Chapter 32 Real Estate
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
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
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
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
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.
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
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.
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.
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.
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
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.
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.
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
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
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.
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
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
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.
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.
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
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.
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.
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
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.
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
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
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?
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
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%
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?
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
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.
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%
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.
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%?
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
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
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.
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
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
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
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
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
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.
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.
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.
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.
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.
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.