The Housing Decision

1. 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. Source: Based on data from Survey of Consumer Finances, Fannie Mae, and Realtor.com. Table 8.1: Sample Amortization Table

14. Source: Based on data from Survey of Consumer Finances, Fannie Mae, and Realtor.com. Figure 8.3: Breakdown Between Principal and Interest on Mortgage Loan

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