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Chapter 9

Chapter 9. Learning Objectives (part 1 of 2). Explain the advantages of pre-qualification Describe the different types of mortgages available Ascertain how much you could afford to pay for a house Decide how much of a down payment you would like to make. Learning Objectives (part 2 of 2).

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Chapter 9

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  1. Chapter 9

  2. Learning Objectives (part 1 of 2) • Explain the advantages of pre-qualification • Describe the different types of mortgages available • Ascertain how much you could afford to pay for a house • Decide how much of a down payment you would like to make

  3. Learning Objectives (part 2 of 2) • Estimate your closing costs • Evaluate whether it would be profitable to refinance your current mortgage • Describe the process by which property taxes are determined • Evaluate automobile financing choices • Analyze an auto lease proposal.

  4. Advantages of Pre-qualification • Identifies maximum mortgage one would be able to obtain • Reduces uncertainty about qualifying for a mortgage • Adds creditability to a bid (if two bids are otherwise equal, the one with the prequal. letter should be chosen

  5. Different types of mortgages (1 of 2) • fixed rate mortgage • 15-year • 30-year • Adjustable rate mortgage (ARM) • 1/1, 3/1, 5/1, 7/1, 10/1 • 5/25, 7/23

  6. Different types of mortgages (1 of 2) • Conventional mortgage • FHA-insured mortgage • VA-guaranteed mortgage • Jumbo mortgage • Reverse annuity mortgage (RAM)

  7. Elements of an ARM • Teaser rate • Convertibility • Margin • Index tied to, & availability of index • Caps • Per each change • Lifetime

  8. Obtaining a mortgage • Get as many quotes as possible • Lock period & application fees • Miscellaneous fees

  9. Maximum size of mortgage • Ultimately, lender’s choice, but they all follow certain rules • PITI not exceed 28% of gross income • PITI and other monthly debt payments not exceed 36% of gross income

  10. Selection of down payment (1 of 2) • Standard is 20% of purchase price • If less, then will need some form of default insurance • Any form of insurance is expensive • If income constraints are a problem then a larger down payment may make it easier to get a mortgage

  11. Selection of down payment (2 of 2) • Putting more down is equivalent to investing money risk-free at the mortgage rate • Putting more down may create a liquidity problem later, that could only be solved with a home equity loan or through refinancing

  12. Closing Costs • Prepaid interest (for first month) • Title insurance • Start escrow account • Tax Stamps • Credit report • Survey • Potentially many more

  13. Choosing a mortgage (1 of 2) • Fixed vs. ARM depends on risk tolerance, income constraints, expected period of occupancy • 15-year vs. 30-year depends on reduction in interest rate vs. opportunity cost of money

  14. Choosing a mortgage (2 of 2) • Paying points to get a lower rate • Great if paid by employer • Foolish if occupancy less than five years (typically) • Depends on opportunity rate of return • Reduces the value of refinancing the mortgage should interest rates drop

  15. Refinancing a mortgage • Sometimes done to get at equity in the house • Popular rule of thumb of 2% reduction vastly overstates when it can be profitably done • Depends on closing costs and the magnitude of reduction in the monthly payment

  16. Appraised vs assessed value • Appraised value = what an appraiser thinks a home would sell for • Required by all lender’s before a mortgage is closed • Required for any home-equity loan or HELOC • Assessed value = an arbitrary value assigned to a home to set property taxes. Unrelated to appraised value.

  17. Property Taxes • Assessed valuation established • Each taxing authority establishes a millage rate (property tax per $1,000 assessed valuation • Some states establish state equilization factors

  18. Financing a Car • Rebate or below market interest rate: both are built in price adjustments, and true value of BMIR needs to be estimated • Amount of down payment • Opportunity cost of money • Reduction in liquidity • May affect ability to obtain a loan

  19. Factors in a lease rate • Selling price of vehicle • Expected value of vehicle at end of lease • Money factor (interest rate) • Monthly depreciation charge • Other taxes and fees

  20. Down payment on a lease • Destination charge • Acquisition fee • Security deposit • refundable

  21. Borrow & buy vs. lease decision • Monthly down payments lower with a lease • Leases usually require less out of pocket cash • Time Value of Money analysis usually favors a purchase

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