copyright ©2004 pearson education, inc. all rights reserved. chapter 9 purchasing and financing a...

Copyright ©2004 Pearson Education, Inc. All rights reserved.

Chapter 9

Purchasing and Financing a Home

Copyright ©2004 Pearson Education, Inc. All rights reserved. 9-2

Chapter Objectives

• Explain how to select a home to purchase

• Explain how to conduct a valuation of a home

• Describe the transaction costs of purchasing a home

• Identify the characteristics of a fixed-rate mortgage


Chapter Objectives

• Describe the characteristics of an adjustable-rate mortgage

• Show how to compare the costs of purchasing versus renting a home

• Explain the mortgage refinancing decision


Selecting a Home

• Purchasing a home may be the single biggest investment you will ever make and requires serious consideration

• Relying on a realtor can be helpful, but make decisions that meet your needs

• Using online realtor services usually saves money in commission charges


Selecting a Home

• How much can you afford?– Affordable down payment

• Down payment usually 10 – 20 percent of purchase price

• What is the market value of the assets you will use to make your down payment?

• You also need to allow for closing costs and some unanticipated expenses


Financial Planning Online:How Much Money Can You Borrow?

• Go to: http://www.financenter.com/products/sellingtools/calculators

• Click on: “Home,” then “How much can I borrow?”

• This Web site provides an estimate of how much you could borrow to finance a home.

http://www.financenter.com/products/sellingtools/calculators






Selecting a Home

– 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

• Criteria used to select a home– Price

– Convenient location


Financial Planning Online: Recent Sales Prices of Nearby Homes

• Go to: http://realestate.yahoo.com/re/homevalues/

• This Web site provides sales prices of homes on a street in a city that you specify over a recent period.

http://realestate.yahoo.com/re/homevalues/






Selecting a Home

– Maintenance– School system– Insurance– Taxes — usually between 1 and 2 percent

of market value of home– Homeowner’s Association– Resale value — consider real estate

commission– Personal preferences


Financial Planning Online:Listing of Homes Nearby for Sale

• Go to: http://www.realtor.com

• This Web site provides a listing of homes for sale in an area that you specify and homes in the price and size range that you specify.

http://www.realtor.com/


Selecting a Home

• Focus on Ethics: Disclosing Defects– Most state laws require disclosure of any

defect that may effect the value of the home

– Disclosure is not only legal, but moral

– Failure to disclose can result in a lawsuit for misrepresentation


Valuation of a Home

• Market analysis: an estimate of the price of a 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


Valuation of a Home

Exhibit 9.1: Using a Market Analysis to Purchase a Home


Valuation of a Home

• Effects on business activity and zoning laws– Business activity nearby increases demand

for housing in an area

– Zoning laws may affect desirability

• Obtaining a second opinion on your valuation– Remember that brokers represent sellers!


Valuation of a Home

• Negotiating a price– 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


Transaction Costs of Purchasing a Home

• Down payment– Usually 10 to 20 percent

– Serves as collateral

– Lower down payment may be required for government backed loans

• Federal Housing Administration (FHA)

• Veterans’ Administration (VA)


Transaction Costs of Purchasing a Home• Closing costs

– Loan application fee — from $100–$500– Points: a fee charged by the lender when a

mortgage loan is provided — from 1–2% of the loan

– Loan origination fee — about 1% of the mortgage amount

– Appraisal fee — from $200–$500– Title search and insurance


Financial Planning Online:Applying For a Mortgage

• Go to: http://www.bloombert.com/money/loan/mtge_calc.html

• This Web site provides access to mortgage applications, and a guide for assessing whether to refinance a mortgage.

http://www.bloombert.com/money/loan/mtge_calc.html






Characteristics of a Fixed-Rate Mortgage

• Fixed-rate mortgage: a mortgage in which a fixed interest rate is specified until maturity

• Preferred when interest rates are expected to rise

• May be assumable under some conditions


Financial Planning Online:Average Mortgage Rates

• Go to: http://biz.yahoo.com/b/r/m.html

• This Web site provides national averages for mortgage rates, as well as average mortgage rates for specific regions and states.

http://biz.yahoo.com/b/r/m.html



• Amortization table– 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



Exhibit 9.2: Amortization Schedule for a 30-Year (360-Month) Fixed-Rate Mortgage for $72,000 at an 8 Percent Interest Rate



Exhibit 9.3:Allocation of Principal versus Interest Paid per Year on a $72,000 Mortgage



Exhibit 9.3 (continued)


Characteristics of a Fixed-Rate Mortgage• Impact of the mortgage amount on the

monthly payment– The larger the mortgage amount, the larger

the mortgage payment

• Impact of the interest rate on the monthly payment– The larger the interest rate, the larger

the mortgage payment



• Impact of the mortgage maturity on the monthly payment– The longer the maturity, the lower the

monthly payment

– The longer the maturity, the more interest you pay over the live of the loan



• Impact of the interest rate on the monthly payment– The higher the interest rate, the higher the

payment

• Impact of the mortgage maturity on the monthly payment– The longer the maturity, the higher the

payment



Exhibit 9.4: Monthly Mortgage Payments Based on Different Mortgage Amounts (30-Year Fixed-Rate Mortgage; Interest Rate = 8 Percent)



Exhibit 9.5: Comparison of Monthly Payments for a 30-Year versus a 15-Year Mortgage of $72,000 Based on Different Interest Rates



Exhibit 9.6: Comparison of Mortgage Balance for a 15-Year versus a 30-Year Mortgage (Initial Mortgage Amount = $72,000; Interest Rate = 8 Percent)



• Estimating the monthly mortgage payment– Many mortgage loan Web sites offer

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


Financial Planning Online:Estimating Mortgage Payments

• Go to: http://www.bloomberg.com/money/loan/mtge_calc.html

• This Web site provides the monthly payment on a mortgage based on the loan amount, interest rate, and the loan maturity.

http://www.bloomberg.com/money/loan/mtge_calc.html






Financial Planning Online: Should You Obtain a 15-Year or a 30-Year Mortgage?


• Click on: “Home,” then “Which is better: 15-or-30 year term?”

• This Web site provides a comparison of payments on a 15-year versus a 30-year mortgage.







Characteristics of an Adjustable-Rate Mortgage• Adjustable-rate mortgage (ARM):

a mortgage where the interest owed changes in response to movements in a specific market-determined interest rate

• Initial rate — usually relatively low

• Interest rate index — determines whether mortgage rate goes up

• Frequency of rate adjustments — varies


Characteristics of an Adjustable-Rate Mortgage

• 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 you expectation of future

interest rates


Financial Planning Online: Should You Obtain a Fixed- or an Adjustable-Rate Mortgage?


• Click on: “Home,” then “Which is better: fixed or adjustable?”

• This Web site provides a comparison of payments on a fixed-rate versus an adjustable-rate mortgage.







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


Financial Planning Online:Should You Rent or Buy?

• Go to: http://loan.yahoo.com/m/

• Click on: Calculators

• This Web site provides a recommendation on whether you would buy a home, based on your rent versus the expenses of the home you are considering.

http://loan.yahoo.com/m/


Decision to Own a Home versus Rent

Exhibit 9.7: Comparing the Total Cost of Renting versus Buying a Home over a Three-Year Period


Special Types of Mortgages

• 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 loan


Mortgage Refinancing

• Mortgage refinancing: paying off an existing mortgage with a new mortgage that has a lower interest rate

• Refinancing analysis — compare the monthly savings to the cost of refinancing– Must pay additional closing costs


How a Mortgage Fits within Your Financial Plan

• 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?


Integrating the Key Concepts


Integrating the Key Concepts

• Part 1: Financial Planning Tools

• Part 2: Liquidity Management

• Part 3: Financing

– In Chapter 8 we learned about personal loans

– In Chapter 9 we learned about purchasing and financing a home

• Part 4: Protecting Your Wealth

• Part 5: Investing

• Part 6: Retirement and Estate Planning

copyright ©2004 pearson education, inc. all rights reserved. chapter 9 purchasing and financing a...

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