Planning Your Financial Future, 4eby: Boone, Kurtz & Hearth

The Housing Decision

Chapter 8

2

Your Personal Housing Requirements

Where do you want to live? Lifestyle: leisure and work activities Commuting distance/time Taxes

Vary across different states & local communities Public services

Health care, police/fire protection, parks, etc. Schools

Some believe good system helps maintain property values, but may pay higher property taxes

3

Your Financial Resources

Experts suggest that you spend no more than one-third of your monthly take-home pay on housing

Decline in mortgage interest in 1990s let more people afford houses

Amount required for down payment is usually more of a hurdle than the monthly payment While there are ways to reduce the needed down

payment, you should plan on paying at least 10% of purchase price in a down payment (plus closing costs, which can easily reach 2.5%)

4

The Kind of Home You Want and Need

Important to do a needs vs. wants analysis

Housing needs change over the life cycle Single person versus family with

children versus retired couple

5

Major Housing Options

Single-family homes About 2/3 of American households are of

this type Typically about 2,100 square feet, 3

bedrooms, 2.5 baths Typically sells for $180,000

Varies widely throughout the country More than 90% are bought via financing

with the property serving as collateral (mortgage)

6

Major Housing Options

Condominiums and co-ops Condo buyers receive title to unit plus

joint ownership in all common areas Owners belong to a homeowners

association Co-op dwellers own shares in a

corporation that owns the building Resident leases unit from corporation

7

Major Housing Options

Manufactured homes 95% are permanent structures Much cheaper than site-built houses If built after June 1976, must conform to national building

code

Rental option Most rentals are unfurnished Average rental in U.S. is $800/month

Varies substantially based upon Type of unit Location

Lease defines rights and obligations of landlord and tenant

8

The Buy-Versus-Rent Decision

Advantages of renting Mobility (no need to be concerned with selling house,

although length of lease is a consideration) No large up-front costs involved Little or no repair and maintenance costs

Advantages of buying ‘Pride of ownership’ Ability to decorate to your satisfaction Potential price appreciation (but depreciation can occur) Tax savings (itemize deduction for mortgage interest) Build up equity

The current value of the house minus the loan balance

9

The Buy-Versus-Rent Decision

In many areas of the country, buying is cheaper than renting even if appreciation in value is not considered

This could change if interest rates rise or mortgage interest deduction is eliminated

10

Financing the Purchase of a Home

Determine how much you can afford in terms of the total purchase price Dependent upon your income, down payment,

interest rates Lenders don’t want monthly mortgage

payment, real estate taxes, and homeowners insurance to exceed 28% of your gross monthly income

Also, make sure you can afford the monthly upkeep Utilities, repairs, maintenance

11

The Down Payment

One of the most critical home-financing factors is the down payment First-time buyers usually pay about 12% Average down payment is 25% for all buyers

If you have a lower loan-to-value ratio, you may get a better interest rate on mortgage

If you purchase private mortgage insurance (PMI), you may be able to reduce the size of your down payment Expensive, but can be canceled after a point

12

The Monthly Payment

Most mortgages are fully amortized Each payment goes partly to principal

reduction and partly to interest Over life of loan, principal is reduced to

zero Initially most of monthly payment goes

toward interest but this decreases (slowly) over the life of the loan

13

Table 8.1: Sample Amortization Table

Source: Based on data from Survey of Consumer Finances, Fannie Mae, and Realtor.com.

14

Figure 8.3: Breakdown Between Principal and Interest on Mortgage Loan

Source: Based on data from Survey of Consumer Finances, Fannie Mae, and Realtor.com.

15

Closing Costs

Include fees involved with the transfer of ownership (such as loan origination fee, credit report, etc.) Most are paid at the closing meeting Points

Fees paid (usually by buyer) to lender (AKA as a loan origination fee or loan discount)

Typically considered interest and are tax deductible Stated as a % of the loan amount

16

Closing Costs

Prepaid interest Generally, over a month passes before your first mortgage

payment is due However, your mortgage is accruing interest charges during

that time If mortgage closed on June 15 and first payment was due July

30th, it would cover interest from June 30th to July 30th, but not June 15th to June 29th

Sales commission Usually paid by seller Compensates real estate agents for their services

Quite expensive (about 6 or 7% of purchase price)

Title Charges Normally split between buyer and seller

17

Sources of Mortgage Loans

Can be obtained through Commercial banks Savings banks Mortgage companies Some credit unions

Shop around Mortgage broker will search for best loan to meet your needs Check the Internet

Lender doesn’t have to be local Loan application is rather detailed May have the option of locking in the current

mortgage rate

18

Types of Mortgages

Fixed-rate loans – interest rate remains constant over the life of the loan 30-year

360 identical payments are made, generally once a month

15-year Are about 33% of all new mortgage loans Interest rates are slightly less than a 30-year

mortgage Monthly payment is larger than 30-year mortgage

19

Types of Mortgages

Adjustable-rate mortgages (ARMs) Interest rate changes at preset

intervals, depending on whether interest rates have increased or decreased Tied to a specific index Limits (caps) to how much the interest rate

can change per period and over the life of the loan

The initial (teaser) rate is far below the rate of fixed-rate loans

20

Types of Mortgages

Choosing between an ARM and fixed-rate loan Many consumers dislike ARMs because

interest rate can change—adds uncertainty

However, may be a good choice for some consumers The shorter the amount of time you plan to

keep the house, the more attractive an ARM

21

Types of Mortgages

FHA mortgages Federally insured mortgages made by

private lenders Down payment is usually quite low (because

buyer receives insurance via federal government)

Buyer pays an FHA insurance premium each month

Ceilings on the amount of money that can be borrowed

Exactly what the ceiling is depends on geographic location

22

Types of Mortgages

VA mortgages Guaranteed by the Veterans Administration

and loans are made through private lenders Only available to veterans Guarantees 100% of the loan amount

Subject to ceilings which vary by region Limits on closing costs Low down payments (sometimes as low as

0%)

23

Types of Mortgages

Conventional mortgages One that is not FHA or VA insured If you borrow more than 80% of

purchase price, most lenders require PMI

If property is sold for less than the loan balance, borrower is still obligated to pay the rest

24

Refinancing a Mortgage

Involves taking out a new loan while paying off the old loan

Costs associated with refinancing Closing costs Are there prepayment penalties on your current

loan? Will there be prepayment penalties on new loan?

Generally, if interest rates have dropped to 2% or more from your current rate, it makes sense to refinance but depends on time you plan to remain in house

25

Second Mortgages

Tax Reform Act of 1986 eliminated interest deductions on car loans, credit cards, etc.

May make sense to obtain a second mortgage on your house to finance car purchases, make home improvements, pay for college costs, etc. Interest is tax-deductible

Similar to home equity loans, except home equity loans are basically a credit limit An amount up to which you can borrow without

reapplying each time Interest is tax deductible

26

Second Mortgages

Warning Even if you pay your primary mortgage

payments on time, you can lose your house if you fail to pay your second mortgage payments on time

If your house drops in value, the amount you owe stays the same

125 loans Loans up to 125% of the market value of the

house Risky!

27

Finding the Right House to Buy

Recommend that you prequalify for mortgage before you start looking Know the max you can afford so you

won’t waste time Lets you quickly arrange financing

once you find the house you want

28

Using a Real Estate Agent

You can either find houses yourself that you are interested in or

Tell an agent what you’re interested in and have them contact you with a list of prospects

Once you’ve selected a house, agent will help you make a formal offer

Prepare a contract stating offer price, desired closing date, etc.

Seller will either accept offer, make counteroffer, or reject offer

You’ll have to put up earnest money A security deposit (which you’ll probably lose if you recant

offer)

29

Home Inspections

You’ll definitely want the house inspected before you buy it, even if it is brand new

You can ask seller to fix things that are found during the house inspection, or lower the purchase price to adjust for these items

Expect to pay $150–$500 for a home inspection

30

Home Warranties

Most new homes come with a one-year warranty

For an older home, you could either buy a warranty (for about $350) that covers certain items (water heater, stove, etc.)

Some sellers now buy these warranties and offer as a sales incentive

31

Selling a Home

Should you use a real estate agent? Agents charge between 6 and 7% of selling price If you don’t use a real estate agent, you have to

advertise the house, arrange for viewing, negotiate with buyer, etc. About 80% of houses are sold via an agent

Setting the asking price Agent will help establish this

Selling costs May include real estate commission, title

insurance, real estate taxes

32

Fixing Up Your Home

Why do home improvements? Satisfy you Increase potential selling price

Bathroom/kitchen improvements tend to recover the best

Don’t improve your home too much If the value is more than 10–15% of average

home price in your neighborhood, you probably won’t get that much for it

Shop around

33

Taxes and the Sale of Your Home

Most homeowners will never pay federal taxes on the sale of their home

However, it is important to keep good records