Garman/Forgue

Personal FinanceNinth Edition

Chapter 9

Buying a Home

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Learning Objectives

1. Decide whether renting or owning is better, both financially and personally.

2. Explain the up-front and monthly costs of buying a home.

3. Describe the steps in the home-buying process.

4. Distinguish among the traditional and alternative ways of financing a home and list the advantages and disadvantages of each.

5. Identify the important aspects of selling a home.

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Introduction

• Mortgage Loan: Loan to purchase real estate in which the property itself serves as collateral.

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“Your Rental Rights” How to Get Your Security Deposit Back

• Make a list of all damages and defects before you move into the unit. Have the landlord sign this list.

• Notify the landlord promptly (in writing, if necessary) of any maintenance problems and malfunctions.

• Give proper written notice of your intention to move out at least 30 days in advance of the lease expiration.

• Make a written list of all damages and defects after moving out but prior to turning over the keys. Have the landlord sign this second list.

• Use certified mail to request the return of your security deposit and to inform the landlord of your new address.

• Use small-claims court, if necessary, to obtain a court-ordered refund.

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• Evaluating Your Alternatives– What influences your choice of housing?• Mobility vs. Permanence; Lifestyle

• Financial factors

• Guideline: monthly housing < 36% of gross monthly income

Advantages of renting Fewer maintenance and repair

responsibilities Easier to move Lower initial costs

Disadvantages of renting No tax / financial benefits Limitations regarding

remodeling Restrictions regarding pets

and other activities Legal concerns of a lease

Advantages of buyingPride of ownershipFinancial benefitsLifestyle flexibility

Disadvantages of buyingFinancial commitmentHigher expensesLimited mobility

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Who Pays More? • Short-term: renters win

• Long-term, when income taxes and appreciation are considered: homeowners win

• What does it cost to buy a home? Most up-front costs are due at the closing (PG 238)

– Closing costs: 2-10% of loan

– Down payment

– Points

– Attorney fees

– Home inspection

– Appraisal fee

– … and many more!

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Consider the tax consequences of buying your home…

What 2 items are deductible on federal and (most) state income tax returns?

Homes (normally) appreciate in value; capital gains (your profit) are not taxable in many cases.

For first-time home buyers, money being saved to buy a home can be in a tax-sheltered account such as a Roth IRA. See page 237

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• Points

– A way for homebuyers to “buy down” the interest rate on their loan

– 1 point = 1% of the total mortgage loan amount

– Homebuyer pays for points at closing

– Lender receives money upfront as compensation for offering a lower rate

– When does it make sense for a buyer to do this?

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Monthly Costs Include Principal & Interest

• PITI

• How are property taxes determined? (See page 241)

• Escrowing of property taxes & homeowners insurance

• PMI (See page 241)

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Amortization Table for Fixed Rate Loans

Month Payment Loan

BalanceInterest Principal

1 790$ 677 1132 790$ 124,887 676 1143 790$ 124,773 676 1144 790$ 124,659 675 1155 790$ 124,544 675 1156 790$ 124,429 674 1167 790$ 124,313 673 1178 790$ 124,196 673 1179 790$ 124,079 672 118

10 790$ 123,961 671 11911 790$ 123,842 671 11912 790$ 123,723 670 12024 790$ 122,240 662 12860 790$ 117,169 635 155

120 790$ 106,185 575 215180 790$ 90,996 493 297360 790$ 786 4 786

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Financing a Home: The mathematics of mortgage loans

• A mortgage is a collateralized loan

– Lender has a lien on the real estate

– Foreclosure if borrower defaults

• A mortgage is an amortized loan

• Equity: market value of home – loan balance

• How are monthly payments divided between P & I?

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Factors Affecting the Monthly Payment

• The Amount Borrowed

• The Interest Rate

– SHOP AROUND! Even tiny increments make a HUGE difference

• The Term of the Loan

• The Type of Mortgage

– Conventional Fixed-Rate

– ARMs (variable-rate loans)

• Teaser Rate

• Rate Caps

<= where is the risk?

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• Fixed-Rate, Fixed-Payment Mortgage– Various terms: 10, 15, 20 or 30 years

– fixed interest rate, fixed monthly payment

– Each payment consists partly of principle and interest

– Payments made in early years mainly go toward interest, with very small reductions in loan principal

• Adjustable-rate mortgages (ARMs)– Interest rate varies over life of the loan

– Why are the initial interest rates typically lower than most fixed-rate mortgages to start?

• Hint: What does risk have to do with the interest rate borrowers pay?

– Caps helps to reduce some risk

– Considerations when evaluating Fixed vs. ARMs:

– What’s the best choice for you?

The Main Types of Mortgages

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• Growing Equity • Goal is to reduce interest costs by paying off loan early

• Bi-weekly mortgage option

– Reverse Mortgage

– Second Mortgage • Home Equity Loan

• Home Equity Line of Credit

• “Eating one’s house”

– Mortgage Refinancing

Alternative Mortgages

Traditional limit for HELs and HELOCs:

80% of MV less loan balance.

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Steps in theProcess of Buying a Home

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• Determine your own affordability first:

Front-end ratio:

– PITI compared to gross income

– PITI should not exceed 25-29% of gross income

Back-end ratio:

– PITI + all other monthly debt (car, student loans, etc)

– Should not exceed 33-41% of gross income

–Most people base affordability on combined incomes

– Why might this be a bad idea?

–Prequalify for a mortgage by arranging financing