Chapter 32

1. Chapter 32 Real Estate

2. Real Estate • You would think that there could not be a safer, surer investment than real estate • Real estate is land and anything attached to it, such as buildings or natural resources. • Real estate is considered the safest form of investment for one simple reason: • As population continues to increase and the demand for land increases, the supply of land remains the same

3. Real Estate • People buy real estate for a number or reasons • Most people buy property for the safety and security of owning their own home • Some people buy property to make income from it • Others buy unused property hoping its value will increase

4. Real Estate • How can you make a poor real estate investment • When demand decreases the value of real estate goes down • So lets say you buy a house in a certain location. One that has become unpopular or unattractive to others

5. Real Estate • People can also choose to sell at a poor time • They can pay too much for the house or through hidden costs • They might make a poor choice regarding the type of real estate in which they invest

6. Home Ownership • Buying a home is the most expensive purchase most people make in their lives. • The rule of thumb for your mortgage is that 40% of your income should be devoted to the housing expenses • Before buying a home, there are a number of factors to consider.

7. Types of Homes • There are different types of homes you can buy depending on your income and needs. • The most popular type of home is the single-family house. • It usually sits on its own lot, with its own yard. • It is separate from other buildings and provides privacy

8. Types of Homes • Single family houses range from modest two bedroom homes to huge mansions. • Multi-unit housing includes duplexes, townhouses, and condominiums. • Multi-unit houses are usually single buildings divided into various units, with a separate person or family living in each unit.

9. Types of Homes • They are like apartment buildings only the people who live in them own rather than rent the space • Mobile homes are usually produced in parts by a factory and assembled on a building site. • They are also known as prefabricated houses.

10. Types of Homes • The owner often does not own any land but rents the space for the house in a mobile home park • Because the parts of these homes can be mass produced cheaply, they usually cost much less than other types of houses.

11. Buying a Home • Few people have enough money to pay for a house in full and have to finance it with a home mortgage loan, or a long-term property loan. • To buy a house also requires a down payment, usually about 10-20 percent. • The down payment is money you have to come up with your self

12. Buying a Home • This means that if you want to buy a house for $100,000 you need $10,000-$20,000 for the down payment • Homebuyers often use the services of a real estate agent to help them find a home • A real estate agent is a person licensed to arrange the buying and selling of homes as well as other types of real estate.

13. Buying a Home • Real estate agents charge a fee for their services, but it is usually charged to the seller not the buyer • Once you find a house you’re interested in buying, it’s a good idea to hire a qualified building inspector. • A house that looks good on the surface might have serious plumbing or electrical problems.

14. Home Values • There are a number of factors that affect the value of a house, such as the size, condition, and location • Location is especially important. • A house that seems like a bargain might turn out to be in a bad neighborhood or in the path of a noisy airport

15. Home Values • If you buy a house in an area where many businesses are closing, the value of your house will go down. • For example, Division Line Road & Dayton Road

16. Home Equity • The amount of equity you have in a home is very important • Your home equity is the amount on the house you actually own as opposed to how much you owe. • As you pay off the mortgage on the house, your equity increases.

17. Home Equity • For example: if you make a $20,000 down payment on a $100,000 house and pay off $3,000 over 4 years, your equity in the house is $23,000 • Your equity also increases as the value of your home increases. • Suppose over 4 years the value of your house increased by $20,000 your equity is now $43,000

18. Advantages of Home Ownership • As a homeowner you can reap on some financial benefits • You can deduct the interest charges on your loan payments form you taxes • Property taxes are also deductible • Also the value of many homes rises steadily over time which means you can sell it for a profit

19. Disadvantages of Home Ownership • As with any investment, owning a home also has some disadvantages • Owning a home gives you less mobility. • A home is the least liquid of all investments. • You have to buy homeowner’s insurance and pay property taxes.

20. Disadvantages of Home Ownership • Maintenance and repairs can be very costly, and if neglected, lower the value of your home. • Property value doesn’t always go up.

21. Income Property • Another reason for buying real estate is to obtain income property, or property used to generate an income • A common type of income property is farmland for producing and selling crops • Land can also be used for raising sheep or cattle

22. Income Property • Natural resources found on land such as oil, timber, or gas, can be produced and sold • You can buy an apartment building and rent out the units to earn income.

23. Undeveloped Property • Undeveloped property is unused land intended only for investment purposes. • Usually the land is not cleared and has not utility services such as drinking water, sewage, or electricity • This type of land is often inexpensive to buy.

24. Undeveloped Property • Investors in undeveloped property hope that its value will increase sharply over the years • the land might be chosen as the site of a shopping center, housing development, or industrial park • But the land might not increase in value

25. Undeveloped Property • For example: a highway might be built leaving the land undeveloped • With undeveloped land, there is no return, like rent or the sale of crops.

26. 30 Year Fixed Rate Loan • The most common, and one of the most expensive types of loans in this country • Under this type of loan you get a certain loan amount (the principal) and to that amount is added a certain amount of interest. • Principal is the amount you pay for the house. If the house is bought for $100,000, then this is your principal amount

27. 30 Year Fixed Rate Loan • Let’s say that the loan amount is $100,000 and the fixed interest rate is 10%. • To calculate the first month’s information, take $100,000 and multiply it by .10 (10%) • $100,000 x .10 = $10,000 • This gives you the amount of interest you would pay on that loan in 1 year IF the principal stayed $100,000 for the entire year

28. 30 Year Fixed Rate Loan • This calculation will give you the amount of your first month’s interest. • Take $10,000 and divide it by 12 months • $10,000/12 = $833.33 • Payments on a $100,000 loan over 30 year @ 10% is $877.57 per month • So if you make a payment of $877.57 and interest is $833.33 how much goes towards interest?

29. 30 Year Fixed Rate Loan • $877.57 - $833.33 = $44.24 • This will give you a remaining balance of $99,955.76 • Again if you multiply this by 10% it will give you the total interest remaining to be paid. • $99,955.76 x .10 = $9,995.57 • $9,995.57/12 = $832.96 • $877.57 – 832.96 = $44.61

30. Interest Rates • Many people don’t realize how much difference a few percentage points in the rate means to both their monthly payment and the overall amount they will be paying for the loan • Let’s say you have a 30 year fixed rate loan of $275,000 @ 6%

31. Interest Rates • The payment on this loan would be $2,012.71 • Your total payments would be $593,557 • Of that $318,557 would be interest payments on your loan • What would happen if you increase the rate to or decrease the rate?

32. Interest Rates • As you can see the higher the interest rate, the higher your payment will be and less of that payment will go towards the principal

33. Adjustable Rate Loans • An adjustable rate loan is just that, a loan in which the interest rate adjust periodically. • Also known as an Adjusted Rate Mgtg (ARM) • This adjustment can occur daily, monthly, yearly, or in just about any interval decreed by the loan.

34. Adjustable Rate Loans • It can be based on the changing market, or maybe by a certain fixed percentage above prime rate. • Prime rate, or Prime Lending Rate, is a term applied in many countries to a reference interest rate used by banks. • Currently 3.25% year ago it was 5.25%

35. Adjustable Rate Loans • One problem with Adjustable Rates is that your payment will increase as your rate goes up • With the payment increasing and rate increasing as well, even though you are making a bigger payment less of it is going towards the principal. • Lets look at another pitfall that is very dangerous.

36. Adjustable Rate Loans • Let’s say we have a loan for $455,000 at an initial rate of 4%, and that rate is to adjust at 1% above each year up to 7%. • Our payment for a $455,000 loan @ 4% is $2512.33, which will stay the same through the whole loan. • So what do you think happens at 7%?

37. Adjustable Rate Loans • What happens is Negative Amortization • Negative amortization arises when the payment made by the borrower is less than the accrued interest and the difference is added to the loan balance. • Remember at the end of the 3rd year your interest rate was 6% which would put your balance at $433,703.46

38. Adjustable Rate Loans • Then the 7% interest kicks in for the remaining time of the loan. • Let see what happens. • Because your term was for 360 months, anything still due at the end of the term would come due and be payable at that time. • In this case it would be $452,872.20

39. Adjustable Rate Loans • Despite that you have just spent 30 years paying nearly one million dollars you still would owe money to pay it off.

40. Sub-Prime Loans, Interest Only Loans • Loans known as “Sub-Prime” refer to not the mortgages at an interest rate below prime rate, but rather to loans given to those with less than ideal credit. • People who do not have good credit who still want to buy a house and get desperate and get into a Sub-Prime loan

41. Sub-Prime Loans, Interest Only Loans • One example is an Interest Only Loan • Interest Only financing is a form of a loan in which a mortgage is structured such that the home buyer pays only interest on his loan each month for a specified period of time. • After this specified period of time, they either begin making standard payments of pay off the entire balance

42. Sub-Prime Loans, Interest Only Loans • The problem with the type of loan is that you are not putting any money towards the principal. • So for example if you buy a $100,000 house and have an interest only loan for 3 years, at the end of those 3 years you will still owe the $100,000

43. Points • Points is an amount of money equal to 1% of the amount of your loan • Points are additional fees you pay the lender • There are two primary types of fees charged in terms of points • Loan Origination Fee • Loan Discount Fee

44. Points • Loan Origination fee is usually one (1%) or two points (2%), of you loan amount, and charged by the bank for giving you the loan. • This is one way the bank makes more money on your loan. • Loan Discount fee depends on the market and the type of loan you get

45. Points • Let say for example you go into your bank to get a mortgage for a house • They pull your credit and tell you that you qualify for a rate of 9%. • You think to yourself that this is too high and you want to get it lower. • What you can do is pay for the discount fee to get a lower rate.

46. Closing Costs • Closing fees, also called settlement costs, cover almost every expense associated with your home loan. Because closing costs typically amount to between 3 percent and 5 percent of the sale price, it is best to wait until you receive the good-faith estimate before committing to a loan.

47. Closing Costs • Your lender is required by the Federal Real Estate Settlement Procedures Act to provide you with a good-faith estimate of the fees due at closing. This document, called the good-faith estimate, or GFE, is supposed to be provided to you within three days of applying for a loan. The requirement is satisfied if the good-faith estimate is mailed within three days.

48. Escrow • Mortgage escrow accounts ensure that homeowners' property taxes, fire and hazard insurance premiums, mortgage insurance premiums and other escrow items are paid in a timely fashion. They are a guarantee that there is always enough money to pay these bills when they are due so that the homeowner avoids the risk of lapsed insurance coverage or delinquent taxes.

49. Escrow • The most obvious advantage of escrow accounts is that they automatically budget the borrower's tax and insurance responsibilities over the course of a year. Homeowners do not have to worry about coming up with several large, lump sum payments, each with different due dates, throughout the year. If there is ever a fire in the home, or if the basement floods causing damage, the homeowner is assured that the home is protected by up-to-date insurance.

50. Escrow • Escrows protect the interests of investors in home mortgage loans. By making home mortgages more attractive and secure as investments, escrowing has led to a healthier mortgage market. As a result, loans with better terms and lower down payments are available to homebuyers.