Transcript Buying a Home - Brigham Young University

BYU Student Alumni Conference
Buying a Home
March 1, 2014
Bryan Sudweeks, Ph.D., CFA.
From the Marriott School of Management’s
“Personal Finance: Another Perspective” web site at
http://personalfinance.byu.edu
from lessons on Understanding Credit
Understanding Consumer and Mortgage Loans, and
The Home Decision
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Session Summary
Buying a home is for most the single largest purchase
for most families and individuals. Yet many put the
same effort into buying a home as they would into
buying a camera or TV. You should spend
significantly more time in the home buying process
as it will save you significant amounts of money in the
long-run. This presentation gives suggestions where I
believe that most of that research and time should be
spent. I discuss perspective, the risks of home
ownership, and a four step process for buying a home.
My overall advice is to follow a prophet who
counseled us on what his father said: “Buy a modest
home, make it beautiful, and pay off the mortgage as
quickly as possible.”
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Definition
House: a hole in the middle of the
yard that you pour money into.
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Objectives
• A. Understand perspective
• B. Understand risks in home ownership
• C. Understand the Four-Step Process for
Buying a Home:
• Step 1. Understand your limits
• Step 2. Find your home
• Step 3. Negotiate your loan
• Step 4. Enjoy home ownership
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A. Understand Perspective
• What is our perspective?
• We all have lists of what we could and should do in
our [ priesthood ] responsibilities. The what is
important in our work, and we need to attend to it. But
it is in the why of [priesthood service] that we discover
the fire, passion, and power. The what of [priesthood
service] teaches us what to do. The why inspires our
souls. The what informs, but the why transforms. . .
My prayer is that . . . we will ever stay attuned to the
why of [priesthood service] and use the principles of
the restored gospel to transform our lives and the lives
of those whom we serve (italics, color and brackets
added, Dieter Uchtdorf, “The Why of Priesthood
Service”, Ensign, May 2012).
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Perspective (continued)
• We all have lists of what we could and should do in
our [personal finance] responsibilities. The what is
important in our work, and we need to attend to it. But
it is in the why of [ personal finance ] that we discover
the fire, passion, and power. The what of [ personal
finance ] teaches us what to do. The why inspires our
souls. The what informs, but the why transforms. . .
My prayer is that . . . we will ever stay attuned to the
why of [ personal finance ] and use the principles of
the restored gospel to transform our lives and the lives
of those whom we serve (italics, color and brackets
added, Dieter Uchtdorf, “The Why of Priesthood
Service”, Ensign, May 2012).
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Perspective (continued)
• What are the “whys” of personal finance?
• I believe we apply personal finance in our lives to:
• 1. Learn the lessons that personal finance can
teach us to help us come to and become more
like our Savior Jesus Christ—to bring us to
Christ
• 2. To learn the things and acquire the resources
needed to prepare for and accomplish our divine
missions for which we were sent here on earth
• 3. Help us return with our families back home
to our Savior and Heavenly Fathers’ presence
• 4. Become wise stewards over the things we are
blessed with
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Perspective (continued)
• On what is that perspective based?
• 1. Ownership: Everything we have is the Lords
• Things we have are not ours but on loan
• 2. Stewardship: We are stewards over all God
shares with us
• We must learn to be better stewards
• 3. Agency: the gift of choice is a wonderful gift
• We must used that agency wisely
• 4. Accountability: We will be held accountable for
all our choices in life
• We must make the best choices we possibly can
as we will be held accountable for them
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Perspective (continued)
• We have received wise counsel on the subject
of buying a home
• President James E. Faust stated:
• Over the years the wise counsel of our
leaders has been to avoid debt except for
the purchase of a home or to pay for an
education. I have not heard any of the
prophets change this counsel (“Doing
the Best Things in the Worst Times,”
Ensign, August 1984, 41).
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Perspective (continued)
• President Gordon B. Hinckley commented:
• We have been counseled again and again
concerning self-reliance, concerning debt,
concerning thrift. When I was a young man, my
father counseled me to build a modest home,
sufficient for the needs of my family, and make it
beautiful and attractive and pleasant and secure. He
counseled me to pay off the mortgage as quickly as
I could so that, come what may, there would be a
roof over the heads of my wife and children. I was
reared on that kind of doctrine (italics added,
Gordon B. Hinckley, “The Times in Which We
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Live,” Ensign, Nov. 2001, 72).
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Perspective (continued)
• He further counseled:
• I recognize that it may be necessary to borrow to get
a home, of course. But let us buy a home that we can
afford and thus ease the payments which will
constantly hang over our heads without mercy or
respite for as long as 30 years. … I urge you to be
modest in your expenditures; discipline yourselves
in your purchases to avoid debt to the extent
possible. Pay off debt as quickly as you can. …
That’s all I have to say about it, but I wish to say it
with all the emphasis of which I am capable (italics
added, Gordon B. Hinckley, “To the Boys and to the
Men,” Ensign, Nov. 1998, 51).
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B. Risks in Home Ownership
• There are significant risks in home ownership:
• You buy too big a house
Your other goals (missions, etc.) are not met
• You buy a fixer-upper without the skills or time
It stays a fixer upper
• You buy the wrong type of house for your lifestyle
You must pay others to keep it up
• You buy a house without the necessary inspections
You pay dearly for someone else’s problems
• You buy a more expensive house than you can afford
You lose your house, credit, and your self-respect
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Risks in Home Ownership (continued)
• The single biggest mistake young couples
make out of school that impacts them the most
financially is they purchase too big a house
• Their other goals cannot be realized as they are
paying so much for their house
• They go farther and farther into debt to furnish
and maintain the house
• They cannot save for their other short-term and
long-term family goals as they have little after
housing costs to save
• Their marriages and families suffer from the
added financial strain
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C. Understand the Home Buying Process
• Purchasing a house is a four-step process:
• Step 1. Understand your limits
• Know yourself, what you can afford and what
you need when
• Step 2. Find your home
• Make sure you know what you want, and get it
• Step 3. Negotiate your loan
• Know what lenders need and be ready
• Step 4. Enjoy home ownership
• Realize you are a steward over all God has
blessed you with. Be the best you can be
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Step 1. Understand your Limits
• Know yourself and your limits relates to 8 areas:
• a. Know your budget and how much you can
afford
• b. Know your credit score
• c. Calculate your front and back-end bank
ratios
• d. Calculate your bank ratios for LDS
• e. Choose your preferred loan type and term
• f. Know what you need for a down payment
and upfront costs
• g. Have two years of copies of taxes
• h. Get pre-approved
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1.a. Know Your Budget and
How Much You Can Afford
• YOU MUST HAVE and Live on a Budget
• President Spencer W. Kimball said:
• Every family should have a budget. Why, we
would not think of going one day without a
budget in this Church or our businesses. We
have to know approximately what we may
receive, and we certainly must know what we
are going to spend. And one of the successes of
the Church would have to be that the Brethren
watch these things very carefully, and we do not
spend that which we do not have (Marvin J.
Ashton, “One for the Money” pamphlet,
Intellectual Reserve, 1992, inside cover).
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Budgeting: The Old Way
Income
Tithing
Expenses
Available for
Savings
Personal Goals
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Budgeting: A Better Way
Income
Pay the
Lord
Pay
Yourself
Expenses
Other
Savings
Personal Goals
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A Better Way (continued)
• Elder L. Tom Perry said:
• After paying your tithing of 10 percent to the
Lord, you pay yourself a predetermined amount
directly into savings. That leaves you a balance
of your income to budget for taxes, food,
clothing, shelter, transportation, etc. It is
amazing to me that so many people work all of
their lives for the grocer, the landlord, the
power company, the automobile salesman, and
the bank, and yet think so little of their own
efforts that they pay themselves nothing (L.
Tom Perry, “Becoming Self-Reliant,” Ensign,
Nov. 1991, 64).
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1b. Know Your Credit Score
• Know your Credit History
• Review your credit history every year from all three
agencies
• Three major credit reporting agencies
• Experian (www.experian.com), Equifax
(www.equifax.com), and Transunion
(www.tuc.com)
• You can get a free copy of your credit report
from each agency each year by going to:
• www.annualcreditreport.com
• Fill out the info and you can get a copy online
• Make sure it is correct
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Know Your Credit Score (continued)
• Get your Credit Score
• After checking your credit report for errors, order a
copy of your credit score. I recommend a FICO
score. You can order it directly from FICO at
www.myfico.com for $19.95 (less with coupons)
• What determines your Credit Score or lending risk?
• Payment History: What is your payment record?
• Amounts Owed: How much do you owe?
• Length of Credit: How established is yours?
• New Credit: Are you taking on more debt?
• Types of Credit Use: Is it a healthy mix?
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1c. Know your Front- and Back-end Bank
Affordability Ratios
• Know the rules for lenders
• Know your affordability ratios
• Ratio 1: Housing Expenses or front-end ratio
• This ratio calculates what percent of an your
income is used to make basic mortgage payments
• Housing expenses should be less than 28% of your
monthly gross income. The formula is:
Monthly PITI* <28%
Monthly Gross Income
*PITI = mortgage principle, mortgage interest,
property taxes, and property insurance
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Affordability Ratios (continued)
• Ratio 2: Debt Obligations or back end ratio
• This ratio calculates what percent of your income
is used for housing expenses plus debt obligations.
• It should not exceed 36% of your monthly gross
income. The formula is:
Monthly PITI* and other obligations < 36%
Monthly Gross Income
*PITI = Mortgage principal, mortgage interest,
property taxes, and property insurance
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1d. Calculate Your Ratios for LDS
• As members of the Church, we have other important
obligations that we also pay, i.e., tithing and paying
ourselves, i.e., saving
• As such, should have smaller houses (at least less
expensive), because we pay the Lord first and
ourselves second.
• For a spreadsheet that takes into account the fact that
we pay the Lord first and ourselves second within this
front-end and back-end ratio framework, see:
• Teaching Tool 7: Maximum Monthly Mortgage
Payments for LDS Spreadsheet (from the
website)
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1e. Choose your Preferred Loan Type
and Loan Term
• Choose your preferred loan type
• The best type of loan takes into account your:
• Goals, budget, income stream, down payment,
and view on risk
• There are a number of different types of mortgage
loans available. These include:
• Fixed Rate (FRMs) - RECOMMENDED
• Variable or Adjustable Rate (ARMs)
• Interest Only (IO): Variable or Fixed Interest
• There are also special loans (if you can get them)
• FHA (best for students) or VA (if military)
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Fixed Rate Mortgages (FRMs)
• These are mortgage loans with a fixed rate of interest
for the life of the loan. This is what I recommend
• Benefits
• Higher but constant payments—you pay down
principle faster
• No risk of negative amortization
• Interest rate risk is transferred to the lender
• Risks
• Interest rates are higher
• Higher monthly payments may make payments
more difficult, particularly for those not on a
regular salary
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Fixed Rate Mortgages (continued)
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Adjustable Rate Mortgages (ARMs)
• Mortgage loans with a rate of interest that changes
periodically over the life of the loan
• Benefits
• Lower initial interest rates
• Generally lower monthly payments, as you
assume the interest rate risk
• No risk of negative amortization
• Risks
• You assume the risk that interest rates rise
• Possible “payment shock” as interest rates rise,
perhaps beyond what you are able to pay
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Adjustable Rate Mortgages (continued)
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Interest Only Options (Fixed or Variable)
• These are FRMs/ARMs with an option that allows
interest only payments for a set number of years. After
that, payments are reset to amortize the loan over the
remaining years of the loan (it is not like a credit card)
• Benefits
• Lower monthly payments as you are paying
interest.
• You can afford more house due to lower payments
• Risks
• There will be a major rise in payments when the
interest only period ends
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• There is no paying down of principle
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Interest Only Options (continued)
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Mortgage Loans (continued)
• Insured Loans
• FHA (Federal Housing Administration) Insured
Loans
• FHA does not originate any loans, but insures the
loans issued by others based on income and other
qualifications
• There is lower PMI insurance, but it is required for
the entire life of the loan (1.5% of the loan)
• While the required down payment is very low, the
maximum amount that can be borrowed is also
low
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FHA Loans
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Mortgage Loans (continued)
• Guaranteed Loans
• VA (Veterans Administration) Guaranteed Loans
• These loans are issued by others and guaranteed
by the Veterans Administration
• Are only for ex-servicemen and women as well
as those on active duty
• Loans may be for up to 100% of the home value
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VA Loans
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Recommended Loan Term
• Choose your loan term
• Generally, I recommend a 30 year fixed rate loan
• However, I recommend you make additional
payments on principal to pay off the loan sooner
if possible after you have 3-6 months income in
your emergency fund
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1f. Know How Much You Need for a Down
Payment and Upfront Costs
• Know what you will need for a down payment
and upfront costs, and begin saving for it
• Down payments:
• You will need a larger down payment to get into
your home now versus two years ago
• Begin saving for that now
• Conventional loans – 20 % recommended,
but you can get in with 5%
• FHA loans – 3.5%
• VA loans – 0% no down payment required
• Once you realize how hard it is to save, it will help
you not to spend too much
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Down Payment and Up-front Costs (continued)
• Upfront costs include closing costs and points
• Down payment (3-20 percent of the loan amount)
• Closing costs including points (3-7 percent)
• Closing costs include:
• Title insurance
• Attorney’s fee
• Property survey
• Recording fees
• Lender’s origination fee
• Appraisal
• Credit report
• Termite inspection
• Prepaids (property insurance
& taxes, mort. interest)
• Points
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Up-front Costs (continued)
• What are points?
• One percent or one hundred basis points of the loan
• This money is paid to the mortgage broker (not the
lender), is deducted from the loan proceeds (you
still must pay it back), and is essentially another fee
for helping you arrange the loan (minimize points)
• Why do lenders charge points?
• To recover costs associated with lending, to
increase their profit, and provide for negotiating
flexibility
• Do I have to pay points?
• Origination points (likely), buy-down points (no)
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1g. Have Copies of 2 Years of Taxes
• Lenders want confirmation that you can pay
back the loan
• As such, they generally want to see two years of tax
records
• Have copies of your last two years of tax
records, even though you were a student
• If you have a confirmed job letter with salary, that
may also be helpful as well
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1h. Get Pre-approved—Not Pre-qualified
• Get pre-approved for your loan by a
number of lenders
• Pre-approved means that lenders have pulled your
credit score, looked at your tax records and
approved you for a specific amount of a loan
• You can borrow up to this pre-approved amount
without a problem
• I recommend you check with multiple lenders
• Remember however that you do not need to borrow
that amount
• I recommend that you borrow less than that
amount
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Step 2. Find Your Home
• There is a six step process to finding your
home:
• a. Determine what is important to you
• b. Develop a plan for finding a home
• c. Use a realtor/team approach to find a home in
your price range
• d. Once you are serious about the home, get a home
inspection (offers can be contingent on the home
inspection)
• e. Determine any CCRs/fees for potential homes
• f. Negotiate the price
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2a. Determine what is Important To You
• Determine what is important to you and what
you will and will not do without!
• This may include:
• Location
• Home style and layout
• Future plans, i.e., kids, work, schools, etc.
• Realize that you will probably move within five to
seven years (if you are like the average family)
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2b. Develop a Plan
• Establish a Plan for finding your home
• Once you know your limits, what you can afford,
where you want to be, and what you want (your
Plan), then:
• Start driving around
• Start looking in earnest
• But keep to your plan
• Use Zillow.com or other resources to find current
home values in other areas you may be interested in
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Develop a Plan (continued)
• Be Patient and take your time
• Estimate the time you will be in the house
• If it is less than 3-5 years, look into renting
• You must make 6-7% on your house price just to
break even when you sell it (realtor fees are 67%)
• You will be in the house for years—don’t make the
decision to quickly
• It will likely be your largest financial
commitment you will make for a long time
• Often renting a luxury apartment for 6 months will
give you time to search thoroughly
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2c. Use a Realtor/Team Approach
• Get a good realtor
• While realtors are working for sellers, it may be
wise to have a buyer’s broker that works for you
• They should know the ins and outs of the
neighborhood you are looking at
• Take matters into your own hands
• Be proactive—talk with friends and others
• Use the internet and other tools that may help
• Stay true to your Plan and have patience
• Be liquid and ready to react quickly
• Be creative if necessary
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Realtor/Team Approach (continued)
• Use a team approach—get lots of good help
• Use others to help
• Buyers broker
• Appraiser
• Attorney
• Don’t become emotionally attached to a potential
house
• Be willing to walk away
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2d. Have a home inspection
• Once you have found the home you like, can
afford, and is where you want to live, have a
home inspection
• This may alert you to potential problems with the
home
• Many of thee problems should be fixed by the
seller prior to purchase
• Don’t buy someone’s problems
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2e. Determine any CCRs/fees for potential homes
• Look to potential homes and potential costs
• Look through all Covenants, Conditions and
Restrictions (CCRs) for a potential home
• These can be quite restrictive as to what you can
and cannot do with your home
• For condos or town homes, determine the amount of
the transfer/setup fees
• Understand any other homeowners/association fees
for potential homes and what they include
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2f. Negotiate the Price of the Home
• Use the best available resources to negotiate a
price for the home
• Use wisdom and judgment in determining what
you can and should pay for the home
• Realize your best negotiating technique is
walking away
• This is a negotiation process—do not be afraid to
haggle
• Realize that closing costs, things that need to be
fixed, and other things can all be part of the
negotiated price
• Most things are negotiable
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Step 3. Negotiate the Loan
1. You’ve found a home
that suites your lifestyle
and budget, using
resources such as a
realtor.
2. The realtor refers you
to a mortgage broker.
3. The broker pulls
credit, determines your
needs and tries to find
lenders among the
competition to meet
those needs.
8. Lender sends out the
documents to escrow for
signing
7. Broker, Title, Escrow, and
Lender work to fill all
conditions
9. Lender audits the
documents, verifies all
conditions are filled, and
funds the loan!
6. Lender takes the loan
package, structures the loan
and conditions for any
additional information they
need to close the deal.
4. Each lender has unique
programs. Lender and
broker negotiate points,
rates, fees, and other
features of the loan.
5. Broker recommends the
best loan to the consumer,
reviewing the features
agreed upon. Consumer
makes the final decision.
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The Lending Process
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Negotiate the Loan (continued)
• Negotiate the loan—this is the final part of the
process. It is a three-step process
• a. Choose multiple lenders to compete for your
business and get Good Faith Estimates from each of
your lenders
• b. Take the various loan offers from the lenders and
calculate your lowest Effective Interest Rate
• c. Find the best rate from the multiple lenders and
take it to your favorite lender and ask him to beat it
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3a. Choose Multiple Lenders and Get Good
Faith Estimates
• You will get a lower interest rate when lenders
compete for your business
• Work with multiple lenders
• Talk with friends and others who have gone
through the process for their favorite brokers
• Hold brokers accountable for what they say
• Get Good Faith Estimates from each lender (not just a
Summary)
• These are the costs you will likely pay
• Compare GFEs from each lender
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3b. Calculate your Effective Interest Rate
• Estimate how long you will be in the home
• This is important as it helps determine over what
period you can allocate points and other costs
• Calculate your effective interest rate for each
loan
• Your effective interest rate is the interest rate you
will pay after all your points, costs, and fees are
taken into account
• Get your best rate
• The lowest effective interest rate is the best
indicator that you got a good rate on your loan
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3c. Negotiate with Your favorite Lender for
the Best Rate
• The key now is to find the lowest rate
• Once you have multiple offers from multiple
lenders, then you have bargaining power
• Determine your lowest rate, which includes points,
fees, and the loan APR after evaluating each of the
offers from the various lenders
• You can take that offer if you want
• Or, you can that offer to your favorite lender
• Then ask them to beat it by 1/8 to ¼ percent and
you will go with them
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Step 4. Enjoy Home Ownership
• Enjoy home ownership
• Maintain it well
• Take care of your purchase and it will take care
of you
• Generally it will take roughly 1% of the
home’s value annually for upkeep. Budget
accordingly
• A professional cleaning a few times a year
can help retain a home’s value
• Now keep the value of your home up!
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Summary
• Keep Buying a house in its proper perspective
• Its part of your personal goals—but not the only
goal
• Keep striving to be financially self reliant
• The habits you develop now will last a
lifetime
• Remember what our leader’s have said about home
ownership
• Buy a modest home that you can afford, and pay
it off quickly)
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Summary (continued)
Our perspective is that personal finance is part of the
gospel of Jesus Christ. It is based on four principles:
• 1. Ownership: Everything we have is the Lords
• Things we have are not ours but on loan
• 2. Stewardship: We are stewards over all God
shares with us
• We must learn to be better stewards
• 3. Agency: the gift of choice is a wonderful gift
• We must used that agency wisely
• 4. Accountability: We will be held accountable for
all our choices in life
• Including our financial choices
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Summary Step 1: Understand your Limits
• Knowing limits is an eight-step process:
• a. Know your budget and how much you can
afford
• b. Know your credit score
• c. Calculate your front and back-end bank ratios
• d. Calculate your bank ratios for LDS
• e. Choose your preferred loan type and term
• f. Know what you need for a down payment and
upfront costs
• g. Have two years of copies of taxes
• h. Get pre-approved
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Summary Step 2. Find Your Home
• Finding your home is a six-step process:
• a. Determine what is important to you
• b. Develop a plan for finding a home
• c. Use a realtor/team approach to find a home in
your price range
• d. Once you are serious about the home, get a home
inspection (offers can be contingent on the home
inspection)
• e. Determine any CCRs/fees for potential homes
• f. Negotiate the price
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Summary Step 3. Negotiate the Loan
• Negotiating the loan is a three-step process:
• a. Choose multiple lenders to compete for your
business and get Good Faith Estimates from each of
your lenders
• b. Take the various loan offers from the lenders to
calculate your lowest Effective Interest Rate
• c. Negotiate with your best lender the best rate by
asking them to beat your best offer by a specific
percentage
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Summary Step 4. Enjoy Home Ownership
• Finally, enjoy home ownership
• Maintain it well
• Take care of your purchase and it will take care
of you
• Generally it will take roughly 1-2% of the
home’s value annually for upkeep
• Budget accordingly
• A professional cleaning a few times a year
can help retain a home’s value
• Now keep the value of your home up!
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Review of Objectives
• A. Do you understand perspective?
• B. Do you understand risks in home ownership?
• C. Do you understand the Four-Step Process for
Buying a Home?
• Step 1. Understand your limits
• Step 2. Find your home
• Step 3. Negotiate your loan
• Step 4. Enjoy home ownership
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Introduction to the
Marriott School of Management
Personal Finance Website
• The Marriott School has put together a website to help
you with this and other Personal Finance decisions.
• Please visit the website at:
• http://personalfinance.byu.net
• This presentation was taken from three lessons on:
Understanding Credit
Understanding Consumer and Mortgage Loans
The Home Decision
These PowerPoints are available under Tools and
Resources, Other Resources, and Buying a Home
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BYU Website 1
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BYU Website 2
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BYU Website 3
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Summary
• Let me share one of my favorite scriptures with
you that summarizes what I feel for each of
you and what is ahead:
• For verily, I say unto you, that great things
await you (D&C 45:62).
For great things truly do!
Thank You
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Opt Out for Credit Card Applications
• Getting too many credit card applications? There is a
national credit opt-out number or an online website that
can take you off the mailing lists of all four major credit
reporting agencies:
• It is easy and painless
• Call 1-888-567-8688 or 1-888-5 OPT OUT or go to
www.optoutprescreen.com
• Answer the questions on the phone or on the net. It
only asks your home phone number, your name, and
your social security number. Then they send a form to
fill out and mail in.
70
70
70
• It is worth it (unless you like junk mail).