CHAPTER 7 Selecting and Financing Housing Or Home, Sweet, Home! A third of Americans now spend at least 30 percent of their income on housing.
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1 CHAPTER 7 Selecting and Financing Housing Or Home, Sweet, Home! A third of Americans now spend at least 30 percent of their income on housing − the federal definition of an “unaffordable” housing burden (The Washington Post) Evaluating Housing Alternatives Your lifestyle and your choice of housing How you spend your time and money, your lifestyle, affects your housing choice Personal preferences are modified by financial factors Traditional financial guidelines suggest you spend no more than 25-30% of take-home pay on housing, or no more than 2 1/2 times your annual income for a home “Ha! Ha! Ha! Ha! Ha! Ha!” The authors obviously don’t live in San Diego!! 2 Rent or Own? 3 Evaluating Housing Alternatives Advantages of renting Mobility Fewer maintenance responsibilities Lower initial costs Disadvantages of renting Few financial benefits – “Not always true!” No growth of equity Restricted lifestyle Legal concerns of a lease Costs including a security deposit, utilities & renter’s insurance Don’t forget renter’s insurance! 4 Housing Rental Activities The search Select an area and rental cost for your needs Compare costs of units Talk to current and past residents Before signing a lease Make sure the lease dates, costs and facilities are clearly represented Talk to a lawyer about unclear lease aspects (?) Note in writing, signed by the landlord, the condition of the rental unit Either person who signs lease can be held responsible for the full rent 5 Legal Details of a Lease Description and address of property Name and address of the owner/landlord Name of tenant The lease Effective date and length of the lease exists to Amount of security deposit protect the Amount and due date of rent Landlord! Location where rent is due Date and amount for late rent payments List of included utilities, appliances Restrictions on certain activities The right to sublet the unit Conditions under which landlord may enter the rental unit 6 Housing Rental Activities (continued) Living in rental property If you can demonstrate that you are a good tenant, sometimes the landlord will keep your rent increases to a minimum A good tenant is worth the lower rent to a landlord At the end of the lease Clean and leave unit in same condition you got it Provide landlord with new address for deposit Require than any deductions from your deposit be documented 7 Advantages of Owning Pride of ownership The American Dream (Dreams can turn into nightmares) Reduced income taxes Deduct mortgage interest Deduct property taxes & state income taxes Build equity by paying down the loan and by price appreciation Protection against inflation Builds your credit rating Lifestyle flexibility – express your individuality 8 Disadvantages of Owning Financial uncertainty Get down payment and financing Home values could drop (“Yeah, right?” “Yeah, right!”) Limited mobility Can take time to sell A home is not a liquid investment Zoning and CCR’s Higher living costs Maintenance, repairs & improvements Real estate taxes “But my house is the best investment I have ever made!” “Of course, it is pretty much the only investment that I have ever made, Except for that penny stock my brother-inlaw, the ex-stockbroker, conned me into buying… But that is worthless now And those gold coins I bought back when the first Gulf War started back in ’91 What did I do with those things, anyway?” Bottom Line: A House is a Home First, an Investment Second 9 10 “But what about San Diego?!” Prices in San Diego have gone down in the past They seem to be still going down now How far they will drop is uncertain Consider: It is not as though San Diego is all of a sudden becoming an undesirable place to live But if you plan on staying here, by all means, buy whatever you can afford San Ysidro and National City are two of the best values in the region, by the way Imperial Beach is also a great beach value 11 Speaking of inSane Diego… Do you own your own home? A. B. Yes No 12 Speaking of inSane Diego… Of those who do not own, do you plan on purchasing a home in San Diego? A. B. C. D. Yes, I am determined to do it Maybe, but not for many years No, I will continue to rent here in San Diego No, I am moving to a cheaper area Sign seen over a desk in a San Diego office, circa 1993 “Please, God, let there be another real estate boom and I promise I won’t piss it all away this time!” 13 14 The Main Elements of Buying a Home “Location, Location, Location” Down payment Parent, Grandparents – Equity Sharing? Mortgage application Get pre-approved at a credit union or broker Points – Each point is 1% of the loan amount Closing costs Close your eyes and sign PITI (principal, interest, taxes, insurance) Escrow account Maintenance costs Assess Types of Housing Than Can be Purchased 15 Single-family dwelling (SFR) Multi-unit dwelling Duplex Townhouse Condominium You own your unit in a building of units It is not a type of structure but a form of ownership Cooperative housing Members own shares in and rent a unit in a building with multiple units East Coast Assess Types of Housing Than Can be Purchased 16 (continued) Manufactured homes Fully or partially assembled in a factory and then moved to the housing site Prefabricated type has components built in the factory and assembled at the site Lower cost than site built homes Mobile homes A type of manufactured home often less than 1,000 square feet Offer same features as a conventional house Safety is debated and they usually depreciate if you don’t own the land underneath the home Assess Types of Housing Than Can be Purchased 17 (continued) Tips for Mobile and Manufactured homes Avoid buying a “complete package” You will usually end up overpaying Find the site first – buy the land if you can afford to Get a warranty on the installation of the home as well as the manufacturing of the home The installation often is the most troublesome aspect If dealer will not provide a warranty, walk away Arrange your own financing This is where the dealers make the most money. They will want you to finance at a very high rate relative to the mortgage market. Credit union! Assess Types of Housing Than Can be Purchased 18 (continued) If building a home, consider… Does the contractor have needed experience? Does contractor have a good working relationship with architect, suppliers, electricians, plumbers, carpenters and others? What assurance do you have about quality? What are payment arrangements? What delays will be considered legitimate? Is the contractor licensed and insured? Home Buying Process Step 1: Determine Homeownership Needs Determine how much you can afford Consider both price and quality Get pre-qualified Price and down payment Available funds for a down payment Your income and living expenses Your ability to make the payments Size and quality As you move to a second and third home you can include more of the features you want Look at the condition of the home 19 Home Buying Process Step 2: Finding and Evaluating a Property to Purchase Select a location Be aware of zoning laws (Can you park your RV?) Assess the school system if you have children Using a real estate agent They present your offer, negotiate the price, assist you in obtaining financing, represent you at the closing, and… Stab you in the back if you are not careful! Get a good referral Obtain an appraisal (This will happen anyway) Conduct a home inspection 20 Home Buying Process Step 3: Pricing the Property Determining the home value Check the neighborhood & recent transactions Negotiating the purchase price Buyer agents (Normally, the agent works for the seller! Always keep this in mind.) Is it a Seller’s or a Buyer’s market? “Earnest money” Contingency clauses Buyer can obtain financing Sale often contingent on the sale of the buyer’s current home 21 Home Buying Process Step 4: Obtaining Financing Determine the amount of the down payment Mortgage insurance (PMI) if less than 20% Apply and qualify for the mortgage If you have not already pre-qualified Can be pre-qualified based on income, assets, debts, credit history, mortgage rate, and length of loan Evaluating points (prepaid interest) “Buy-down” a lower interest rate Good idea if you intend on living in the house for a long time 22 Private Mortgage Insurance (PMI) 23 Private Mortgage Insurance protects the lender from financial loss due to default on the loan Notice that it protects the lender but the borrower pays for it – What a scam, uh… deal! Usually required if the homebuyer puts down less than 20% on the home When the equity builds to 20%, it is supposed to end automatically But do not wait for the lender to get around to stopping it – Get rid of it as soon as you can! Some borrowers avoided it by taking 2 loans 80% fixed – 15% HELOC – 5% down 24 Types of Mortgages Conventional Fixed rate, fixed payment, amortized 5%, 10% or 20% down 15, 20 or 30 years of fixed payments Adjustable rate mortgages Interest rate varies but usually has a rate cap Interest rate tied to prime rate or other industry rate Sometimes come with a “negative amortization” provision – Beware the Option ARM! Government guaranteed financing programs Veterans Administration Federal Housing Authority 25 Types of Mortgages (continued) Graduated payments Payments start lower and go up For persons whose income is expected to increase Typical characteristic of Option ARM mortgages Interest-only loans (a.k.a. IO, pronounced “eye-owe”) Balloon Fixed monthly payments plus one large payment, usually after 3, 5 or 7 years Advertised as… “30 due in 7” or “30/7” “30 due in 5” or “30/5” 26 Types of Mortgages (continued) A second mortgage Home is collateral and interest is normally tax deductible (Schedule A) Home equity loan is an example Reverse mortgages Provides elderly with tax-free income based on the home equity – Careful! Get a lawyer! Shared appreciation (a.k.a. equity sharing) Borrower agrees to share appreciated value of the home with the lender – Careful! Refinance – To getting a better interest rate 27 Financing & Mortgage Fees It used to be almost impossible to compare “apples-to-apples” when shopping for a loan A lower interest rate was usually a “come on” in exchange for being soaked with “garbage fees” Loan applicants often were not made aware of these extra fees until the day of the closing! It is much easier and safer now New rules forbid “bait ’n’ switch” maneuvers that used to be commonplace In 2003, there was an effort to create a standardized method for pricing home loans. The industry shot it down. But after the recent debacle in the home loan industry, the home loan reform advocates finally got their way. http://www.latimes.com/business/la-fi-perfin29-2009nov29,0,6612155.column Should I have a large down payment? Should I pay off my mortgage early? 28 The two are really the same question “How much equity should I have in my house?” Real estate agent sez, “No, you should buy a new house every 4 or 5 years.” So she can make another commission… Financial representative sez, “No, you should invest the extra in a mutual fund.” So he can make another commission… I sez, “If you intend on staying in your house for more than a few years, YES!” “Make Love, Not Loan$!” Should I refinance? When interest rates trend lower, many homeowners consider refinancing their mortgage and getter a lower interest rate Payments usually go down as a result But you can incur points and closing costs all over again as when you purchased the house You essentially sell your house back to yourself The rule of thumb is: “If you can get your rate down by 2%, then go ahead and refinance” BUT, if you can find a no-cost or low-cost refinance, as long as your rate goes down, even if not by much, it makes sense to refinance 29 Home Buying Process Step 5: Closing the Purchase Transaction Closing Costs Insist on a “walk-through” Title insurance and search fee Escrow fee Attorney’s and appraiser’s fees Property survey Recording fees; transfer taxes Credit report Termite inspection Lender’s origination fee Tax and insurance reserve Pre-paid interest Real estate commission 30 Title Insurance 31 Title insurance guarantees… That the seller owns the property That the seller and buyer are who they say they are That there are no liens or other encumbrances on the property If your home was purchased or refinanced within the past few years, you can ask for (and should get) a discount on the title insurance policy It definitely pays to shop around for title insurance. Do not assume the company your real estate agent suggests will give you the best price. Selling Your Home Preparing your home – white picket fence Determining the selling price Appraiser – $350 Realtor – Free (???) Check the neighborhood for current prices For sale by owner To save $42,000, I will get my real estate agent’s license if I have to! (But I have sales experience…) Listing with a real estate agent – 6% Be careful – Keep your back to the wall! 32 Selling Your Home 33 (continued) Tax consequences Single – $250,000 tax free capital gains Married – $500,000 tax free capital gains Once every two years Some folks are buying “fixer-uppers” Fixing them up in two years and selling them with no capital gains taxes No capital losses on homes allowed 30-Year versus 15-Year Mortgage Yrs Pmt per $300,000 Rate $1,000 Loan Num Pmts Total Amount 30 4% $4.774 $1,432.20 360 $515,592 15 3½% $7.149 $2,144.70 180 $386,046 Extra each month: $712.50 Less: $129,546 On a $300,000 mortgage, you can spend $129,546 less with a 15-year loan. But that means coming up with an extra $712.50 each month. 34 Mortgage Exercises Let’s do some more exercises. Don’t get too depressed… 35