The housing decision
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The Housing Decision. Chapter 8. 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

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Your personal housing requirements l.jpg
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

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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%)

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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

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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)

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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

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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

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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

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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

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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

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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

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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

Table 8 1 sample amortization table l.jpg

Source: Based on data from Survey of Consumer Finances, Fannie Mae, and

Table 8.1: Sample Amortization Table

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Source: Based on data from Survey of Consumer Finances, Fannie Mae, and

Figure 8.3: Breakdown Between Principal and Interest on Mortgage Loan

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Closing Costs Fannie Mae, and

  • 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

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Closing Costs Fannie Mae, and

  • 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

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Sources of Mortgage Loans Fannie Mae, and

  • 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

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Types of Mortgages Fannie Mae, and

  • 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

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Types of Mortgages Fannie Mae, and

  • 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

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Types of Mortgages Fannie Mae, and

  • 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

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Types of Mortgages Fannie Mae, and

  • 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

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Types of Mortgages Fannie Mae, and

  • 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%)

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Types of Mortgages Fannie Mae, and

  • 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

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Refinancing a Mortgage Fannie Mae, and

  • 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

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Second Mortgages Fannie Mae, and

  • 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

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Second Mortgages Fannie Mae, and

  • 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!

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Finding the Right House to Buy Fannie Mae, and

  • 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

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Using a Real Estate Agent Fannie Mae, and

  • 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)

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Home Inspections Fannie Mae, and

  • 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

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Home Warranties Fannie Mae, and

  • 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

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Selling a Home Fannie Mae, and

  • 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

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Fixing Up Your Home Fannie Mae, and

  • 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

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Taxes and the Sale of Your Home Fannie Mae, and

  • Most homeowners will never pay federal taxes on the sale of their home

  • However, it is important to keep good records