [whatever the HOA fees are]? And if you can't, then it's time to sell and do something else. But if you can and you love the place, just suck it up and enjoy it.
Anderson: I picture the scene -- I think it was the Austin Powers 2 -- where there was the slow-moving car that was going to run over the guy and he sees it coming from really far away but just doesn't move. You're kind of in that spot right now, John. It's coming after you. You've got three years. Don't wait until it's right on top of you before you make a decision because you're going to lose options.