Personal finance 6th madura chapter 10 purchasing and financing at home

Personal Finance SIXTH EDITION Chapter 10 Purchasing and Financing a Home Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Chapter Objective (1 of 2) 10.1 Describe the factors that determine how much you can afford when buying a home 10.2 Explain how to select a home to purchase 10.3 Explain how to conduct a valuation of a home 10.4 Describe the transaction costs of purchasing a home 10.5 Describe the characteristics of a fixed-rate mortgage Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Chapter Objective (2 of 2) 10.6 Describe the characteristics of an adjustablerate mortgage 10.7 Show how to compare the costs of purchasing versus renting a home 10.8 Describe special types of mortgages 10.9 Explain the mortgage refinancing decision 10.10 Explain how a mortgage fits within your financial plan Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved How Much Can You Afford? (1 of 3) • Usually need 10-20% down payment • Typical mortgages are fixed-rate and 30 years • Home price should be no more than 2.5 times your total gross annual household income • Monthly mortgage payment should not exceed 28% of gross monthly income • Monthly debt payments (including the mortgage) should not exceed 40% of gross monthly income Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved How Much Can You Afford? (2 of 3) • Affordable down payment – What is the market value of the assets you will convert to cash and use for your down payment? – You also need to allow for closing costs and some liquidity for unanticipated bills • Affordable monthly mortgage payments – Refer to your cash flow statement – Your mortgage payment may replace a rent payment but there are other expenses to consider – Allow for continued saving Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved How Much Can You Afford? (3 of 3) – Lessons learned from others’ mistakes  Don’t go for the maximum you can afford  Don’t buy above what you can afford  Home values don’t always rise over time, values can also drop  Consider current economic conditions and job stability Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Selecting a Home (1 of 3) • Purchasing a home may be the single biggest investment you will ever make and requires serious consideration • Decide on a price range and then identify a home you want • Compare the cost of buying to the cost of renting • Consider a condominium Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Selecting a Home (2 of 3) • Relying on a real estate agent – Listen to their input, but make your own decisions • Using online realtor services – Not available in all areas but may save commissions – www.ziprealty.com is an example Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Selecting a Home (3 of 3) • Criteria used to select a home – Price – Convenient location – Maintenance – School system – Insurance – Taxes–usually between 1% and 2% of market value of home – Homeowner’s Association – Resale value–consider real estate commission – Personal preferences Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Financial Planning Online (1 of 6) • Go to www.calculatorweb.com • This Web site will allow you to estimate how much you could borrow to finance a home, based on your income and other financial information Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Characteristics of a Fixed-Rate Mortgage (2 of 3) EXHIBIT 10.6 Comparison of Monthly Payments for a 30-Year versus a 15-Year Mortgage of $100,000 Based on Different Interest Rates Monthly Payment on a: Interest Rate 30-Year Mortgage 15-Year Mortgage $477 $740 537 791 600 844 665 899 734 956 4% Note: Payments are rounded to the nearest dollar Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Characteristics of a Fixed-Rate Mortgage (3 of 3) EXHIBIT 10.7 Comparison of Mortgage Balance for a 30-Year versus a 15-Year Mortgage ($100,000 Initial Mortgage Amount; 5% Interest Rate) End of Year Balance on 30-Year Mortgage $98,525 $95,406 96,974 90,577 95,343 85,500 93,630 80,166 91,829 74,577 89,935 68,661 87,945 62,464 85,853 55,950 83,654 49,103 10 81,342 41,905 11 78,912 34,385 12 76,357 26,385 13 73,673 18,025 14 70,850 9,237 15 67,884 Note: Balances are rounded to the nearest dollar Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Balance on 15-Year Mortgage Financing with a Fixed-Rate Mortgage (9 of 9) • Adjustable-rate mortgage (ARM): a mortgage where the interest owed changes in response to movements in a specific marketdetermined interest rate • Advantage is that rates could go down; disadvantage is that rates could increase • Initial rate—usually relatively low • Interest rate index—determines whether mortgage rate goes up Frequency of rate adjustmentsvaries Copyright â 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Characteristics of an Adjustable-Rate Mortgages (1 of 2) • Initial rate is relatively low for a year or so • Interest rate index tied to mortgage contract • Frequency of rate adjustments – Specified in mortgage contract – Many alternatives available from once a year to every five years Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Characteristics of an Adjustable-Rate Mortgages (2 of 2) • Caps on adjustable-rate mortgages – Caps: maximum and minimum fluctuations in the interest rate on an ARM  Limits the fluctuations in interest rate – Financing with a fixed- versus an adjustable-rate mortgage  Depends on your expectation of future interest rates Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Decision to Own a Home versus Rent • Consider financial assessment before considering personal preferences • Estimating the total cost of renting and owning – Renting–rent payment, security deposit – Owning–down payment, mortgage payment, closing costs, maintenance, taxes and insurance  Owning also has tax advantages Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Exhibit 10.8 Comparing the Total Cost of Renting Versus Buying a Home over a Three-Year Period EXHIBIT 10.8 Comparing the Total Cost of Renting Versus Buying a Home over a Three-Year Period Cost of Renting Rent ($600 per month) Renter’s insurance Opportunity cost of security deposit Total cost of renting Amount per Year Total over Next Three Years $7,200 $21,600 0 20 60 $7,220 $21,660 $9,492 $28,476 Cost of Purchasing Mortgage payment ($791 per month) Down payment Opportunity cost of down payment Property taxes Home insurance 8,000 8,000 (first year only) 160 480 1,500 4,500 600 1,800 Closing costs 3,100 3,100 (first year only) Maintenance costs 1,000 3,000 Total costs before tax benefits Total tax savings $49,356 $325 Equity investment $23,000 Cost of purchasing home over three years $26,031 Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Special Types of Mortgages (1 of 2) • Graduated payment mortgage: a mortgage where the payments are low in the early years and then rise to a higher level over time • Balloon payment mortgage: a mortgage where the monthly payments are relatively low, but one large payment is required after a specified period to pay off the mortgage loan Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Special Types of Mortgages (2 of 2) • Interest-only mortgages – Adjustable-rate mortgages that allow home buyers to pay only interest on the mortgage during the first few years Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Mortgage Refinancing • Mortgage refinancing: paying off an existing mortgage with a new mortgage that has a lower interest rate • Rate modification—may be available to some fixed-rate mortgage holders • Refinancing analysis—compare the monthly savings to the cost of refinancing – Must pay additional closing costs Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Financial Planning Online (6 of 6) • Go to www.mortgageloan.com and insert the search term “refinance” • This Web site provides information about refinancing loans Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved How a Mortgage Fits Within Your Financial Plan (1 of 4) • Key mortgage loan decisions for your financial plan are: – What mortgage amount can you afford? – What maturity should you select? – Should you consider a fixed-rate or an adjustable-rate mortgage? Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved How a Mortgage Fits Within Your Financial Plan (2 of 4) EXHIBIT 10.9 How Mortgage Financing Fits Within Stephanie Spratt’s Financial Plan GOALS FOR MORTGAGE FINANCING Limit the amount of mortgage financing to a level that is affordable Select a short loan maturity if possible, assuming that the payments are affordable Select the type of mortgage loan (fixed- or adjustable-rate) that is more likely to result in lower interest expenses ANALYSIS Monthly payment Total interest payments Advantages Difference between mortgage payment and rent payment 15-Year Mortgage (5% interest rate) 30-Year Mortgage (5% interest rate) $791 $537 $42,343 $93,256 Pay off mortgage in half the time of a 30-year mortgage; pay lower interest expenses on the loan Smaller monthly payment $791 – $600 = $191 $537 – $600 = –$63 Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved How a Mortgage Fits Within Your Financial Plan (3 of 4) EXHIBIT 10.9 How Mortgage Financing Fits Within Stephanie Spratt’s Financial Plan DECISIONS Decision on Affording a Mortgage: The monthly interest payment on a $100,000 mortgage loan with a 15year maturity is $791 My rent is $600 per month, so the difference is $191 per month Since my monthly cash flows (from my salary) exceed my typical monthly expenses (including my car loan payment) and my purchases of clothes by almost $600, I can afford that difference I will not save as much money as I planned if I buy a home, but I will be building equity Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved How a Mortgage Fits Within Your Financial Plan (4 of 4) EXHIBIT 10.9 How Mortgage Financing Fits Within Stephanie Spratt’s Financial Plan Decision on the Mortgage Maturity: I prefer the 15-year mortgage because I will pay o a larger portion of the principal each year Decision on the Type of Mortgage Loan: I prefer the fixed-rate mortgage because I know with certainty that the monthly payments will not increase I am worried that interest rates may increase in the future, which would cause interest expenses to be higher on the adjustable-rate mortgage Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved ... of homes for sale in an area that you specify and homes in the price and size range that you specify Copyright © 2017, 2014, 2011 Pearson Education, Inc All Rights Reserved Valuation of a Home. .. Valuation of a Home (3 of 7) • Economic impact on home values – Economic conditions affect the valuation of homes – As demand for homes increase, prices rise – When economic conditions weaken, and. .. conduct a valuation of a home 10. 4 Describe the transaction costs of purchasing a home 10. 5 Describe the characteristics of a fixed-rate mortgage Copyright © 2017, 2014, 2011 Pearson Education, Inc