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

All Rights Reserved10.8 Describe special types of mortgages 10.9 Explain the mortgage refinancing decision 10.10 Explain how a mortgage fits within your financial plan... All Rights Rese

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Personal Finance

SIXTH EDITION

Chapter 10

Purchasing and Financing a Home

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you can afford when buying a home

10.4 Describe the transaction costs of purchasing a home

10.5 Describe the characteristics of a fixed-rate

mortgage

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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

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your total gross annual household income

28% of gross monthly income

should not exceed 40% of gross monthly income

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– 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

– 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

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– Lessons learned from others’ mistakes

 Don’t go for the maximum you can afford

 Home values don’t always rise over time, values can also drop

 Consider current economic conditions and job stability

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investment you will ever make and requires

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– Listen to their input, but make your own decisions

– Not available in all areas but may save commissions– www.ziprealty.com is an example

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you could borrow to finance a home, based on

your income and other financial information

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street in a city that you specify over a recent

period It can also provide a list of homes in the

city you specify that sold within a certain price

range

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home based on the prices of similar homes in the area

– Usually based on price per square foot

– Information can be obtained from a real estate broker

or appraiser

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EXHIBIT 10.1 Using a Market Analysis to Purchase a Home

House Size Price Price per Square Foot

1,300 square feet $120,000 $120,000/1,300 = $92 1,200 square feet $104,100 $104,100/1,200 = $87 1,100 square feet $94,000 $94,000/1,100 = $85 Average price per square foot = ($92 + $87 + $85)/3 = $88

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– Economic conditions affect the valuation of homes– As demand for homes increase, prices rise

– When economic conditions weaken, and demand

declines resulting in lower home prices

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in an area that you specify and homes in the price and size range that you specify

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– Mortgage defaults

– Impact on home prices

– Resolving the crisis

– Lessons from the crisis

– Correcting the mortgage application process

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– Business activity nearby increases demand for housing

in an area

– Zoning laws may affect desirability

– Remember that brokers represent sellers!

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– Most sellers will accept less than their asking price

– Seller may accept your offer, reject it, or suggest a

revision

– A contract will stipulate the agreed upon price and any

other conditions

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Transaction Costs of Purchasing a

 Veterans’ Administration (VA)

– Private mortgage insurance (PMI) may be required if

your down payment is less than 20% of the home’s value

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Transaction Costs of Purchasing a

– Loan application fee—from $100 to $500

– Points: a fee charged by the lender when a mortgage

loan is provided; stated as a percentage of the mortgage loan amount

– Loan origination fee—about 1% of the mortgage

amount

– Appraisal fee—from $200 to $500

– Title search and insurance

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interest rate is specified until maturity

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mortgage rates, as well as average rates for specific regions and states

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– Basis for monthly mortgage payment amount for a

fixed-rate mortgage

– Allocation of the mortgage payment—each payment

represents a partial payment of principal and a partial payment of interest

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EXHIBIT 10.3 Amortization Schedule for a 30-Year (360-Month)

Fixed-Rate Mortgage for $100,000 at a 5% Interest Rate

Month Payment Principal Interest Balance

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payment

– The larger the mortgage amount, the larger the

mortgage payment

– The larger the interest rate, the larger the mortgage

payment

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EXHIBIT 10.4 Allocation of Principal Versus Interest Paid per Year on a $100,000 30-Year

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EXHIBIT 10.5 Monthly Mortgage Payments Based on Different Mortgage Amounts (30-Year Fixed-Rate Mortgage;

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Characteristics of a Fixed-Rate Mortgage

(1 of 3)

– Many mortgage loan Web sites offer mortgage

calculators to estimate monthly payments based on a specific mortgage amount, interest rate, and maturity

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http://www.bloomberg.com

section

mortgage based on the loan amount, interest rate, and the loan maturity

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(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

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(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 Balance on 15-Year Mortgage

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a mortgage where the interest owed changes in

response to movements in a specific

market-determined interest rate

disadvantage is that rates could increase

rate goes up

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Characteristics of an Adjustable-Rate

– Specified in mortgage contract

– Many alternatives available from once a year to every

five years

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Characteristics of an Adjustable-Rate

– 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

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Decision to Own a Home versus Rent

personal preferences

– Renting–rent payment, security deposit

– Owning–down payment, mortgage payment, closing

costs, maintenance, taxes and insurance

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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 Purchasing

Cost of purchasing home over three years $26,031

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the payments are low in the early years and then rise to a higher level over time

monthly payments are relatively low, but one large payment is required after a specified period to pay off the mortgage loan

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– Adjustable-rate mortgages that allow home buyers to

pay only interest on the mortgage during the first few years

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Mortgage Refinancing

mortgage with a new mortgage that has a lower interest rate

fixed-rate mortgage holders

savings to the cost of refinancing

– Must pay additional closing costs

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search term “refinance”

refinancing loans

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How a Mortgage Fits Within Your

plan are:

– What mortgage amount can you afford?

– What maturity should you select?

– Should you consider a fixed-rate or an adjustable-rate

mortgage?

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EXHIBIT 10.9 How Mortgage Financing Fits Within Stephanie Spratt’s Financial Plan

GOALS FOR MORTGAGE FINANCING

1 Limit the amount of mortgage financing to a level that is affordable.

2 Select a short loan maturity if possible, assuming that the payments are affordable.

3 Select the type of mortgage loan (fixed- or adjustable-rate) that is more likely to result in lower interest expenses.

ANALYSIS

15-Year Mortgage (5% interest rate)

30-Year Mortgage (5% interest rate)

Total interest payments $42,343 $93,256

Advantages Pay off mortgage in half the

time of a 30-year mortgage;

pay lower interest expenses on

Difference between mortgage

payment and rent payment $791 – $600 = $191 $537 – $600 = –$63

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DECISIONS

Decision on Affording a Mortgage:

The monthly interest payment on a $100,000 mortgage loan with a year maturity is $791 My rent is $600 per month, so the difference is

15-$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.

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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.

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