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11
Presentation to the Society of Automotive Engineers Club
Buying a Home March 16, 2011
Bryan Sudweeks, Ph.D., CFA.
From the Marriott School of Management’s“Personal Finance: Another Perspective” web site at
http://personalfinance.byu.edufrom lessons on Understanding Credit
Understanding Consumer and Mortgage LoansThe Home Decision
33
Abstract
Buying a home is for most the single largest purchase for most families and individuals. Yet many couples put the same effort into buying a home as they would into buying a TV or automobile. I propose that couples spend significantly more time in the home buying process as it will save them significant amounts of money in the long-run. This presentation gives suggestions where most of that research and time should be spent. I discuss what our leaders have said about buying a home, the risks, and a four step process for buying a home. My advice is the same as Dave Ramsey who said “Live like most people won’t for the first 10 years after school, and you will live like most people can’t after that.” Buy a modest home, fix it up and pay it off quickly.
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Objectives
A. Understand what our Leaders have said Regarding Buying a Home
B. Understand risks in home ownershipC. Understand the Four-Step Process for
Buying a Home:Step 1. Understand your limitsStep 2. Find your homeStep 3. Negotiate your loanStep 4. Enjoy home ownership
55
A. Understand what our Leaders have said Regarding
Buying a HomeWe must have a correct perspective for life. It is
based on four key principles of finance:1. Ownership: Everything we have is the
LordsThings we have are not ours but on loan
2. Stewardship: We are stewards over all God shares with usWe must learn to be better stewards
3. Agency: the gift of choice is a wonderful gift We must used that agency wisely
4. Accountability: We will be held accountable for all our choices in lifeWe must make the best choices we possibly
can as we will be held accountable for them
66
Our Leaders Counsel (continued)
We have received wise counsel on the subject of buying a home. President James E. Faust stated:
oOver the years the wise counsel of our leaders has been to avoid debt except for the purchase of a home or to pay for an education. I have not heard any of the prophets change this counsel. (“Doing the Best Things in the Worst Times,” Ensign, August 1984, 41.)
77
Our Leaders Counsel (continued)
President Gordon B. Hinckley commented:We have been counseled again and again
concerning self-reliance, concerning debt, concerning thrift. When I was a young man, my father counseled me to build a modest home, sufficient for the needs of my family, and make it beautiful and attractive and pleasant and secure. He counseled me to pay off the mortgage as quickly as I could so that, come what may, there would be a roof over the heads of my wife and children. I was reared on that kind of doctrine. (italics added, Gordon B. Hinckley, “The Times in Which We Live,” Ensign, Nov. 2001, 72.)
8
Our Leaders Counsel (continued)
He further counseled: I recognize that it may be necessary to borrow
to get a home, of course. But let us buy a home that we can afford and thus ease the payments which will constantly hang over our heads without mercy or respite for as long as 30 years. … I urge you to be modest in your expenditures; discipline yourselves in your purchases to avoid debt to the extent possible. Pay off debt as quickly as you can. … That’s all I have to say about it, but I wish to say it with all the emphasis of which I am capable (italics added, Gordon B. Hinckley, “To the Boys and to the Men,” Ensign, Nov. 1998, 51).
99
B. Risks in Home Ownership
You buy too big a houseYour other goals (retirement, missions) are not
metYou buy a fixer-upper without the skills or time
It stays a fixer upperYou buy the wrong type of house for your lifestyle
You must pay others to keep it upYou buy a house without the necessary inspections
You pay dearly for someone else’s problemsYou buy a more expensive house than you can
affordYou lose your house, credit, and your self-respect
1010
Risks in Home Ownership (continued)
The single biggest mistake young couples make out of school that impacts them the most financially is they purchase too big a houseTheir other goals cannot be realized as they
are paying so much for their house They go farther and farther into debt to
furnish and maintain the houseThey cannot save for their other goals as
they have little after housing costs to saveTheir marriages and families suffer from the
added financial strain
1111
C. Understand the Home Buying Process
Purchasing a house is a four-step process: Step 1. Understand your limits
Know yourself , what you can afford and what you need when
Step 2. Find your homeMake sure you know what you want, and get it
Step 3. Negotiate your loanKnow what lenders need and want so you can
be ready Step 4. Enjoy home ownership
Realize you are a steward over all God has blessed you with. Be the best you can be
12
Step 1. Understand your Limits
Know yourself and your limits relates to 8 areas:a. Know your budget and how much you can
affordb. Know your credit scorec. Calculate your front and back-end bank
ratiosd. Calculate your bank ratios for LDSe. Choose your preferred loan type and termf. Know what you need for a down payment
and upfront costsg. Have two years of copies of taxesh. Get pre-approved
13
1.a. Know Your Budget and How Much You Can Afford
YOU MUST HAVE and Live on a Budget
President Spencer W. Kimball said:
Every family should have a budget. Why, we would not think of going one day without a budget in this Church or our businesses. We have to know approximately what we may receive, and we certainly must know what we are going to spend. And one of the successes of the Church would have to be that the Brethren watch these things very carefully, and we do not spend that which we do not have (Marvin J. Ashton, “One for the Money” pamphlet, Intellectual Reserve, 1992, inside cover).
1616
A Better Way (continued)
Elder L. Tom Perry said:After paying your tithing of 10 percent to
the Lord, you pay yourself a predetermined amount directly into savings. That leaves you a balance of your income to budget for taxes, food, clothing, shelter, transportation, etc. It is amazing to me that so many people work all of their lives for the grocer, the landlord, the power company, the automobile salesman, and the bank, and yet think so little of their own efforts that they pay themselves nothing (L. Tom Perry, “Becoming Self-Reliant,” Ensign, Nov. 1991, 64).
1717
1b. Know Your Credit Score
Know your Credit HistoryReview your credit history every year from all
three agenciesThree major credit reporting agencies
Experian (www.experian.com), Equifax (www.equifax.com), and Transunion (www.tuc.com)
You can get a free copy of your credit report from each agency each year by going to: www.annualcreditreport.com
Fill out the info and you can get a copy onlineMake sure it is correct
1818
Know Your Credit Score (continued)
Pay for your Credit ScoreAfter checking your credit report for errors,
order a copy of your credit score. I recommend a FICO score. You can order it directly from FICO at www.myfico.com for $16.95 (less with coupons)
What determines your Credit Score or lending risk?
Payment History: What is your payment record?
Amounts Owed: How much do you owe?Length of Credit: How established is yours?New Credit: Are you taking on more debt?Types of Credit Use: Is it a healthy mix?
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1c. Know your Front- and Back-end Bank Affordability Ratios
Know the rules for lendersKnow your affordability ratios, and be sure to
take into account your savings and tithing when you calculate these ratiosRatio 1: Housing Expenses (front-end
ratio) Monthly PITI* <28%Monthly Gross Income
Ratio 2: Debt Obligations (back end ratio)Monthly PITI* and other obligations < 36%
Monthly Gross Income*PITI = Principal, interest, property taxes, and
property insurance
2020
1d. Calculate Your Ratios for LDS
As members of the Church, we have other important obligations that we also pay, i.e., tithing and paying ourselves, i.e., savingAs such, should have smaller houses (at least
less expensive), because we pay the Lord first and ourselves second.
For a spreadsheet that takes into account the fact that we pay the Lord first and ourselves second within this front-end and back-end ratio framework, see:
Teaching Tool 7: Maximum Monthly Mortgage Payments for LDS Spreadsheet (from the website)
2121
1e. Choose your Preferred Loan Type
and Loan TermChoose your preferred loan type.
The best type of loan takes into account your:Goals, budget, income stream, down
payment, and view on riskThere are a number of different types of
mortgage loans available. These include:Fixed Rate (FRMs) - RECOMMENDEDVariable or Adjustable Rate (ARMs)Interest Only (IO): Variable or Fixed Interest
There are also special loans (if you can get them) FHA o(best for students) or VA
2222
Fixed Rate Mortgages (FRMs)
These are mortgage loans with a fixed rate of interest for the life of the loan. This is what I recommend Benefits
Higher but constant payments—you pay down principle faster
No risk of negative amortization Interest rate risk is transferred to the lender
RisksInterest rates are higherHigher monthly payments may make
payments more difficult, particularly for those not on a regular salary
2424
Adjustable Rate Mortgages (ARMs)
Mortgage loans with a rate of interest that changes periodically over the life of the loanBenefits
Lower initial interest ratesGenerally lower monthly payments, as you
assume the interest rate riskNo risk of negative amortization
RisksYou assume the risk that interest rates risePossible “payment shock” as interest rates
rise, perhaps beyond what you are able to pay
2626
Interest Only Options (Fixed or Variable)
These are FRMs/ARMs with an option that allows interest only payments for a set number of years. After that, payments are reset to amortize the loan over the remaining years of the loan (it is not like a credit card)Benefits
Lower monthly payments as you are paying interest.
You can afford more house due to lower payments
RisksThere will be a major rise in payments when
the interest only period endsThere is no paying down of principle
2828
Mortgage Loans (continued)
Insured LoansFHA (Federal Housing Administration)
Insured LoansFHA does not originate any loans, but
insures the loans issued by others based on income and other qualifications
There is lower PMI insurance, but it is required for the entire life of the loan (1.5% of the loan)
While the required down payment is very low, the maximum amount that can be borrowed is also low
3030
Mortgage Loans (continued)
Guaranteed LoansVA (Veterans Administration) Guaranteed
LoansThese loans are issued by others and
guaranteed by the Veterans Administration
Are only for ex-servicemen and women as well as those on active duty
Loans may be for up to 100% of the home value
32
Recommended Loan Term
Choose your loan termGenerally, I recommend a 30 year fixed
rate loanHowever, I recommend you make
additional payments on principal to pay off the loan sooner if possible
33
1f. Know How Much You Need for a Down Payment and Upfront
CostsKnow what you will need for a down payment
and upfront costs, and begin saving for itDown payments:
You will need a larger down payment to get into your home now versus two years agoBegin saving for that now
Conventional loans – 20 % recommended, but you can get in with 5%
FHA loans – 3.5%VA loans – 0% no down payment required
Once you realize how hard it is to save, it will help you not to spend too much
3434
Down Payment and Up-front Costs (continued)
Upfront costs include closing costs and pointsDown payment (3-20 percent of the loan amount)Closing costs including points (3-7 percent)
Closing costs include:
• Title insurance
• Attorney’s fee
• Property survey
• Recording fees
• Lender’s origination fee
• Appraisal
• Credit report
• Termite inspection
• Prepaids (property insurance & taxes, mort. interest)
• Points
3535
Up-front Costs (continued)
What are points?One percent or one hundred basis points of the
loanThis money is paid to the mortgage broker (not the
lender), is deducted from the loan proceeds (you still must pay it back), and is essentially another fee for helping you arrange the loan (minimize points)
Why do lenders charge points?To recover costs associated with lending, to
increase their profit, and provide for negotiating flexibility
Do I have to pay points?Origination points (likely), buy-down points (no)
36
1g. Have Copies of 2 Years of Taxes
Lenders want confirmation that you can pay back the loanAs such, they generally want to see two
years of tax recordsHave copies of your last two years of tax
records, even though you were a studentIf you have a confirmed job letter with
salary, that may also be helpful as well
37
1h. Get Pre-approved—Not Pre-qualified
Get pre-approved for your loan by a number of lendersPre-approved means that lenders have pulled
your credit score, looked at your tax records and approved you for a specific amount of a loanYou can borrow up to this pre-approved
amount without a problemI recommend you check with multiple lenders
Remember however that you do not need to borrow that amountI recommend that you borrow less than that
amount
3838
Step 2. Find Your Home
There is a five step process to finding your homea. Determine what is important to youb. Develop a plan for finding a homec. Use a realtor/team approach to find a
home in your price ranged. Once you are serious about the home,
get a home inspection (offers can be contingent on the home inspection)
e. Determine any CCRs/fees for potential homes
f. Negotiate the price38
39
2a. Determine what is Important To You
Determine what is important to you and what you will and will not do without!This may include:
Location,Home style and layoutFuture plans, i.e., kids, work, schools,
etc.Realize that you will probably move
within five to seven years (if you are like the average family)
4040
2b. Develop a Plan
Establish a Plan for finding your home Once you know your limits, what you can
afford, where you want to be, and what you want (your Plan):Then start driving aroundThen start looking in earnestBut keep to your plan
Use Zillow.com to find current home values in other areas you may be interested in
4141
Develop a Plan (continued)
Be Patient and take your timeEstimate the time you will be in the house
If it is less than 3-5 years, look into rentingYou must make 6-7% on your house price
just to break even when you sell it (realtor fees are 6-7%)
You will be in the house for years—don’t make the decision to quicklyIt will likely be your largest financial
commitment you will make for a long timeOften renting a luxury apartment for 6
months will give you time to search thoroughly
4242
2c. Use a Realtor/Team Approach
Get a good realtorWhile realtors are working for sellers, it may
be wise to have a buyer’s broker that works for youThey should know the ins and outs of the
neighborhood you are looking atTake matters into your own hands
Be proactive—talk with friends and othersUse the internet and other tools that may
helpStay true to your Plan and have patience
Be liquid and ready to react quicklyBe creative if necessary
4343
Realtor/Team Approach (continued)
Use a team approach—get lots of good help Use others to help
Buyers brokerAppraiserAttorney
Don’t become emotionally attached to a potential houseBe willing to walk away
44
2d. Have home inspections before you Buy
Once you have found the home you like, can afford, and is where you want to live, have a home inspectionThis may alert you to potential problems
with the homeMany should be fixed by the seller prior
to purchaseDon’t buy someone’s problems
45
2e. Determine any CCRs/fees for potential homes
Look to potential homes and potential costsLook through Determine Covenants,
Conditions and Restrictions (CCRs) for a potential homeThese can be quite restrictive as to what
you can and cannot do with your homeFor condos or town homes, determine the
amount of the transfer/setup feesUnderstand any other
homeowners/association fees for potential homes and what they include
46
2f. Negotiate the Price of the Home
Use the best available resources to negotiate a price for the homeUse wisdom and judgment in determining
what you can and should pay for the homeRealize your best negotiating technique
is walking awayThis is a negotiation process—do not be
afraid to haggleRealize that closing costs, things that
need to be fixed, and other things can all be part of the negotiated price
4747
Step 3. Negotiate the Loan
9. Lender audits the documents, verifies all conditions are filled, and funds the loan!
1. You’ve found a home that suites your lifestyle and budget, using resources such as a realtor.
2. The realtor refers you to a mortgage broker.
3. The broker pulls credit, determines your needs and tries to find lenders among the competition to meet those needs.
4. Each lender has unique programs. Lender and broker negotiate points, rates, fees, PPP, and other features of the loan.
5. Broker recommends the best loan to the consumer, reviewing the features agreed upon. Consumer makes the final decision.
6. Lender takes the loan package, structures the loan and conditions for any additional information they need to close the deal.
7. Broker, Title, Escrow, and Lender work to fill all conditions
8. Lender sends out the documents to escrow for signing
4848
Negotiate the Loan (continued)
Negotiate the loan is the final part of the processa. Choose multiple lenders to compete for
your business and get Good Faith Estimates from each of your lenders
b. Take the various loan offers from the lenders to calculate your lowest Effective Interest Rate
c. Negotiate with your best lender the best rate
49
3a. Choose Multiple Lenders and Get Good Faith Estimates
You will get a lower interest rate when lenders compete for your businessWork with multiple lendersTalk with friends and others who have
gone through the process for their favorite brokers
Get Good Faith Estimates from each lender (not just a Summary)These are the costs you will likely pay
50
3b. Calculate your Effective Interest Rate
Estimate how long you will be in the homeThis is important as it helps determine over
what period you can allocate points and other costs
Calculate your effective interest rate for each loanYour effective interest rate is the interest rate
you will pay after all your points, costs, and fees are taken into account
The lowest effective interest rate is the best indicator that you got a good rate on your loan
51
3c. Negotiate with Your favorite Lender for the Best Rate
The key now is to find the lowest rateOnce you have multiple offers from multiple
lenders, then you have bargaining powerDetermine your lowest rate, which includes
points, fees, and the loan APR after evaluating each of the offers from the various lendersYou can take that offer if you wantOr, you can that offer to your favorite lender
Then ask them to beat it by 1/8 to ¼ percent and you will go with them
5252
Step 4. Enjoy Home Ownership
Enjoy home ownershipMaintain it well
Take care of your purchase and it will take care of you Generally it will take roughly 1% of the
home’s value annually for upkeep. Budget accordingly
A professional cleaning a few times a year can help retain a home’s value
Now keep the value of your home up!
5353
Summary
Keep Buying a house in its proper perspective
Its part of your personal goals—but not the only goal
Keep striving to be financially self reliant
The habits you develop now will last a lifetime
Remember what our leader’s have said about home ownership
Buy a modest home that you can afford, and pay it off quickly)
54
Step 1: Understand your Limits
Know yourself and your limits relates to 8 areas:a. Know your budget and how much you can
affordb. Know your credit scorec. Calculate your front and back-end bank
ratiosd. Calculate your bank ratios for LDSe. Choose your preferred loan type and termf. Know what you need for a down payment
and upfront costsg. Have two years of copies of taxesh. Get pre-approved
5555
Step 2. Find Your Home
There is a six step process to finding your homea. Determine what is important to youb. Develop a plan for finding a homec. Use a realtor/team approach to find a
home in your price ranged. Once you are serious about the home,
get a home inspection (offers can be contingent on the home inspection)
e. Determine any CCRs/fees for potential homes
f. Negotiate the price55
5656
Step 3. Negotiate the Loan
Negotiating the loan is the final part of the processa. Choose multiple lenders to compete for
your business and get Good Faith Estimates from each of your lenders
b. Take the various loan offers from the lenders to calculate your lowest Effective Interest Rate
c. Negotiate with your best lender the best rate by asking them to beat your best offer by a specific percentage
5757
Step 4. Enjoy Home Ownership
Enjoy home ownershipMaintain it well
Take care of your purchase and it will take care of you Generally it will take roughly 1% of the
home’s value annually for upkeep. Budget accordingly
A professional cleaning a few times a year can help retain a home’s value
Now keep the value of your home up!
5858
Review of Objectives
A. Do you understand what our Leaders have said regarding buying a home?
B. Do you understand risks in home ownership?
C. Do you understand the Four-Step Process for Buying a Home?Step 1. Understand your limitsStep 2. Find your homeStep 3. Negotiate your loanStep 4. Enjoy home ownership
5959
Introduction to the Marriott School of Management
Personal Finance Website
The Marriott School has put together a website to help you with this and other Personal Finance decisions. Please visit the website at:http://personalfinance.byu.net
This presentation was taken from three lessons on:Understanding Credit
Understanding Consumer and Mortgage LoansThe Home Decision
These PowerPoints are available under Tools and Resources, Other Resources, and Buying a Home
6464
Opt Out for Credit Card Applications
Getting too many credit card applications? There is a national credit opt-out number or an online website that can take you off the mailing lists of all four major credit reporting agencies:It is easy and painless
Call 1-888-567-8688 or 1-888-5 OPT OUT or go to www.optoutprescreen.com
Answer the questions on the phone or on the net. It only asks your home phone number, your name, and your social security number. Then they send a form to fill out and mail in.It is worth it (unless you like junk mail).