7

Selecting and Financing Housing

Evaluating Renting and Buying Alternatives • Your lifestyle and your choice of housing – How you spend your time and money – Every buying decision = lifestyle statement • Personal preferences vs. financial factors • Traditional financial guidelines : – Spend no more than 25-30% of take-home pay on housing, or – No more than 2 1/2 times your annual income – More difficult to do in inexpensive urban areas 7-1

Objective1 Assess Costs and Benefits of Renting

Choice should be based on: – Lifestyle (do you like or want to do maintenance tasks?) – Financial factors (e.g., affordability, tax deductions, equity) – Mobility vs. permanence (are you able to “settle down”?) – Renting = less costly in short run (monthly payment) – Home ownership =long-term financial advantages (tax deductions and equity growth over time) 7-2

Renting vs. Buying Housing

Advantages RENTING vs. BUYING Disadvantages Renting Easy to move Fewer responsibilities for maintenance Minimal financial commitment No tax benefits Limitations regarding remodeling Restrictions regarding pets, etc Pride of ownership Financial benefits Lifestyle flexibility Buying Financial commitment Higher living expenses than renting Limited mobility

7-3

Rental Activities

• Selecting a rental unit – Apartment or house • Advantages of renting – Easier to move – Fewer maintenance responsibilities – Minimal financial commitments • Disadvantages of renting – No tax benefits – “Money down the drain” (not building equity) – Limitations regarding remodeling – Restrictions regarding pets and other activities 7-4

Legal Details of a Lease

• Description and address of property • Name and address of the owner/landlord

(lessor)

• Name of tenant

(lessee)

• Effective date and length of the lease • Amount of security deposit • Amount and due date of rent • Date and amount for late rent payments • List of included utilities, appliances, etc.

• Restrictions on certain activities (e.g., pets, remodeling) • The right to sublet the unit; transfer clause • Conditions under which landlord may enter unit 7-5

Objective 2 Implement the Home-Buying Process

7-6

Home Buying Activities

Step 1: Determine Homeownership Needs

•

Evaluate Home Ownership

– Stability of Residence • American dream/norm (personalized living location) – Financial Benefits • Deduct property taxes, mortgage interest • Potential increase in value of your home • Building equity in your home – Lifestyle Flexibility – Can Express Your Individuality •

Drawbacks of Homeownership

– Financial Uncertainty • Obtaining money for the down payment • Obtaining mortgage financing • Home values could drop; can go “underwater” and lose money – Limited Mobility • Can take time to sell your home – Higher Living Costs (Than Renting) • Maintenance, repainting, repairs, and home improvements • Rising real estate taxes 7-7

Home Buying Activities

Types of Housing Available

• Single-Family Dwelling • Multi-Unit Dwelling – Duplex (two homes) – Townhouse (2, 4, or 6 units) • Condominium – Individual ownership of a unit in a building – “Condominium” ≠ a type of building structure – “Condominium” = a legal form of homeownership • Cooperative Housing – Units owned by a non-profit organization – Shareholders purchase stock for right to live in unit in building with multiple units • Manufactured Homes – Fully or partially assembled in a factory, and then moved to the housing site – Prefabricated = components factory-built and assembled at the site – Mass production under factory conditions keeps costs lower than site-built homes 7-8

Home Buying Activities Types of Housing Available

Mobile Homes

– Type of manufactured home, often <1,000 sq. ft.

– Same basic features as a conventional house – Safety is debated – Tend to depreciate in value (like cars) – Owners must own the land or rent the “pad” on which mobile home is placed 7-9

Home Buying Activities Types of Housing Available

•

Building a Custom Home:

– Does the contractor have needed experience?

– Does contractor have a good working relationship with: - Architect?

- Suppliers?

- Electricians?

- Plumbers ?

- Carpenters?

– What assurance do you have about quality?

– What are payment arrangements?

– What delays will be considered legitimate?

– Is the contractor licensed and insured?

– Are there any complaints about this contractor?

– Contract should have a time schedule, cost estimates, description of work, and a payment schedule 7-10

Home Buying Activities Determine What You Can Afford

– Consider both price and quality – Look at your income, your current living expenses, and how much you have for a down payment – Have a loan officer prequalify you •

Front-End Ratio-

monthly payment for PITI should not exceed 25% to 29% of gross income •

Back-end Ratio-

monthly payment for PITI plus ALL CONSUMER DEBTS should not exceed 33% to 41% of gross income – Purchase what you can afford NOW - you can always move up – Buy a “fixer-upper” at a lower price ONLY if you have the time, skills, and money to fix it up 7-11

Home Buying Activities Step 2: Find and Evaluate a Home

• Select a

location, location, location

– Be aware of zoning laws – Assess the school system-if you have children OR not • Services of real estate agents – Will show homes that meet your needs, present your offer, negotiate the price, assist in obtaining financing, and represent you at the closing – Commission paid by seller; built into price – Seller’s agent, Dual agent, or Buyer’s agent • The Home Inspection – Conduct a home inspection or hire an inspector – Mortgage company will require an appraisal 7-12

Home Buying Activities Step 3: Price the Property

•

Determine the Home Price

– Price affected by selling prices in the area – Current demand for housing – Time home has been on the market – Owner’s need to sell – Financing options – Features and condition of the home •

Negotiate the Purchase Price

– Counteroffers are common – Earnest money • Portion of the price deposited as evidence of good faith – Contingency clause • Offer dependent on certain events: – Obtaining financing – Sale of current home 7-13

Objective 3 Determine Costs Associated with Purchasing a Home

• The Finances of Home Buying: The Downpayment and The Mortgage

Step 4: Obtain Financing

• Determine down payment amount – Large (> 20%) downpayment makes the process easier • Mortgage insurance if < 20% down (PMI) • Automatic PMI termination when equity =>22% – Required by Homeowners Protection Act • Feature of a mortgage: LEVERAGE (using other people’s money; magnifies a home’s gain or loss) 7-14

Home Buying Activities The Mortgage

• • • Long-term loan on a specific piece of property (e.g., primary home or other real estate) Usually 10, 15, 20, 25, or 30 years Three main phases 1. Complete application and meet with lender to provide evidence of qualification 2. Lender obtains credit report and verifies application 3. Mortgage is approved or denied – Lender commits to make loan for a set period; check lender’s interest-rate lock-in rules 7-15

Home Buying Activities The Mortgage

• Qualifying for a mortgage includes: – Income – Debts – Credit history (700+ score) – Down payment amount – Length of the loan – Current mortgage rates • “Points” = prepaid interest as a % of loan amount – Each point =1% of the loan amount – Premium paid to obtain a lower mortgage rate 7-16

Home Buying Activities The Mortgage

• • • Loan for which you qualify will be greater when rates are lower • Calculating the monthly principal and interest payment: – Exhibit 7-7 = Mortgage payment factors (page 230) – Example: • 30-year, 7%, $223,000 mortgage • Monthly payment = 223 X $6.65 = $1,482.95

• Payment = Principal repayment + interest • PITI = payment + taxes + insurance

Fixed-Rate, Fixed-Payment Mortgage

– Fixed rate, fixed payment, amortized – 5%, 10% or 20% down – 15, 20 or 30 years of fixed payments

Government-Guaranteed Financing Programs

– Veterans Administration (VA) – Federal Housing Authority (FHA) – Lower down payment than conventional 7-17

Home Buying Activities Types of Mortgages

• • • • •

Adjustable Rate Mortgage (ARM)

– – –

Flexible-rate

or

variable-rate

mortgage – Interest rate varies over the life of the loan

Rate cap

restricts amount of change in rate

Payment cap

restricts amount of change in payment • Can result in

negative amortization

Convertible ARM

– Allows conversion to a fixed rate during a certain period

Balloon Mortgage

– Fixed monthly payments – Large final payment after 3, 5, or 7 years

Growing-Equity Mortgage (GEM)

– Payments increase to allow loan to be paid off more quickly

Interest-Only Mortgage

– Lower payments for the first few years – Payments go towards interest only 7-18

Home Buying Activities Other Financing Options

• • •

Shared Appreciation Mortgage (SAM)

– Borrower gets a lower interest rate – Agrees to share appreciated value of home with the lender

Second Mortgage

– Home equity loan (fixed payments) or HE Line of credit to tap – Home = collateral – Interest may be tax deductible

Reverse mortgages

–

Home equity conversion mortgage

– Provides homeowners who are 62+ with tax-free income based on home equity; high up-front costs • •

Mortgage Repayment Strategies Refinancing

– Consider costs of refinancing in decision

Making extra payments

– Reduces payoff time & interest paid 7-19

Home Buying Activities

Step 5: Close the Purchase Transaction

• • Make arrangements for a

walk through

– Last-minute items for negotiation

Closing

– Meeting including buyer, seller, lawyers (if any) and sometimes lender – Document signing – Last-minute details settled; expense payments – Closing costs = settlement costs – Real Estate Settlement Procedures Act • Requires buyers be given closing costs estimate before the closing 7-20

Home Buying Activities Closing Costs

• • • • • • • • • • • • • • Title insurance and search fee Attorney’s and appraisers fees Property survey Pest inspection Recording fees Transfer taxes Credit report Lender’s origination fee Escrow account for tax and insurance reserve Pre-paid interest Real estate broker’s commission

Title Insurance

– Title company defines boundaries of property – Title search to insure property is free of claims – Protects against future defects in title

Deed

– Document that transfers ownership –

Warranty deed

guarantees the title is good • • Seller is true owner with right to sell the property No outstanding claims against the title

Escrow Account

– Money deposited with lending institution for payment of taxes and insurance 7-21

Objective 4 Develop a Strategy for Selling a Home

Preparing your home

– Repair, repaint, clean, reduce clutter – When showing home, “Stage It”: • Turn on lights • Open draperies • Bake bread or make coffee for welcoming smell • “Curb appeal” – Lawn and landscaping – Outdoor clutter – Exterior paint 7-22

Selling Your Home

• •

Determining the selling price

– Appraisal = estimate of the current value

“For Sale by Owner”

– Use a lawyer or title company – Time consuming for seller •

Listing with a Real Estate Agent

– Consider agent’s knowledge of the community – Various services and marketing efforts – Screens potential buyers 7-23

Wrap Up

• Chapter Quiz • Concept Check 7-1- Rent or Buy?

• Concept Check 7-2- Quality of School for Childless Home Buyers?

• Concept Check 7-3- Main Sources of Money for Downpayment? and Type of Home Financing Action?