Chapter 9

Garman/ForguePersonal Finance

Ninth 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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IntroductionMortgage: Loan to purchase real estate in which

the property itself serves as collateral.

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Facts & Figures:

• 90% of young people rent• 80% of people 55-64 own homes

Is a home an investment or just a place to live?

CONSIDER

Housing values typically

increase less than 4% annually

Since 2006, home prices

have declined 20-50% in most

markets

Why the recent explosion in mortgage

foreclosures?

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Should you rent or buy? Short-term: renters win, based on

initial upfront costs

• Rent• Damage/security deposit• Lease contractPeriodic tenancyTenancy for specific timeSubleasing Your rights w/o a lease (pg 250)

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Long-term: homeowners win, when income taxes and

appreciation are considered

• Equity and Appreciation• Deductibility of items on taxesReal estate taxesMortgage interest

• Beware of flipping• Being “upside down” (under water)• Foreclosure• Strategic default (pg 253)

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Most up-front costs are due at the closing (PG 255)

** Closing costs can range 2-10% of loan ** Down payment Attorney fees Title search/insurance Home inspection Appraisal fee Points … and many more!

What does it cost to buy a home?

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Points• Homebuyers can “buy down” the interest rate on their loan• 1 point = 1% of 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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Important Terms to Understand• Monthly payments include principle & interest • Property taxes & homeowners insurance may be

ESCROWED: PITI• Loan-to-value ratio (LTV) (Lenders expect 80%)

– Ex: $80,000 mortgage ÷ $100,000 home value = 80%• PMI if LTV is too high (pg 257)

– Protects who? Paid for by who?

The New Realities of Home Buying (pg 258)Historically

Low Interest Rates

Tougher Lending

StandardsA Buyer’s

MarketLarger Down

Payments

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How are property taxes determined? (pg 259)

• Based on the ASSESSED VALUE of buildings and land

• Many people appeal their assessed value… and win!

• How does NY compare? http://www.osc.state.ny.us/localgov/pubs/research/propertytaxes.pdf

ADVICE:Decide Based on ALL Costs!

(Average 30-40% added to loan payment for all other housing costs)

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Steps in Home Buying

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1. Get your finances in order• Clean up your credit! • Use Internet to Estimate Housing Costs

2. Prequalify for Loan (Determine your own affordability first!)Front-end ratio: PITI compared to gross income

– PITI should not exceed 25-29% of gross incomeBack-end ratio: PITI + all other monthly debt (car, student loans, etc) compared to gross income

– Should not exceed 33-41% of gross income

3. Search for home online and in person

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4. Agree to terms with seller (NEGOTIATE!)• Make offer; counteroffer• Specify conditions (contingency clauses)• Sign purchase contract

5. Formally apply for Mortgage Loan• Good faith estimate• Mortgage lock-in rate

6. Prepare for closing• Hire your own inspector• Hire your own attorney

7. Closing Day! Uniform Settlement Statement

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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

• A mortgage is an amortized loan (pg 269)• How are monthly payments divided between P & I?

– See chart page 268

• Equity = Market Value of Home - Loan Balance• Some people made additional payments on loan

– Affect of this?

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Amortization Table for Fixed Rate LoansMonth Payment Loan

Balance Interest 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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3 Factors Affect the Mortgage Payment

• The Amount Borrowed (see chart pg 270)• The Interest Rate

– SHOP AROUND! Even tiny increments make a HUGE difference

• The Length of the Loan

• Conventional Fixed-Rate• ARMs (variable-rate loans)

• Teaser Rate• Rate Caps

<= where is the risk?

Types of Mortgages

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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?– Caps helps to reduce some risk– Considerations when evaluating Fixed vs. ARMs

What’s the best choice for you?

The Main Types of Mortgages

Locale rates

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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 or Home Equity Line of Credit• Rates slightly higher than first mortgages• “Eating one’s house”• Fin PP pg 276

– Mortgage Refinancing

Alternative Mortgages

Traditional limit for HELs and HELOCs: 80% of MV less loan

balance (pg 274).