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Slides by Pamela L. HallWestern Washington

University

Chapter 8The Housing Decision

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Your Personal Housing RequirementsWhere do you want to live?

Lifestyle: leisure and work activities Commuting distance/time Taxes

Vary across different states & local communities Public services

Health care, police/fire protection, parks, etc. Schools

Some believe good system helps maintain property values, but may pay higher property taxes

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Your Financial ResourcesExperts suggest that you spend no more than

30% of your monthly take-home pay on housing

Decline in mortgage interest in 1990s let more people afford houses

Amount required for down payment is usually more of a hurdle than the monthly payment While there are ways to reduce the needed down

payment, you should plan on paying at least 10% of purchase price in a down payment (plus closing costs, which can easily reach 2.5%)

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The Kind of Home You Want and NeedImportant to do a needs vs. wants

analysisHousing needs change over the life

cycle Single person versus family with children

versus retired couple

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Major Housing OptionsSingle Family Homes

About 2/3 of American households are of this type

Typically about 2,225 square feet, 3 bedrooms, 2.5 baths

Typically sells for $145,000 Varies widely throughout the country

More than 90% are bought via financing with the property serving as collateral (mortgage)

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Major Housing OptionsCondominiums and Co-ops

Condo buyers receive title to unit plus joint ownership in all common areas Owners belong to a homeowners association

Co-op dwellers own shares in a corporation that owns the building Resident leases unit from corporation

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Major Housing Options Manufactured homes

95% are permanent structures Much cheaper than site-built houses If built after June 1976 must conform to national building code

Rental option Most rentals are unfurnished Average rental in U.S. is $788/month

Varies substantially based upon Type of unit Location

Lease defines rights and obligations of landlord and tenant

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Buy-vs.-Rent Advantages of renting

Mobility (no need to be concerned with selling house, although length of lease is a consideration)

No large up-front costs involved Little or no repair and maintenance costs

Advantages of buying ‘Pride of ownership’ Ability to decorate to your satisfaction Potential price appreciation (but depreciation can occur) Tax savings (itemize deduction for mortgage interest) Build up equity

The current value of the house minus the loan balance

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Buy-vs.-RentIn many areas of the country buying

is cheaper than renting even if appreciation in value is not considered

This could change if interest rates rise or mortgage interest deduction is eliminated

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Web Links

Checkout Buying a Home: Settlement Costs and Helpful Information at:

www.hud.gov/buying/index.cfm www.pueblo.gsa.gov

Interactive guide to the home buying decision

www.fanniemae.com

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Financing the Purchase of a HomeDetermine how much you can afford in terms of

the total purchase price Dependent upon your income, down payment,

interest rates Lenders don’t want monthly mortgage

payment, real estate taxes and homeowners insurance to exceed 28% of your gross monthly income

Also, make sure you can afford the monthly upkeep Utilities, repairs, maintenance

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Financing the Purchase of a HomeDown payment

First-time buyers usually pay about 12% Average down payment is 25% for all

buyers If you have a lower loan-to-value ratio may get

a better interest rate on mortgage If you purchase Private Mortgage

Insurance (PMI) you may be able to reduce the size of your down payment Expensive, but can be canceled after a point

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The Monthly PaymentMost mortgages are fully amortized

Each payment goes partly to principal reduction and partly to interest

Over life of loan, principal is reduced to zero

Initially most of monthly payment goes toward interest but this decreases (slowly) over the life of the loan

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Table 8.1Payment Number

Payment Beginning Balance

Interest Principal Ending Balance

Interest Principal

1 790 125,000 677 113 124,887 677 1132 790 124,887 676 114 124,773 1,354 2273 790 124,773 676 114 124,659 2,029 3414 790 124,659 675 115 124,544 2,705 4565 790 124,544 675 115 124,429 3,379 5716 790 124,429 674 116 124,313 4,053 6877 790 124,313 673 117 124,196 4,727 8048 790 124,196 673 117 124,079 5,399 9219 790 124,079 672 118 123,961 6,071 1,039

10 790 123,961 671 119 123,842 6,743 1,15811 790 123,842 671 119 123,723 7,414 1,27712 790 123,723 670 120 123,603 8,084 1,39724 790 122,240 662 128 122,112 16,074 2,88860 790 117,169 635 155 117,014 39,419 7,986

120 790 106,185 575 215 105,970 75,780 19,030180 790 90,996 493 297 90,699 107,914 34,301360 790 786 4 786 0 159,431 125,000

Cumulative

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Figure 8.5

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Closing Costs Include fees involved with the transfer of

ownership (such as loan origination fee, credit report, etc.) Most are paid at the closing meeting Points

Fees paid (usually by buyer) to lender (AKA as a loan origination fee or loan discount)

Typically considered interest and are tax deductible Stated as a % of the loan amount

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Closing Costs Prepaid Interest

Generally over a month passes before your first mortgage payment is due

However, your mortgage is accruing interest charges during that time

If mortgage closed on June 15 and 1st payment was due July 30th, it would cover interest from June 30th to July 30th, but not June 15th to June 29th

Sales Commission Usually paid by seller Compensates real estate agents for their services

Quite expensive (about 6 or 7% of purchase price) Title Charges

Normally split between buyer and seller

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Sources of Mortgage Loans Can be obtained through

Commercial banks Savings banks Mortgage companies Some credit unions

Shop around Mortgage broker will search for best loan to meet your needs Check the Internet

Lender doesn’t have to be local Loan application is rather detailed May have the option of locking-in the current

mortgage rate

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Types of Mortgages Fixed-rate loans—interest rate remains

constant over the life of the loan 30-year

360 identical payments are made, generally once a month

15-year Are about 33% of all new mortgage loans Interest rates are slightly less than a 30-year

mortgage Monthly payment is larger than 30-year

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Types of MortgagesAdjustable-Rate Mortgages (ARMs)

Interest rate changes at preset intervals, depending on whether interest rates have increased or decreased Tied to a specific index Limits (caps) to how much the interest rate

can change per period and over the life of the loan

The initial (teaser) rate is far below the rate of fixed-rate loans

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Types of MortgagesChoosing between an ARM and Fixed-

Rate loan Many consumers dislike ARMs because

interest rate can change—adds uncertainty

However, may be a good choice for some consumers The shorter the amount of time you plan to

keep the house, the more attractive an ARM

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Sources of Mortgage LoansFederal Housing Administration (FHA)

Federally insured mortgages made by private lenders Down payment is usually quite low (because

receive insurance via federal government) Buyer pays an FHA insurance premium each

month Ceilings on the amount of money that can be

borrowed Exactly what the ceiling is depends on geographic

location

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Sources of Mortgage LoansVeterans Administration

Guaranteed by the Veterans Administration and loans are made through private lenders

Only available to veterans Guarantees 100% of the loan amount

Subject to ceilings which vary by region Limits on closing costs Low down payments (sometimes as low as 0%)

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Sources of Mortgage LoansConventional Mortgages

One that is not FHA or VA insured If borrow more than 80% of purchase

price most lenders require PMI If property is sold for less than the loan

balance, borrower is still obligated to pay the rest

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Refinancing a Mortgage Involves taking out a new loan while paying off

the old loanCosts associated with refinancing

Closing costs Are there pre-payment penalties on your current loan

Will there be pre-payment penalties on new loan? Generally if interest rates have dropped to 2% or

more from your current rate, it makes sense to refinance but depends on time you plan to remain in house

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Second MortgagesTax Reform Act of 1986 eliminated interest

deductions on car loans, credit cards, etc.May make sense to obtain a second mortgage

on your house to finance car purchases, make home improvements, pay for college costs, etc. Interest is tax-deductible

Similar to home equity loans, except home equity loans are basically a credit limit An amount up to which you can borrow without

reapplying each time Interest is tax deductible

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Second MortgagesWarning:

Even if you pay your primary mortgage payments on time, you can lose your house if you fail to pay your second mortgage payments on time

If your house drops in value the amount you owe stays the same

125 loans Loans up to 125% of the market value of the

house Risky!

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125 Loans Recently 125 loans have become available

Before the most you could borrow was 80-85% of the home owner’s equity

Example: If your home is appraised at $150,000 and you owe $135,000 on the mortgage, you can borrow $18,750 (125% x (150,000 – 135,000)

Disadvantages Charge high interest rates Not all the interest is tax deductible (the % above the value of the

home is not) If you are having a financial crisis you can stop paying your credit

card debt (or pay the minimum) but you can’t stop paying this loan without losing your home

You can’t sell your home if you can’t repay the 125 loan If you file for personal bankruptcy, your credit card debt would be

wiped out (probably) but mortgage debt remains (usually)

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Finding the Right House to BuyRecommend that you pre-qualify for

mortgage before you start looking Know the max you can afford so you

won’t waste time Lets you quickly arrange financing once

you find the house you want

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Using a Real Estate Agent You can either find houses yourself that you are

interested in or Tell an agent what you’re interested in and have

them contact you with a list of prospects Once you’ve selected a house, agent will help you

make a formal offer Prepare a contract stating offer price, desired closing date, etc.

Seller will either accept offer, make counteroffer or reject offer

You’ll have to put up earnest money A security deposit (which you’ll probably lose if you recant offer)

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Home InspectionsYou’ll definitely want the house inspected

before you buy it, even if it is brand newYou can ask seller to fix things that are

found during the house inspection, or lower the purchase price to adjust for these items

Expect to pay $150-$500 for a home inspection

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WarrantiesMost new homes come with a one-year

warranty For an older home you could either buy

a warranty (for about $350) that covers certain items (water heater, stove, etc.)

Some sellers now buy these warranties and offer as a sales incentive

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Selling a HomeShould you use a real estate agent?

Agents charge between 6 and 7% of selling price If you don’t use a real estate agent, you have to

advertise the house, arrange for viewing, negotiate with buyer, etc. About 80% of houses are sold via an agent

Setting the asking price Agent will help establish this

Selling costs May include real estate commission, title insurance,

real estate taxes

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Web Links

References associated with selling a house:

www.realtor.com www.hud.gov/selling/index.cfm

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Fixing Up Your HomeWhy do home improvements?

Satisfy you Increase potential selling price

Bathroom/kitchen improvements tend to recover the best

Don’t improve your home too much If the value is more than 10-15% of average

home price in neighborhood, probably won’t get that much for it

Shop around

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Taxes and the Sale of Your HomeMost homeowners will never pay

federal taxes on the sale of their home

However, it is important to keep good records