Research and Reflect
9 Obtaining Affordable Housing
YOU MUST BE KIDDING, RIGHT?
Kelvin Lattimore bought a new home and borrowed $230,000 at 4.75 percent interest for 30 years. His monthly payment for interest and principal will be $1200. A friend suggested that Kelvin should have been able to find a loan at 4.5 percent with a monthly payment of $1165. Kelvin dismissed his friend's comments, arguing that the difference in the monthly payments was no big deal. His friend replied, “Kelvin, it's not the monthly payment, it's the interest.” How much more in interest will Kelvin pay over the life of the loan because he took a loan with the higher rate?
A. $3600
B. $6600
C. $9600
D. $12,600
The answer is D. Kelvin will be making a higher payment each and every month for 30 years. While the difference in the monthly payment seems small [$35 ($1200 − $1165) per month in this example], even such a little difference in the interest rates on mortgage loans can add up to thousands of dollars in extra interest over the life of the loan. Searching for the lowest possible interest rate is very important when buying a home!
LEARNING OBJECTIVES
After reading this chapter, you should be able to:
Decide whether renting or owning your home is better for you.
Explain the up-front and monthly costs of buying a home.
Describe the steps in the home-buying process.
Understand the mathematics of mortgage loans and distinguish among ways of financing the purchase of a home.
Identify some key considerations when selling a home.
WHAT DO YOU RECOMMEND?
Shelby Clark has worked for a major consumer electronics retailer since graduating from college. The company has operations across the country with regional headquarters in Atlanta, Denver, Minneapolis, and Boston. She has been based in the Atlanta area for the past three years, and has begun to think about buying a home rather than renting her townhouse apartment. Then, last month, Shelby was promoted to deputy regional director for the Denver office. The promotion represents a key step for becoming a regional director in four or five years.
What do you recommend to Shelby on the subject of buying a home regarding:
1. Buying or renting housing in the Denver area?
2. Steps she should take prior to actively looking at homes?
3. Finding a home and negotiating the purchase?
4. The closing process in home buying?
5. Selecting a type of mortgage to fit her needs?
6. Things to consider regarding the sale of her new home should she ultimately be promoted to a position in another of the four regions?
YOUR NEXT FIVE YEARS
In the next five years, you can start achieving financial success by doing the following related to obtaining affordable housing:
1. Read your leases and other real estate contracts thoroughly before signing.
2. Save the money for a home down payment within a tax-sheltered Roth IRA account.
3. Get your finances in order before shopping for a new home by reducing debt, budgeting better, and clearing up anything that keeps you from having a high credit score.
4. Buy a home as soon as it fits your budget and lifestyle so you can take advantage of special income tax deductions and price appreciation over time.
5. If you make a down payment of less than 20 percent on a home, cancel private mortgage insurance as soon as the equity in your home pushes the loan-to-value ratio down to 80 percent.
The housing market bubble of the last decade was the largest in history. A housing bubble is a run-up in housing prices fueled by demand, speculation and the belief that recent history is an infallible forecast of the future. It can be identified through rapid increases in valuations of real property until they reach unsustainable levels and then decline.
Housing prices rose 50 to 100 percent or more in just a few years and then sharply crashed. This occurred partly because millions of Americans took out complicated mortgages that they did not understand. And they often bought too expensive a home. Mortgages that seemed affordable at first turned out later to be unaffordable as the monthly repayment amounts increased because the contracts allowed for increasing interest rates. The resulting rising payments and declining home values were a disaster and especially for those who lost their jobs in the Great Recession. Only recently has the housing market rebounded in most communities to pre-bubble prices.
The lingering effects of the economic downturn include the fact that today three in ten people in their 20s and early 30s are currently living with their parents. And 60 percent of all young adults are receiving financial assistance from them. This contrasts to a generation ago when only one in ten young adults moved back home and very few received financial support.
About 90 percent of all independent young adults rent their housing. In contrast, approximately 80 percent of people aged 55 to 64 are homeowners. Given these statistics, it is likely that one day you will want to buy a home. At that point, you should be able to mathematically evaluate the financial benefits of renting versus buying and take a hard look at what it really costs to buy a home. If you decide to buy, you will likely obtain a mortgage loan —a loan to purchase real estate in which the property itself serves as collateral. There are many types of mortgage loans, and you will need to fully understand your mortgage options before you obligate yourself for 15 to 30 years.
mortgage loan Loan to purchase real estate in which the property itself serves as collateral.
9.1 SHOULD YOU RENT OR BUY YOUR HOME?
LEARNING OBJECTIVE 1
Decide whether renting or owning your home is better for you.
Whether to rent or buy depends on your preferences and what you can afford. In the short run, renting is usually less expensive than buying. In the long run, the opposite is usually true.
9.1a Renting Housing May Be Less Expensive in the Short Term
People may choose to rent their housing for many reasons. The large down payment and high monthly loan payments are barriers to buying a home. Some may simply prefer the easy mobility of renting or want to avoid many of the responsibilities associated with buying. Prospective renters need to consider the monthly rental fees, damage and security deposits, the lease agreement and restrictions, and tenant rights.
Rent, Deposit, and Related Expenses Rent is the cost charged for using an apartment or other housing space. It is usually due on a specific day each month, with a late penalty being assessed if the tenant is tardy in making the payment. Other fees could be assessed for features such as use of a clubhouse and pool, exercise facilities, WIFI, cable television, Internet service, and space for storage and parking.
rent Cost charged for using an apartment or other housing space.
A damage deposit is an amount given in advance to a landlord to pay for repairing the unit beyond the damage expected from normal wear and tear. It is often charged before the tenant moves in, is often equal to one month's rent, and is refundable if at the end of the lease the tenant leaves the home in good condition. You may also be required to pay a security deposit to provide some assurance that you will not move without paying your rent. Again, this amount is often equal to the last month's rent payment. It too is refundable or is applied to the last month's rent. Thus, to rent an apartment might require payment of $900 for the first month's rent, a $900 security deposit, and a $900 damage deposit for a total of $2700.
How to Make Sure Your Damage Deposit Is Returned
If you leave a rental unit clean and undamaged, you have a legal right to a refund of your damage deposit when you move out. Several steps will help ensure that you receive a full refund:
• Make a list of all damages and defects when you first move into the unit. Have the landlord sign this list.
• Maintain the unit and keep it clean.
• Notify the landlord promptly (in writing, if necessary) of any maintenance problems and malfunctions.
• Give proper written notice of your intention to move out at least 30 days in advance of the lease expiration.
• Make a written list of all damages and defects after moving out but prior to turning over the keys. Have the landlord sign this second list.
• Use certified mail (with a return receipt) to request the return of your security deposit and to inform the landlord of your new address.
• Use small-claims court (see Chapter 8 , page 243), if necessary, to obtain a court-ordered refund.
Written Lease Contracts Protect All Parties A lease is a contract specifying the legal responsibilities of both the tenant and the landlord. It identifies the amount of rent and security deposit, the length of the lease (typically one year), payment responsibility for utilities and repairs, penalties for late payment of rent, eviction procedures for nonpayment of rent, and procedures to follow when the lease ends. Leases often state whether the security deposit accumulates interest, how soon the unit must be inspected for cleanliness after the tenant vacates the premises, and when the security deposit (or the balance) will be forwarded to the tenant. Illustrative leases may be found at Nolo. com. Renting housing without a formal, written lease may seem like an easy and congenial way to do business, but it is fraught with potential for disagreements later.
lease In this context, a contract specifying both tenant and landlord legal responsibilities.
Two Types of Leases Two types of leases generally govern tenant-landlord relationships. The first provides for periodic tenancy (for example, week-to-week or month-to-month residency), where the agreement can be terminated by either of the parties if they give proper notice in advance (for example, one week or one month). Without such notice, the agreement stays in effect. This arrangement also typically applies in situations in which no written lease is established. The second type of lease provides for tenancy for a specific time, usually for one year. When this period expires, the agreement terminates unless prior notice is given by both parties that the agreement will be renewed.
Lease Restrictions Lease agreements may contain a variety of restrictions that are legally binding on tenants. For example, pets may or may not be permitted; when they are permitted, landlords often require a larger security deposit. Excessive noise from home entertainment systems or loud parties may be prohibited as well. To protect renters from overcrowding, a clause may limit the number of overnight guests.
An important restriction applies to subleasing (wherein an original tenant leases the property to another tenant). Here a tenant who moves before the lease expires may need to obtain the landlord's permission before someone else can take over the rental unit. The new tenant may even have to be approved, and the original tenant often retains some financial liability until the term of the original lease expires.
subleasing An arrangement in which the original tenant leases the property to another tenant.
9.1b Tenants Have Rights Even in the Absence of a Written Lease
Tenants have a number of legal rights under laws in most states and many local communities. Some important rights are as follows:
• Prohibitions against retaliatory actions such as rent increases, eviction, or utility shut-off for reporting building-code violations or otherwise exercising a tenant's legal rights.
• Assurances of some legally prescribed minimum standard of habitability for items such as running water, heat, and a working stove and the safety of access areas such as stairways.
• The right to make minor repairs and deduct the cost from the tenant's next rent payment. This right is subject to certain restrictions, such as giving sufficient prior written notification to the landlord.
• Prompt return of a security deposit, with limits placed on the kinds of deductions that can be made. Landlords must explain specific reasons for deductions. Some state laws require that interest be paid on security deposits.
• The right to file a lawsuit against a landlord for nonperformance. Such suits can be brought in a small-claims court.
9.1c Owned Housing May Be Less Expensive in the Long Term
Americans have historically chosen single-family dwellings to satisfy their owned-housing desires. Other alternatives are popular, too, such as condominiums, cooperatives, manufactured housing, and mobile homes.
Single-Family Dwellings A single-family dwelling is a housing unit that is detached from other units. Buyers have many choices available for both new and existing homes with varying floor plans and home features. Some people prefer the modern kitchens and other features found in newer homes; others prefer the larger rooms, higher ceilings, and completed landscaping of older homes.
single-family dwelling Housing unit that is detached from other units.
Condominiums and Cooperatives The terms condominium and cooperative describe forms of ownership rather than types of buildings. These forms of ownership typically cost less than single-family dwellings, offer recreation facilities, and have few if any resident maintenance obligations.
Be sure to factor homeowners association fees into the monthly income needed to purchase a condominium.
With a condominium (or condo ), the owner holds legal title to a specific housing unit within a multiunit building or project and owns a proportionate share in the common grounds and facilities. The entire development is run by the owners through a homeowners association. Besides making monthly mortgage payments, the condominium owner must pay a monthly homeowners association fee that is established by the homeowners association. This fee covers expenses related to the management of the common grounds and facilities and insurance on the building.
condominium (condo) Form of ownership with the owners holding legal title to their own housing unit among many, with common grounds and facilities owned by the developer or homeowners association.
Some areas of concern for condominium owners include potential increases in homeowner's fees and limited resale appeal of the unit. Condo market prices are much more volatile than for single-family dwellings and condos don't increase as much in value as single-family dwellings. In addition, during a housing downturn, their values decline more than single-family homes.
Understand Your Deed Restrictions
Most communities, new housing developments, and cooperative and condominium associations have deed restrictions established by local zoning laws, by the developer, and by the owners themselves. These rules govern such things as minimum lot size, the outside appearance and landscaping of the property, allowable secondary buildings, parking of vehicles, and other aspects of the use and appearance of the property. You should ask for and read the deed restrictions very carefully before buying.
With a cooperative (or co-op ), the owner holds a share of the corporation that owns and manages a group of housing units. The value of this share is equivalent to the value of the owner's particular unit. The owner also holds a proportional interest in all common areas. A monthly fee for the cooperative covers the same types of items as does a condominium fee and also includes an amount to cover the professional management of the complex as well as payments on the cooperative's mortgage debt. (The pro rata share for interest and property taxes is deductible on each shareholder's income tax return.)
cooperative (co-op) Form of ownership in which the owner holds a share of the corporation that owns and manages a group of housing units as well as common grounds and facilities.
Manufactured Housing and Mobile Homes Manufactured housing consists of fully or partially factory-built housing units designed to be transported (often in portions) to the home site. Final assembly and readying of the housing for occupancy occurs at the home site. Mobile homes, in contrast, are fully factory-assembled housing units that are designed to be towed on a frame with a trailer hitch. Mobile homes depreciate in value every year just like automobiles.
9.1d So Who Pays More—Renters or Owners?
According to conventional wisdom, homeowners enjoy a financial advantage over renters when total housing costs are calculated over many years. Renters generally pay out less money in terms of annual cash flow, but owners receive annual income tax advantages and they can see increases in the value of their homes over time that can improve their financial situation. However, as evidenced by events of recent years, there is no guarantee that housing values will increase in a uniform fashion over time; they might even decline.
Ask your real estate agent for the price-to-rent ratio in your community. This ratio shows the average home price divided by annual rent in a community. The national average is 11. The higher the ratio number, especially above 15, is more attractive for renting a home versus buying similar housing. (See Chapter 16 , page 483 for more information on price-to-rent ratios.)
Should 20-Somethings Buy Their Own Home?
The prevailing wisdom is to buy a home as soon as you can afford to do so. However, the most critical factor for a potential first-time buyer is their job situation. You want to be confident that your job is secure before buying a home. Plus you don't want to be forced to sell a home you recently purchased if you are going to be transferred by your employer to another community because that would likely result in a financial loss on the sale. Assess your situation carefully.
Based on Initial Cash Flow, Renters Appear to Win The Run the Numbers worksheet “Should You Buy or Rent?” on page 254 illustrates a comparison between a condominium and an apartment with similar space and amenities. For the apartment, rent would total $1000 per month. Assume you could buy the condominium for $180,000 by using $36,000 in savings as a down payment and borrowing the remaining $144,000 for 30 years at 6.0 percent interest. As the worksheet shows, renting would have a cash-flow cost of $11,640 after a reduction for the interest that could be earned on your savings (after taxes). Buying requires several expenses beyond the monthly mortgage payment, including a monthly $150 homeowner's fee ($1800 annually) in our example. In this case, the cash-flow cost of buying is $16,485, or $4,845 more than renting.
After Taxes and Appreciation, Owners Usually Win To make the comparison more accurate, you must also consider the tax and appreciation aspects of the two options. If you rent, you would pay $180 ($720 × 0.25) in income taxes on the interest on the amount in your savings account ($36,000) not used for a down payment. If you buy the condominium, $1768 of the $10,360 in annual mortgage loan payments during the first year will go toward the principal of the debt, and the remainder—$8592 ($10,360 −$1768)—will go toward interest. Both mortgage interest and real estate property taxes qualify as income tax deductions. If you are in the 25 percent marginal tax bracket, your taxes would be reduced by $2148 ($8592 × 0.25) as a result of deducting the mortgage interest and by $750 ($3000 × 0.25) as a result of deducting the real estate tax. In effect, every time you make a payment you will get some of it back from the government.
Condominiums also have a possibility of appreciation, or increase, in the home's value. A conservative assumption would be that the condominium will increase in value by 1 percent per year since condo values do not usually rise as fast as single family dwellings. A condominium valued at $180,000 would, therefore, be worth $181,800 ($180,000 × 1.01) after one year, a gain of $1800. In this case, buying is financially better than renting by approximately $1801 ($11,820−$10,019).
Should You Buy or Rent?
This worksheet can be used to estimate whether you would be better off renting housing or buying. If you are renting an apartment and planning to buy a house, qualitative differences will enter into your decision. This worksheet will put the financial picture into focus. A similar worksheet can be found at www.finance.yahoo.com/calculator/real-estate/hom06/
DO IT IN CLASS
Walking Out on a Mortgage Is Usually a Bad Idea
In recent years some home borrowers have decided to take a strategic default. When the value of their homes decreased, they found themselves horribly upside down (also known as under water) meaning that they owed more than the homes were worth. Some financially strapped borrowers in such a situation choose to stop paying on their mortgage and let the lender take back the home. This is attractive because mortgages are nonrecourse loans. With such loans, the lender may not go after other assets if the foreclosed home brings an insufficient amount to cover the outstanding debt when sold at auction. Given the moral issue this is a difficult decision for the underwater homeowner.
Note that the calculations above compare somewhat equivalent housing types. The process is more complicated when you want to compare renting an apartment with buying a house. You definitely should still do the math but recognize that you are comparing unlike properties. It is probable that you will find that buying a home is significantly more expensive than renting for the first few years. But if you stay in the home for five years or longer, the financial situation generally improves for the homeowner, especially for one with a fixed interest rate loan. This assumes you do not pay too much for it in the first place.
About Buying a Foreclosed Property
Any slip-up in making mortgage repayments may result in foreclosure . This is a specific legal process in which a lender attempts to recover the balance of a loan from a borrower who has stopped making payments to the lender by forcing the sale of the asset used as the collateral for the loan. Foreclosed properties are sometimes viewed as a way to buy a home for a low price. If interested in buying such a property you should understand the basic aspects of foreclosed properties:
foreclosure Process in which the lender sues the borrower to prove default and asks the court to order the sale of the property to pay the debt.
1. Short Sale. A short sale occurs when a home sale is negotiated with the owner at a price below the actual balance of the debt. The property may or may not be in foreclosure as yet but the seller is trying to get out from under the debt. The lender must approve the short sale. Lenders are tough negotiators as they want to get as much money as possible for the property but may be willing to waive closing costs and other fees, making the overall cost more affordable.
2. Preforeclosure. Preforeclosure is the time between when the homeowner has been notified by the lender that he or she is in default and the actual foreclosure has been completed. To purchase such a property, you would negotiate a price directly with the owner The owner may be willing to take a price lower than the market value especially if the offer is above the mortgage balance. Here the owner can get out of the loan and avoid foreclosure and perhaps still recoup some money. Or the purchase may be a short sale.
3. Bank-owned property. Once the foreclosure process has been completed, the lender typically takes ownership of the property. The lender then will attempt to sell the property on its own, through a real estate agent, or at a foreclosure auction . Most of the people bidding on these homes at auction are professionals and the buyer must come up with the cash immediately.
There are many potential pitfalls when buying a foreclosed residence. The property is likely to need repairs, so insist upon a professional home inspection. Also, taxes and other assessments may be owed. Foreclosure properties can be found on such websites as www.Foreclosure.com , www.Foreclosures.com , and www.RealtyTrac.com , which charge monthly subscription fees for access to their databases. Use a licensed real estate agent and hire a real estate attorney to help when making an offer and for the closing process.
CONCEPT CHECK 9.1
1. Explain the purpose and value of a lease for both the renter and the landlord.
2. Distinguish between periodic tenancy and tenancy for a specific time when renting housing.
3. Identify three ways that home buyers can save on their income taxes.
4. Illustrate how housing buyers can pay less than renters when taxes and appreciation of housing values are considered.
9.2 WHAT DOES IT COST TO BUY A HOME?
LEARNING OBJECTIVE 2
Explain the up-front and monthly costs of buying a home.
Buying housing represents the largest outlay of funds over most people's lifetime. Some of these costs occur up front. The largest of these is usually the down payment. Others, such as the mortgage payment, occur monthly. A few items, such as real estate property taxes, require both an initial outlay and recurring monthly payments. Table 9-1 illustrates these outlays for the purchase of a $185,000 single-family dwelling with $25,000 down financed by a 30-year mortgage at 6.0 percent interest. (We have used a 6.0 percent rate for illustration purposes. Rates may be lower or higher depending on your credit score and market conditions.) This same example is used repeatedly throughout this chapter to illustrate the costs of home buying as it is near the median price for firsttime buyers.
9.2a Pay Up-Front Costs at the Closing
First-time home buyers are faced with substantial initial costs when buying a home. These include the down payment and closing costs. Closing costs include fees and charges other than the down payment and typically vary from 2 to 7 percent of the mortgage loan amount. The down payment and closing costs must be paid at a meeting called the closing at which ownership of the property is transferred. All the parties to the purchase, sale, and the mortgage loan are represented at the closing. Up-front costs are indicated on page 257 in Table 9-1 .
closing costs Include fees and charges other than the down payment and typically vary from 2 to 7 percent of the mortgage loan amount.
The Down Payment The down payment is an initial payment made in the context of buying expensive items on credit, such as a vehicle or home. When buying a home, the buyer actually writes a check to the seller for that amount. In this example, we assume that the prospective homeowner has $25,000 saved to use as a down payment on a $185,000 home and will, therefore, need to borrow $160,000.
down payment An initial payment made in the context of buying expensive items on credit, such as a vehicle or home.
Points A point (or interest point ) is a fee equal to 1 percent of the total loan amount. Any charges for points must be paid in full when the home is bought, although sometimes they can be added to the amount borrowed. Lenders use points to increase their income return on loans. For example, a lender might advertise a loan as having an interest rate 0.25 percentage point below prevailing rates but then charge 1 point. Points are, in effect, prepaid interest and compensate the lender for having a lower interest rate. In our example, the lender charged 1 point on the $160,000 loan, resulting in a charge of $1600. By law, interest points must be included when calculating the APR for the loan because they really are interest. Interest points are deductible on federal income tax returns.
point/interest point Fee equal to 1 percent of the total mortgage loan amount.
Attorney Fees Home buyers should hire an attorney to review documents and advise and represent them prior to and during closing. Attorney fees commonly amount to 0.5 percent of the purchase price of the home, although some attorneys do this work for a flat fee ($500 in our example).
Table 9-1 Illustrated Up-Front and Monthly Costs When Buying a Home (Purchase Price of a Home, $185,000 with $25,000 Down; Closing on July 1)
|
Home-Buying Costs |
At Closing |
Monthly |
|
Payments Required Up Front |
|
|
|
Down payment |
$25,000 |
|
|
Points (1) |
1,600 |
|
|
Attorney's fee |
500 |
|
|
Title search |
200 |
|
|
Title insurance (to protect lender) |
320 |
|
|
Title insurance (to protect buyer) |
320 |
|
|
Loan origination fee |
800 |
|
|
Credit reports |
60 |
|
|
Home inspection |
400 |
|
|
Deed recording fees |
250 |
|
|
Appraisal fee |
250 |
|
|
Termite and radon inspection fee |
130 |
|
|
Lot survey fee |
100 |
|
|
Pro-rata interest |
435 |
|
|
Home title transfer fee |
1,180 |
|
|
Notary fee |
150 |
|
|
Payments Required Monthly |
|
|
|
Principal and interest (from Table 9-3 for a $160,000 loan for 30 years at 6.0%) |
|
$ 959.28 |
|
Mortgage insurance |
|
53.33 |
|
Warranty insurance |
|
30.00 |
|
Payments Required Up Front and Then Monthly |
|
|
|
Property taxes ($2160 for the entire year, $1080 for first half-year, then $180 monthly) |
1,080 * |
180.00 |
|
Homeowner's insurance ($1200 for the entire year; $600 for first half-year, then $100 monthly) |
600 † |
100.00 |
|
Subtotal |
$33,375 |
$1,322.61 |
|
Less amount owed by seller |
– 1,080 * |
_________ |
|
Total |
$32,295 |
$1,322.61 |
* Would be received from seller, who legally owes these taxes, and then deposited in escrow account to be available when the tax bill comes due at the end of the year.
† Would be paid to escrow account to be available when the premium for the next year is due.
Title Search and Insurance The title to real property is the legal right of ownership interest. In real estate transactions, the title is transferred to a new owner through a deed , which is a written document used to convey real estate ownership. Although there are several types of deeds, a warranty deed is the safest as it guarantees that the title is free of any previous mortgages.
title Legal right of ownership interest to real property.
deed Written document used to convey real estate ownership.
A title search and the purchase of title insurance protect the buyer's title to the property. Your attorney or title company will conduct a title search by inspecting court records and prepare a detailed written history of property ownership called an abstract. The fees for this process can be paid by the seller or buyer ($200 paid by buyer in our example). Lenders often require buyers to purchase title insurance because it protects the lender's interest if the title is later found faulty. Premiums for title policies vary among title companies. The one-time charge at closing may amount to 0.20 percent of the amount of the loan for each policy ($320 [$160,000 × 0.002] in our example). Homeowners who wish to insure their own interest must purchase a separate title insurance policy (another $320 in our example).
title insurance Protects the lender's interest if the title search is later found faulty.
Miscellaneous Fees When a prospective mortgage borrower applies for a loan, the lender may charge a loan origination fee at the closing to process the loan ($800 or half of a point in our example). In addition, credit reports ($75 in our example) are needed before a home buyer can obtain a loan—and the borrower pays the fee for this report as well. Another important up-front cost is the home inspection ($400 in our example) conducted to ensure that the home is physically sound and that all operating systems are in proper order. Title and deed recording fees ($250 in our example) are charged to transfer ownership documents in the county courthouse. An appraisal fee ($250 in our example) may be required to obtain a professionally prepared estimate of the fair market value of the property by an objective party. If you are charged an appraisal fee, you have the right to receive a copy of the appraisal. Occasionally, termite and radon inspections ($130 in our example) are required by local laws, and these are a good idea even when not required. A survey ($100 in our example) is sometimes required to certify the specific boundaries of the lot. Finally, separate notary fees ($150 in our example) may be charged for the services of those legally qualified to certify (or notarize) signatures. Some communities also charge a home title transfer fee, which is simply a tax imposed to support community services such as police, fire, and schools. Pro-rata interest may be required if the closing does not occur on the due date of the mortgage payment and interest will accrue before the first payment is due.
home inspection Conducted to ensure that the home is physically sound and that all operating systems are in proper order.
appraisal fee Fee charged for a professionally prepared estimate of the fair market value of the property by an objective party.
9.2b Your Monthly Costs Include Both Principal and Interest
Once a home is purchased, the monthly costs can consume as much as 30 or 40 percent of your disposable income. These costs include the portion of your monthly payment that goes to principal (the amount you owe) and interest. Additional monthly costs can include mortgage insurance, home warranty insurance, property taxes, and homeowner's insurance. Monthly costs are indicated 259 in Table 9-1 .
Joint Ownership Is Best when Couples Buy a Home
Almost one-quarter of married homeowners age 18-34 bought a home together before they were married. Both unmarried and married couples buying a home together should generally put the ownership in both names using joint tenancy with right of survivorship. If one of the parties dies, the other will have clear title to the entire property.
Mortgage Principal and Interest A mortgage loan requires repayment of both principal (P) and interest (I), which are the first two letters of the acronym PITI , which real estate agents and lenders often use to indicate a mortgage payment that includes principal, interest, real estate taxes, and homeowner's insurance. In the example in Table 9-1 , the mortgage payment for principal and interest on a 30-year mortgage for $160,000 at 6.0 percent is $959.28. (Later in this chapter, you will learn how the P and I components for any mortgage loan are calculated).
PITI Elements of a monthly real estate payment consisting of principal, interest, real estate taxes, and homeowner's insurance.
Mortgage Insurance Lenders today expect a 70 to 80 percent loan-to-value (LTV) ratio when a home is purchased. The LTV ratio is simply the loan amount divided by the value of the home (the purchase price initially). An 80 percent LTV ratio translates into a 20 percent down payment, an amount that is difficult to come by for many first-time buyers. When a buyer makes a lower down payment that results in an LTV higher than that desired by the lender, the lender requires that the borrower purchase mortgage insurance.
loan-to-value (LTV) ratio Original or current outstanding loan balance divided by the home value.
Mortgage insurance insures the difference between the amount of down payment required by the lender's desired LTV ratio and the actual, lower down payment. In this way, the lender is assured of payment of the loan balance if the home were later foreclosed for default and sold for less than the amount owed. Mortgage insurance may be obtained from several sources and can be canceled when the LTV ratio reaches the desired percent as the loan is paid down. You can obtain mortgage insurance from the following three sources.
mortgage insurance Insures the difference between the amount of down payment required by an 80 percent LTV ratio and the actual, lower down payment.
• Private Mortgage Insurance. Private mortgage insurance (PMI) is obtained from a private company. The largest private mortgage insurer is the Mortgage Guaranty Insurance Corporation (MGIC, pronounced “magic”). The cost of PMI varies from 0.25 to 2.0 percent of the debt, depending on the degree to which the LTV ratio exceeds the lender-desired percentage. In our example, the LTV ratio is 86.5 percent ($160,000 ÷ $185,000), and the lender required 80 percent (20 percent down). As a result, the annual private mortgage insurance premium is 0.4 percent of the mortgage loan (0.004 × $160,000) and is $640, or $53.33 per month ($640 ÷ 12). It may be possible to obtain lender-paid mortgage insurance in return for paying a fractionally higher interest rate. The downside is that the insurance cannot be canceled when the LTV ratio hits the desired percentage without completely refinancing the loan.
private mortgage insurance (PMI) Mortgage insurance obtained from a private company.
• FHA Mortgage Insurance. The Federal Housing Administration (FHA) of the U.S. Department of Housing and Urban Development (HUD) insures loans that meet its standards. FHA-insured loans can allow you to borrow with as little as 3.5 percent down. The insurance is paid for by a combination up-front charge ranging from 1.00 to 2.25 percent of the amount borrowed and a monthly charge of up to 1.15 percent. The maximum amount of the loan varies by geographic region. To obtain such mortgage insurance, the borrower must be creditworthy and the home must meet the FHA's minimum-quality standards.
(For information on HUD mortgage programs, visit www.hud.gov/buying/index.cfm .)
Federal Housing Administration (FHA) Part of the U.S. Department of Housing and Urban Development (HUD) that insures loans that meet its standards to encourage home ownership.
• VA Mortgage Insurance- The federal Department of Veterans Affairs (VA) promotes home ownership among military veterans (active-duty, reserve, and National Guard veterans may qualify) by providing the lender with a guarantee against buyer default. In effect, the VA ( www.benefits.va.gov/homeloans/ ) guarantee operates much like FHA or private mortgage insurance—that is, the lender is guaranteed a portion of the loan's value in the event that the home must be foreclosed and sold below the outstanding balance on the loan.
Home Warranty Insurance All homes for sale carry some type of implied warranty (see page 234 Chapter 8 ). In most states, home sellers must complete and sign a form required by state law to verify the condition of home features and major mechanical equipment at the time of sale. A seller who knowingly hides serious defects might be liable, but the buyer may have to hire an attorney and sue to prove this point. Also, many new-home builders provide an express warranty good for one year on the new homes they sell.
Home warranty insurance, another option for the homeowner, operates much like a service contract (also discussed in Chapter 8 on pages 234–235). Insurance companies sell this type of insurance on existing homes through real estate agents and builders. The example in Table 9-1 has a $30-per-month home warranty insurance protection for one year. Typically, the homeowner must pay the first $100 to $500 of any repair.
9.2c Taxes and Insurance Are Paid Both Up Front and Monthly
Some home-buying costs do not fit neatly into an up-front or monthly pattern. This is because they are billed annually, although they often can be paid monthly. Examples are taxes (T) and insurance (I), which represent the last two letters of PITI. To ensure that these are paid when due, the lender usually requires that monthly installments be paid into an escrow account. An escrow account is a special reserve account at a financial institution in which funds are held until they are paid to a third party. When the insurance and tax bills are due, the institution pays them out of the escrow account.
escrow account Special reserve account at a financial institution in which funds are held until they are paid to a third party—in this case, for home insurance and for property taxes.
Real Estate Property Taxes Real estate property taxes (the T in PITI) must be paid to local governments annually and may range from 1 to 4 percent of the value of the home. The total property tax ($2160 in our example) is due once a year when the government mails out its tax bill. However, if a buyer takes possession during the tax year, the buyer must pay the taxes accrued so far into the escrow account at the closing ($1080, or 6 × $180 here) to ensure that sufficient funds will be available when the bill comes due at the end of the year. Then the monthly amount ($180 in our example) is paid thereafter into the escrow account. (Because it is the seller who really owed the taxes for the six months prior to the sale, the seller will pay the buyer $1080 on the day of the closing.)
Real estate property taxes are based on the value of buildings and land. To calculate these taxes, local government officials first establish a fair market value which is what a willing buyer would probably pay a willing seller for the owner's home and land. Next, the assessed value of the property is calculated. This is the dollar value assigned for the purposes of measuring applicable taxes. A home with a fair market value of $160,000, for example, might have an assessed value of $120,000. Some government officials establish the assessed value of a property as the same as the fair market value. You might reduce your property taxes by claiming that the assessed valuation of your home is too high. If successful, your tax bill will be lowered. About one-half of all appeals succeed.
Homeowner's Insurance Lenders always require homeowners to insure the home itself in case of fire or other calamity. Both the home and its contents can be covered in a typical homeowner's insurance policy (the second I in PITI). ( Chapter 10 covers this information in detail.) The annual premium for such insurance must be paid each year in advance ($1200 in this example). Lenders require prepayment of the estimated insurance premium each month ($100 here) into the escrow account. In our example illustrated in Table 9-1 , the purchaser must be prepared to pay one-half year's premium ($600 here) on the closing day so that there will be sufficient funds in the account to pay the next year's full premium in six months when it is due.
9.2d Make a Decision Based on All Costs
The wise financial planner will carefully estimate all initial and monthly costs of housing. Focusing only on the down payment and the monthly payment for principal and interest does not tell the whole story.
In our example, the borrower was able to put less than 20 percent down (13.5% = $25,000 ÷ $185,000). However, with points and other up-front costs, actually had to come up with $32,295 at the closing. Similarly, the monthly payment for principal and interest was $959.28, but the actual monthly outlay will be $1322.61. This is the real dollar amount that this buyer must fit into his or her budget when trying to determine whether he or she can afford to buy a home.
CONCEPT CHECK 9.2
1. What is the standard down payment amount on a mortgage loan?
2. If you make a down payment that is lower than standard, identify the extra cost you will be required to pay.
3. Why do lenders use points in home loans, and who is responsible for paying points?
4. Explain why the down payment and mortgage principal and interest understate the actual up-front and monthly costs of home ownership.
5. When should you request that private mortgage insurance be canceled if such insurance was required at the time of purchase of a home?
6. Identify the components of PITI.
LEARNING OBJECTIVE 3
Describe the steps in the home-buying process.
Do not be in a hurry. Buying a home is the biggest purchase you will likely ever make and special attention needs to be paid to the seven steps outlined in Figure 9-1 .
9.3a 1. Get Your Finances in Order
You need to be financially ready to buy a home. The first three steps ease the home buying process: doing a credit checkup, accurately estimating all monthly housing costs, and fitting projected housing costs into your budget.
Clean Up Your Credit History Your credit history can make or break your chances of buying the home of your dreams. The average FICO credit score for home loan borrowers is above 730. Obtain copies of your credit report and your credit scores from all three major credit reporting agencies (lenders use all three) about six months in advance of starting to buy a home. That way you will have time to clear up any errors and problems before the loan application process begins. To finance a home purchase you also will need a sufficient and steady earnings history.
Figure 9-1 Steps in the Process of Buying a Home You should plan on it taking about 6 months to buy a home from the time you begin your efforts until you actually move in.
Use Internet Resources to Estimate Your Monthly Housing Costs It is vital to have an accurate estimate of what you will have to pay on a monthly basis for your new home. You should include all likely components of the monthly payment into your budget: the principal and interest, property taxes, homeowner's insurance, mortgage insurance, and perhaps a home warranty fee. You should also consider any additional costs you might pay for utilities. Heating, air-conditioning, electric, and water are all areas for which homeowners generally pay more than renters. Estimating a 50 percent increase from what you are currently spending might be a starting point.
1. Resources are available on the Internet to help estimate housing costs ( www.cgi.money.cnn.com/tools/houseafford/houseafford.xhtml and www.homes.yahoo.com/calculators/afford.xhtml ).
2. Then choose the type of home you would like to own and the neighborhoods in which you would like to live.
3. Go to the www.realtor.com website to search for housing that matches your interests. You will be able to estimate the selling price of similar housing and, by subtracting your available down payment amount, estimate the amount you will need to borrow.
4. Go to the www.bankrate.com website to estimate the current interest rates on mortgage loans in your market.
5. Use the calculator at www.bankrate.com/calculators/mortgages/mortgage-calculator.aspx to estimate the monthly payment for a loan of the amount you need at the prevailing interest rates. Or use Table 9-4 on page 273.
6. Add an additional 30 to 40 percent (it was 39 percent in the Table 9-1 example) to the monthly payment on the loan itself for such things as homeowner's insurance, property taxes, private mortgage insurance, and warranty insurance.
Fit the Housing Costs into Your Budget Once you have an estimate of the monthly costs associated with buying a home, you will need to see how these costs fit into your budget. You can follow a similar process as outlined in Chapter 8 on pages 227 to 228 to fit your payment into your budget. Base the budget on only one person's income. A young couple who buys a home based on their combined incomes is locked into a full-time, dual-income lifestyle to pay the loan. Family obligations or a job loss may later disrupt their ability or willingness to continue that lifestyle. Instead, base your housing affordability on just one income. Or, perhaps include part-time work income for the second person.
Bias toward Having the Best
People engaged in obtaining affordable housing have a bias toward certain behaviors that can be harmful, such as a tendency toward wanting to have the best. Many first-time homebuyers want to purchase a home that has all the most desirable features but doing so stretches their budgets. What to do? When purchasing your first home, buy it thinking “to get started” by making sure it easily fits your budget. Don't make your first home a really large “dream home.”
Special Insurance Programs for Those Who Can Only Afford a Low Down Payment
Many state and local governments provide support for first-time homebuyers through various housing agencies. These supports often take the form of special low down payment loan programs, forgivable down payment loans, and certain guarantees that encourage lenders to accept lower than usual down payments or mortgage interest rates. Lenders in your area can provide you with information about programs that target these special-needs groups. Or go to www.hud.gov/buying/localbuying.cfm for links to programs in each state.
9.3b 2. Prequalify for a Mortgage
Before you even start looking at specific homes you should look into whether you will prequalify for a mortgage loan given the price range of homes that you like and your intended down payment. To prequalify means that a lender believes it is likely that a loan would be granted based on preliminary information provided such as a credit report, amount borrowed and likely down payment. It tells you if you can obtain a loan and the tentative APR. Make a list of three or four possible lenders at this point including your own bank (see www.bankrate.com ). If your budget cannot accommodate the estimate of monthly costs you find in the pre-qualification, you may need to revise your goals by downsizing the type of home you desire or choose housing in a less expensive neighborhood. Helpful information can be found at the websites for the U.S. Department of Housing and Urban Development ( www.hud.gov/buying/booklet.pdf ) and the Federal National Mortgage Association ( www.homepath.com/financing.xhtml ).
Consult Multiple Lenders Once you have an idea of the interest rate you might pay, you can consult other lenders to determine whether you would actually qualify for a mortgage in the amount you would like. Be aware that prequalifying for a loan carries no guarantee that you will be able to get a loan on a specific property. The purpose of the prequalification is to help you set the price range when you start looking for particular homes.
Perhaps Use a Mortgage Broker A mortgage broker is an individual or company that acts as an intermediary between borrowers and lenders. In other words, a broker helps lenders find borrowers and borrowers find lenders. Either the lender or the borrower may pay the fee charged by the broker. If the lender pays this fee, the broker legally represents the lender. If the borrower pays it, the broker legally represents the borrower. Thus, if you want the broker to work to find you the lowest possible rate, you should be prepared to pay for the service. On-line services such as at www.lendingtree.com make your application information available to multiple lenders who then contact you with loan offers. About 10 percent of all mortgage loans today are arranged through a mortgage broker.
mortgage broker Individual or company that acts as an intermediary between borrowers and lenders.
Lenders Use Two Rule of Thumb for Home Loans To estimate the maximum affordability of housing expenses for a home loan applicant lenders use two rules of thumb.
• The front-end ratio compares the total annual expenditures for housing (the principal and interest on the mortgage plus the real estate taxes and insurance) with the loan applicant's gross annual income (before taxes). Generally, the total annual expenditures should not exceed 25 to 29 percent of gross annual income. Applying a 28 percent front-end ratio, a young couple with a combined gross annual income of $84,000 could qualify for a mortgage requiring total annual expenditures of less than $23,520 (0.28 × $84,000), or $1960 per month.
front-end ratio Compares the total annual PITI expenditures for housing with the loan applicant's gross annual income to assess the borrower's ability to pay the mortgage.
• The back-end ratio is also known as the debt-to-income ratio. To calculate divide the total of all monthly debt repayments (for the mortgage, real estate taxes, and insurance, plus auto loans and other debts) by one's gross monthly income (before taxes) and multiply by 100. A ratio of 0.36 or less is desirable. Home loan seekers may not exceed 43 percent to obtain a qualified mortgage, according to the Dobb-Frank law. Applying a back-end ratio of 38 percent, the same couple could qualify for any loan that does not result in total monthly debt repayments exceeding $2660 (their monthly income of $7000 [$84,000 ÷ 12] × 0.38). The fastest way to improve (or lower) your back-end ratio is to pay down your debts.
back-end ratio Compares the total of all monthly PITI expenditures plus auto loans and other debts with gross monthly income.
DO IT IN CLASS
The Income Needed to Qualify for a Mortgage
The table below gives you a quick idea of how much income you need to buy a home at a certain price using a front-end ratio of 28 percent. The illustration is for a 30-year loan with a 20 percent down payment. For each home price, the top figure in each row shows the monthly payment for principal, interest, real estate taxes, and homeowner's insurance for the interest rates; the bottom figure shows the required gross annual income to qualify for the loan. For example, a 6 percent loan on a $180,000 home requires a monthly payment of $1088 plus an income of $46,600 to qualify. Taxes and insurance are assumed to be 1.5 percent of the purchase price (divided by 12 months). Visit the Garman/Forgue companion website to perform these calculations for a variety of home prices and interest rates.
DO IT IN CLASS
About Parental Help for Buying a Home
Many young, first-time home buyers look to family members, usually parents, to help them buy a home. Typically they need money to help make the required down payment. If the assistance is a gift to be paid at the closing, the lender will usually require a gift letter with the mortgage application stating that the funds will truly be a gift and from the giver's own funds.
Loans from parents are more complicated. The lender will require that the loan terms be put in writing and the payment amounts will be included when determining mortgage affordability.
Interest paid to any down payment lender will be considered taxable income for the lender. If there is no interest or the rate is below current market interest rates, and the buyer's tax return is audited, the IRS will determine the imputed interest amount that would otherwise have been paid, and that amount will be taxable for the lender of the down payment.
Interest paid by the borrower will not be tax deductible unless the down payment loan is secured by a lien on the home. Mortgage lenders will rarely agree to have a second lien holder, however. It may also be possible to borrow the entire amount from a family member. The paperwork must be drawn up carefully to ensure that the loan is secured and tax-advantages are safeguarded. For details visit www.nationalfamilymortgage.com/ .
9.3c 3. Search for a Home Online and in Person
Searching for a home requires a commitment of time. You do not want to be impulsive when you will be committing yourself to many thousands of dollars of expense. You can find housing in any number of ways, but the Internet is most helpful. You can narrow your choices to excellent prospects without ever leaving home. Simply go to www.realtor.com and search for homes in your community. Never buy without knowing the typical prices for homes in the area in which you wish to buy; not just a particular home of interest. Use Zillow.com or Truvia.com to determine prices for homes that have sold recently in the area. You will be able to see floor plans, photos, descriptions of features and condition, and price-related information. Once you have found some homes you would like to see, you can contact the seller or the real estate agent handling the properties. Make a list of questions to ask including recent repairs such as to the roof, the cost of utilities over the past year, and many others. A convenient checklist can be found at www.hud.gov/buying/checklist.pdf .
Keep Your Debts Low if You Want to Buy a Home
High student loan, car loan, or credit card payments can easily disqualify a potential home buyer based on a lender's use of the back-end ratio. If you plan on buying a home, you need to be very careful about taking on too much debt while in school and after graduation.
9.3d 4. Agree to Terms with the Seller
Once you have your finances in order and have received assurances that you can qualify for a mortgage, you can start looking for a home in earnest.
Make an Offer to Buy The written offer to purchase real estate is called a purchase offer (or an offer to purchase ). Sellers generally put a price on the property that is 5 to 15 percent higher than the amount that they actually expect to receive. Therefore, you may want to make an offer to buy that is somewhat lower than the asking price. How much lower is a big question. If you have done your homework and know what homes have been selling for (not offered for) in the area, you will be able to make a knowledgeable offer slightly below what you have found. For more on making an offer to buy consult www.new.realtor.com/basics/buy/chooseoffer/makeoffer.asp?source=web
purchase offer/offer to purchase Written offer to purchase real estate.
Earnest Money Other aspects of the sale should be included in your offer as well. Examples of conditions include successful termite and radon inspections; a home inspection of the plumbing, heating, cooling, and electrical systems; and inclusion of the living room drapes and kitchen and other appliances. When you make an offer, you need to give the seller some earnest money as a deposit; 2 or 5 percent of the purchase price should be sufficient to show your good faith when making an offer to purchase the seller's property. This money is returned if the seller rejects the offer.
earnest money Funds given to the seller as a deposit to hold the property until a purchase contract can be negotiated.
How to Search for a Home
You can be a more effective home shopper if you do the following:
• Make a list in advance of special features and “must have” items that you are looking for in your new home.
• Drive around desirable neighborhoods before you visit a property. Look at the condition and upkeep of the homes and yards. Are there many homes for sale in the area? Get out of the car and listen. Are there industrial noises or excessive highway noises? Any pet noises from neighbors? Look at the availability and quality of parks and schools.
• Look at only two or three properties in one day at most. Looking at too many homes at one time can be confusing and exhausting.
• Bring a notepad and tape measure with you. Make sketches of the floor plans that you like. Bring along a camera or video equipment. Photos and videos you see on-line are taken from the most advantageous camera angles.
• Use a checklist to record, describe, and evaluate features of the home. These can be found on line such as at www.hud.gov/buying/checklist.pdf .
• Check for slope and sags by setting a small rubber ball at various places on floors, countertops, and door frames. The ball should not move.
• Walk around the outside of the property to assess the external condition of the home and yard. Look for signs of water damage to the home or drainage issues in the yard.
Respond to a Counteroffer Most home sellers do not accept the first offer from a prospective buyer. Instead, they usually make a counteroffer, which is a legal offer to sell (or buy) a home at a different price and perhaps with different conditions from those outlined in the original offer. You can assume that a seller who is willing to make a counteroffer may also be willing to sell at a slightly lower price. Thus, if you make a counteroffer falling between the two prices, a sale will usually result. But, it is common to have other offers outstanding on a home of choice. So, if you push the seller too far, you risk having the seller back out of the negotiations altogether.
Negotiate a Price and Sign a Purchase Contract A purchase contract (or sales contract ) is the formal legal document that outlines the actual agreement that results from the real estate negotiations. It includes the final negotiated price and a list of conditions that the seller has agreed to accept. When the purchase contract is signed, the seller keeps the earnest money as a deposit. If at this point you simply change your mind about buying, you will forfeit your earnest money and may be sued for damages.
purchase contract/sales contract Formal legal document that outlines the actual agreement that results from the real estate negotiations.
The Role of Real Estate Agents
A real estate broker (agent) is a person licensed by a state to provide advice and assistance, for a fee, to buyers or sellers of real estate. Real estate brokers who are members of the National Association of Realtors often use the registered trademark of Realtor® to describe themselves. Brokers typically earn a commission of 6 to 7 percent on the sale price of a home. The seller—not the buyer—usually pays this commission. Flat-fee brokers, who charge a flat fee for their services rather than a percentage-based commission, are also available in most real estate markets.
real estate broker (agent) Person licensed by a state to provide advice and assistance, for a fee, to buyers or sellers of real estate.
Almost any agent can show you housing that is listed (under contract with the seller and the broker) by the realty firm.
Buyers should understand that a real estate agent can play various roles. The listing agent is the party with whom the seller signs the listing agreement. Listing agents advertise the property, show it to prospective buyers, and assist the seller in negotiations. They receive a commission when the home is sold and owe the seller undivided loyalty. A selling agent is any real estate agent that seeks out buyers for a home. Listing agents also play this role, but any real estate agent can search for buyers to whom to sell a property.
Most home buyers use a real estate agent in their search for a home. They should understand that the agent's legal obligation is to the party who will pay his or her fee or commission—generally the seller! Buyers should be wary of this potential conflict of interest and hire their own broker if they need such services. That is, home buyers who want an agent to represent their interests should obtain the services of a buyer's agent. This person serves as the buyer's representative in the real estate negotiations and transaction. You can find reputable buyer's agents at www.rebac.net/buyers-rep or www.naeba.org .
Why is the distinction among the three types of agents important? Consider the example of a buyer who has asked a selling agent to help him find a home. During negotiations, the potential buyer decides to offer $175,000 for a property with an asking price of $189,000 but tells the selling agent that he would be willing to go as high as $180,000. The selling agent would then be legally obligated to tell the seller about this $180,000 figure. The seller's agent is not your friend.
Contingency Clauses These are very important to a potential buyer because you want to make sure that your earnest money is protected by including one or more clauses in the purchase contract. These clauses specify that certain conditions must be satisfied before a contract is binding. One recommended clause would stipulate that the seller must refund the earnest money if the buyer cannot obtain satisfactory financing within a specified time period, usually 30 days. Other important contingency clauses should allow the buyer to opt out of the deal if the appraisal comes in below the agreed upon price or the home fails to pass certain aspects of the home inspection (for example, the inspection uncovers a major structural defect).
contingency clauses Specify that certain conditions must be satisfied before a contract is binding.
9.3e 5. Formally Apply for a Mortgage Loan
Only after you sign a purchase contract do you formally apply for a mortgage loan on the specific home you have selected. Mortgage loan applications are complicated, and providing false information on the form can be considered fraud. Lenders all use the same form found at www.fanniemae.com/content/guide_form/1003rev.pdf . The potential lender usually pre approves or turns down this request within a few days A loan preapproval means that the lender agrees to grant a loan subject to verification of the information provided in the application.
The loan officer assigned to manage your application must mail you a good-faith estimate of all costs associated with the loan within three days of your application. The format for this document as shown at www.hud.gov/offices/hsg/ramh/res/gfestimate.pdf . The good-faith estimate lists the annual percentage rate, application and processing fees, and any other charges that must be paid when the deal is legally consummated. Almost all the items listed on the good-faith estimate are negotiable so be sure to do so.
good-faith estimate Lender's list of all the costs associated with the loan, including the annual percentage rate (APR), application and processing fees, closing costs, and any other charges that must be paid when the deal is legally consummated.
Table 9-1 provides an example of the type of information in the good-faith estimate. Do not be afraid to shop around for a lender at this stage. Show the good-faith estimate to other lenders you have identified to see if they can give you better terms.
The exact interest rate on your mortgage may be the current rate at the time of application or the rate in force at the time of closing. If you expect rates to rise between the time you apply for the loan and the actual closing, you may wish to pay a small fee to obtain a mortgage lock-in. This agreement includes a lender's promise to hold a certain interest rate for a specified period of time, such as 30 or 60 days. Make sure you receive a written lock confirmation of the lender's promise. If needed, a lock extension can be obtained for an additional fee. A mortgage lock-in may be part of, but is not the same as, a loan commitment , which is a lender's promise to grant a loan.
loan commitment Lender's promise to grant a loan.
What to Do if You Are Turned Down for a Mortgage Loan
A common nightmare of most first-time homebuyers: being denied a mortgage, What should you do if you get turned down for a mortgage loan?
1. Find out specifically why you were turned down. Request a written explanation from your lender as to why you were turned down for a mortgage. By law, your lender must provide you with this information within 30 days from your request. This explanation is called an adverse action notice, and it will detail the reasons why you were refused a mortgage.
2. Try again with better information. The adverse action notice may contain reasons for the turndown that can be corrected. Perhaps your income was too low. Did you include all sources and correct amounts of income? Perhaps your employment history was the problem. Can you provide additional information that would improve the assessment?
3. Revisit a too-low appraisal. If the appraisal on the home came in too low, the lender will be concerned that you were planning to pay too much for the home. It is against the law for you or your loan officer to obtain a new appraisal with a different appraiser. Occasionally, though, the first appraiser will reconsider when given new evidence such as the sales prices of recent sales for higher prices in the neighborhood.
4. Repair your credit. If your credit score was too low to qualify, you may be able to improve your credit scores by correcting errors and rearranging credit accounts. See www.myfico.com/CreditEducation/ImproveYourScore.aspx for suggestions. Also see Chapter 6 , page 182 for the steps to take to correct errors in your credit report and how to do so for free.
5. Take steps to improve your front- and back-end ratios. These ratios are based on your income, current debts, debt payments, and projected cost of the home you are considering. Changing any of these three items may help you qualify when you reapply. You may need to pay down some debt. Perhaps you should consider a still nice home in a lower price range.
6. Save more. Being turned down because of a too-low down payment, can be a sign that you need to wait to save more to afford the home you want.
7. Try another lender. Credit unions and small local banks often have more freedom to work with a client who has been turned down elsewhere. Understand, though, that a second turn-down may mean that the timing is just not right for you to buy.
Your Credit Score Affects the Mortgage Rate You Pay
Mortgage lenders charge interest rates based on your credit score. Illustrative FICO credit scores and the corresponding mortgage loan interest rates can be found at www.myfico.com/myfico/CreditCentral/LoanRates.aspx . Loan applicants whose scores are lower than desired are turned down. At that point the borrower may seek a lender in the subprime market, which serves higher-risk applicants with low credit scores. Borrowers who are placed in this market are often happy to have obtained a loan. However, such loans carry higher interest rates that may lead to future repayment difficulties. Therefore, it might be better for people with low credit scores to wait and build up their scores before applying for conventional mortgages.
9.3f 6. Prepare for the Closing
After you have obtained a mortgage, you are not yet finished. Of course, you will want to do all the usual tasks associated with moving: giving notification of your change of address, hiring a moving company (or not), and getting your utilities shut off at your old residence and on at your new one are examples. However, there are two very important additional steps to take that can save you thousands of dollars and many headaches.
Protect Your Credit Score while Waiting for Your Mortgage to Close
In the weeks leading up to the closing for a home purchase, it may be tempting to begin buying furniture, appliances, outdoor equipment, and other costly items for the home. Think twice if doing so means racking up high balances on your credit cards. Your mortgage lender will raise your interest rate if you significantly change your credit score before closing.
Hire Your Own Home Inspector Recall that you should always have a contingency clause included in your purchase contract so that you can back out of the deal if the house fails to pass the home inspection. The licensed or certified inspector should look for termite infestation, wood rot, mold, and radon gas as well as examine the general condition of the home, including heating/cooling, plumbing, and electrical. You should pay the inspector yourself ($250 to $350 is the typical fee) and should not choose one based on the recommendation of the seller's real estate agent. You want an independent person who is well qualified to look out for your interests (See www.ashi.org/find/default.aspx .) If the inspector finds problems, you can negotiate with the seller for an adjustment in the purchase price of the home or use the contingency clause to back out of the deal.
Hire an Attorney The good-faith estimate that you receive is a legal document outlining your entire up-front and monthly home-buying costs. Hiring an attorney to go over the estimate and your purchase contract to ensure that everything is in order is money well spent. Many of the closing costs are negotiable, and your attorney can advise on how to keep these costs to a minimum. If you are buying a home that was previously foreclosed, it is absolutely critical that you hire an attorney well experienced in these transactions. Some unfortunate buyers of foreclosed properties have later found serious defects in their titles as well as claims against the home.
9.3g 7. Sign Your Name on Closing Day
To complete the sale, the buyer, the seller, and their chosen representatives generally gather in the lender's office for the closing. At the closing, all required documents are signed and payments are made. A key document is the uniform settlement statement , which lists all of the costs and fees to be paid at the closing. You have the right to see this statement one business day before the closing and again at the closing so that you can avoid surprises and can compare the fees with the good-faith estimate provided earlier. Challenge any discrepancy. You can negotiate every closing cost item. A full description of the required disclosures can be found by going to www.hud.gov/respa to learn more about your rights under the Real Estate Settlement Procedures Act.
uniform settlement statement Lists all of the costs and fees to be paid at the closing.
Money Websites for Obtaining Affordable Housing
Informative websites for obtaining housing, including current prices on homes in your community are:
Bankrate.com ( www.bankrate.com/mortgage.aspx )
Department of Housing and Urban Development (portal.hud.gov/hudportal/HUD)
Federal Housing Administration ( www.fha.gov )
FSBO.com ( www.fsbo.com )
Kiplinger's Personal Finance ( www.kiplinger.com/fronts/channels/real-estate/ )
MoneyCNN ( www.money.cnn.com/real_estate/?iid=PF_Subr )
NOLO ( www.nolo.com/legal-encyclopedia/real-estate-rental-property )
Trulia ( www.trulia.com )
Veteran's Administration ( www.benefits.va.gov/homeloans/ )
Yahoo Finance ( www.finance.yahoo.com/real-estate/ )
Zillow ( www.zillow.com )
Sean's Success Story
Sean knew that he could not afford to buy a home for a few years after he took his first job following college. Nonetheless, he began saving for this goal by using direct deposit to put 5 percent of his salary into a Roth IRA account set up exclusively as a home-buying savings fund. At the end of each year, he used the funds to buy certificates of deposit designed to mature six years after his graduation. Now after six years, he has a fund exceeding $20,000 and has begun taking steps to buy a condominium. Sean's first step was to obtain his credit reports and credit score to ensure that his financial history was accurate. He then contacted multiple lenders to determine the interest rate and monthly payment he could expect on a property costing about $200,000. His good credit allowed him to be preapproved at that amount so he reworked his budget to see if he could afford the required monthly payment including an estimate for homeowner's insurance and property taxes. He was happy to see that he could do so. He has begun shopping for condos in the $180,000 range to give him a budget cushion once mortgage payments begin. Sean is excited about buying his first home.
CONCEPT CHECK 9.3
1. Distinguish between the two rules of thumb that lenders use to assess housing affordability.
2. What services does a mortgage broker offer?
3. What services do real estate agents provide for buyers?
4. Why should a buyer be cautious about working with a seller's agent?
5. Explain the benefits of having contingency clauses in a home purchase agreement
LEARNING OBJECTIVE 4
Understand the mathematics of mortgage loans and distinguish among ways of financing the purchase of a home.
People often rent housing for five years or more while they save enough to make a down payment to purchase a home. Before buying, you must become knowledgeable about mortgage loans and learn how they are used to purchase a home.
9.4a The Mathematics of Mortgage Loans
Mortgage loans are available from depository institutions (described in Chapters 5 and 7 ) and mortgage finance companies that focus specifically on making mortgage loans. (To find approved lenders in your area go to www.hud.gov/ll/code/llslcrit.cfm .) In exchange for the loan, the lender (mortgagee) has a lien on the real estate— that is, the legal right to take and hold property or to sell it in the event the borrower (mortgagor) defaults on the loan.
The term mortgage receives its name from the concept of amortization, which is the process of gradually paying off a loan through a series of periodic payments to a lender. Each payment is allocated in two ways:
1. A portion goes to pay the simple interest on outstanding debt for that month multiplied by the periodic (monthly) interest rate.
2. The remainder goes to repay a portion of the principal, which is the debt remaining from the original amount borrowed.
As the principal is paid down, increasingly smaller portions of the payments will be required to pay interest while the portion of the payments devoted to the principal will grow larger. These changes in the allocation of each payment are illustrated in Figure 9-2 . Note the very slow decline in the amount of each monthly payment going toward interest. It takes 7 years before the $800 going toward interest drops to $700. A high proportion of each monthly payment during the early years of a mortgage loan is allocated to interest.
Figure 9-2 Change in Principal and Interest Components of the Monthly Payment on a $160,000 Mortgage Loan at 6.0 Percent Interest Rate for 30 Years
Table 9-2 shows the interest and principal payment amounts for the first three months of a $160,000, 30-year, 6.0 percent mortgage loan. For the first month, $800 goes for interest costs, and only $159.28 goes toward retirement of the principal of the loan. Table 9-3 provides a partial amortization schedule for the same loan. When you take out a mortgage loan, you will receive a full amortization schedule for each month of the loan listing each and every monthly payment, which will show the portions that will go toward interest and principal, and the debt remaining after each payment is made.
amortization schedule List that shows all the monthly payments, the portions that will go toward interest and principal, and the debt remaining after each payment is made throughout the life of the loan.
It takes many years of monthly payments to significantly reduce the outstanding balance of the loan. At any point, the amount that has been paid off (including the down payment) plus any appreciation in the value of the home represents the homeowner's equity (the dollar value of the home in excess of the amount owed on it).
homeowner's equity Dollar value of the home in excess of the amount owed on it.
DO IT IN CLASS
Table 9-2 Amortization Effects of Monthly Payment of $959.28 on a $160,000, 30-Year Mortgage Loan at 6.0 Percent
|
First Month |
$160,000 × 6.0% × 1/12 = $800.00 Interest payment |
|
|
$959.28 − 800.00 = $159.28 Principal repayment |
|
|
$160,000 − 159.28 = $159,840.72 Balance due |
|
Second Month |
|
|
|
$159,840.72 × 6.0% × 1/12 = $799.20 Interest payment |
|
|
$959.28 − 799.20 = $160.08 Principal repayment |
|
|
$159,840.72 − 160.08 = $159,680.64 Balance due |
|
Third Month |
|
|
|
$159,680.64 × 6.0% × 1/12 = $798.40 Interest payment |
|
|
$959.28 − 798.40 = $160.88 Principal repayment |
|
|
$159,680.64 − 160.88 = $1 59,519.76 Balance due |
Table 9-3 Partial Amortization Schedule for a $160,000, 30-Year (360-Payment) Mortgage Loan at 6.0 percent Figure 9-3 Change in Loan Balance and Owner's Equity for a $185,000 Home Purchased with $25,000 Down at a 6.0 Percent Interest Rate for 30 Years (Assumes a 3% Annual Market Price Increase)
Figure 9-3 illustrates the buildup of equity in a home that results from reductions in the amount owed and the growth in the home's value. Note that the bulk of the increase in equity is a result of increases in the market value of the home. You want to buy a home based on its features and location, not as an investment. Nonetheless, equity buildup over the long run is a definite plus. If desired, additional payments can be directed toward the principal at any time to reduce the amount owed, increase equity, and reduce the eventual total amount of interest paid on the loan. The equity portion of a mortgage payment is a type of forced savings and helps explain why homeowners typically have a higher net worth than renters.
9.4b Three Factors That Affect the Mortgage Payment
Three factors affect the monthly payment on a mortgage loan: the amount borrowed, the interest rate charged, and the length of maturity of the loan.
1. Amount Borrowed The payment schedule illustrated in Table 9-4 gives the monthly payment required for each $1000 of a mortgage loan at various interest rates. Using this table, you can calculate the monthly payment for mortgage loans of different amounts. For example, the $160,000 mortgage loan described earlier (6.0 percent for 30 years) costs $5.9955 per $1000 per month. Thus, 160 × $5.9955 equals $959.28.
Making a down payment that is larger than required lowers the borrower's monthly payments. For example, a down payment of 30 percent, or $55,500, would lower the monthly payment on the loan to $776.42 [$5.9955 × ($185,000 - $55,500) ÷ 1000]. A smaller loan also carries lower total interest costs and may qualify for an interest rate that is perhaps 0.5 percentage points lower. In that case, the payment for the same loan would amount to only $735.29 [$5.6779 × ($185,000 − $55,500) ÷ 1000].
2. Interest Rate The higher the interest rate, the higher the monthly payment on a mortgage loan (see Table 9-4 ). For example, a $959.28 monthly payment is required for a $160,000 mortgage loan taken out for 30 years at 6.0 percent. If the interest rate were 7.0 percent, the monthly mortgage payment would be $1064.48 (160 × $6.6530), an increase of over $100. The effects are even greater when you consider the total of all the monthly payments and the total interest paid over the life of the loan. The 6.0 percent loan will have total payments of $345,340.80 (360 × $959.28) with total interest of $185,340.80 ($345,340.80 − $160,000.00). For the 7.0 percent loan, total payments are $383,212.80 (360 × $1064.48), and total interest is $223,212.80 ($383,212.80 − $160,000.00). Thus, the added cost for the 30-year loan at 7.0 percent is $37,872 over the life of the loan.
DO IT IN CLASS
Table 9-4 Estimating Mortgage Loan Payments for Principal and Interest (Monthly Payment per $1000 Borrowed)
Cancel Mortgage Insurance as Soon as Possible
Most first-time home buyers cannot make the standard loan-to-value ratio of 80 percent (20 percent down) and must buy mortgage insurance. As the borrower makes mortgage payments over time, the amount of principal remaining to be paid will decline until eventually the 80 percent threshold is reached. At that point, the lender must notify the borrower of the opportunity to drop the insurance. And, by law, the lender must terminate the PMI when the loan-to-value ratio reaches 78 percent based on the market value of the home at the beginning of the mortgage.
But there is no need to wait that long. In this chapter's example mortgage, the borrower starts out owing $160,000 or 86.5 ($160,000/$185,000) percent of the value of the home. It takes about five and one-half years to reach the 80 percent threshold ($148,000 = 0.80 × $185,000) simply by making loan payments. The good news is that the value of the home may increase faster than the loan principal declines. In the example the 80 percent threshold will be reached in about three years if the value of the home increases at 3 percent per year. When that threshold is attained, the borrower can ask the lender to cancel the mortgage insurance. Lenders usually require an appraisal of the property before doing so, but the cost of the appraisal (perhaps $300) represents money well spent. It is a smart move to make such a request, and it is even smarter to continue making the same monthly payment on the mortgage after the insurance is removed. The extra amount will be applied to the principal of the loan, thereby paying it off even sooner.
Michael Ruff and Sherry Tshibangu
Monroe Community College, Rochester, NY
3. Length of the Loan Table 9-5 illustrates the relationships among maturity length, monthly payment, and interest cost for a $100,000 loan at various interest rates. A longer term of repayment results in a smaller payment (for loans with the same interest rate). More total interest is paid over the longer repayment time period despite the lower monthly payment. For example, the monthly payment on a 5.5 percent loan is $688 for 20 years but only $568 for 30 years. When the loan is paid back in 20 years, the total interest costs are much lower ($65,100 rather than $104,400, for a savings of $39,300).
Some borrowers choose a mortgage loan with a comparatively short 15-year maturity. The advantages include a faster buildup of equity, lower total interest, and a quicker payoff of the loan. These advantages can also be gained with a 20- or 30-year mortgage by simply paying additional amounts toward the principal during the time period of the loan. It is wise to take a longer repayment period, such as 30 years, even if you plan to pay off the loan in 15 (or fewer) years. This way the faster payoff is optional rather than mandatory.
9.4c Conventional Mortgage and Adjustable Mortgage Loans
A conventional mortgage is a fixed-rate, fixed-term, fixed-payment mortgage loan. Borrowers like conventional mortgages because they are so predictable. For example, a $160,000 loan could be granted at a 6.0 percent annual interest rate over a period of 30 years with a fixed monthly payment of $959.28. The payment is the same for month after month and year after year. Most borrowers see a conventional fixed-rate loan as the best possible choice because the amount of all future payments is known in advance.
conventional mortgage A fixed-rate, fixed-term, fixed-payment mortgage loan.
With an adjustable-rate mortgage (ARM) —sometimes called a variable-rate mortgage —the borrower's interest rate fluctuates according to some index of interest rates based on the rising or falling cost of credit in the economy. With an ARM, the risk of interest rate changes is assumed by the borrower, not the lender. As a consequence, the monthly payment could increase or decrease, usually on an annual basis.
adjustable-rate mortgage (ARM)/variable-rate mortgage Mortgage in which the borrower's interest rate fluctuates according to some index of interest rates based on the rising or falling cost of credit in the economy—thus transferring interest rate risk to the borrower.
Table 9-5 Monthly Payment and Total Interest to Repay a $100,000 Loan
Some adjustable-rate loans may have a fixed rate for the first 3 or 5 years after which the rate can vary. Borrowers with ARMs should always determine the “worst case” scenario for interest rate increases under their loan contract and calculate the monthly payment that would result.
ARM rates are usually 1 to 2 percentage points below conventional mortgage rates. Lenders sometimes offer an even lower teaser rate to entice people to borrow using an ARM. If you do not feel you can afford even a minimal increase in the rate, you should not take out this type of loan.
teaser rate Low interest rate that lenders sometimes use to lure buyers; these rates will be low for the first year or so and then will rise to more realistic rates.
ARMs have an interest-rate cap limit the amount by which the interest rate can increase to no more than 2 percent per year and no more than 6 percent over the life of the loan. This may not seem like much, but if the 6 percent loan we have been using as an example in this chapter were to go up 5 points after ten years because of rising inflation, the new payment would be almost $1300, which would be $340, or 35 percent more than the original $959 payment. While such an increase is unlikely, it could happen under the terms of the agreement.
When mortgage rates are low or rising, borrowers are wise to look for a fixed-rate loan. If rates are headed down, get an adjustable mortgage loan.
About Qualified Residential Mortgages
A qualified residential mortgage (QRM) is a descriptor placed on a home loan that meets strict underwriting guidelines and a specified set of product features built into the loan. The QRM was designed to set the standard for residential mortgages and to minimize the risk that borrowers may default. It requires that debt-to-income ratios be limited to 43 percent and loan fees limited to 3 percent, and interest-only loans and negative amortization are not allowed in most cases. A QRM does not require a special down payment requirement, such as 20 percent. To obtain a QRM, documentation of income must be verified. The lowering of debt-to-income limits on most loans will force some buyers to wait longer and save more to make that first purchase. As a result, these loans will have a lower risk of default compared to a decade ago.
The Tax Consequences of Buying a Home
Home ownership makes you eligible for three big tax breaks.
1. Mortgage interest and real estate taxes are tax deductible on federal (and most state) income tax returns. These amounts often exceed the IRS's standard deduction (see Chapter 4 ). You can then take advantage of even more deduction opportunities that are available to taxpayers who itemize.
2. You can save the funds to buy a home in a tax-sheltered account. Individuals can use Roth IRAs (see Chapter 17 ) to save for retirement. Once the account is five years old, as much as $10,000 may be withdrawn tax free and penalty free, provided that a qualifying, first-time home buyer uses the funds for home-buying costs.
3. The profits made by selling a home can be tax free. If you sell a home for more than you originally paid, you have a capital gain . Gains are ordinarily taxable, but homeowners can avoid paying taxes on gains by buying a home that is more expensive, thus rolling the gain into the new home. Also, capital gains of up to $500,000 if married and filing jointly and up to $250,000 if single may be avoided. To qualify, the home must have been owned and used as the principal residence for two of the last five years prior to the date of the sale.
9.4d Other Housing Financing Arrangements
There are other ways to finance a home purchase.
Growing-Equity Mortgage The growing-equity mortgage (GEM) is a fixed rate mortgage on which the monthly payments increase over time. The interest rate on the loan does not change and as the payments increase the additional amounts are applied to the remaining balance, thus shortening the life of the mortgage and increasing interest savings.
One form of GEM is the biweekly mortgage , which calls for payments to be made every two weeks that represent half of the normal monthly payment. The borrower, therefore, makes 26 payments per year. For example, a $160,000, 6 percent, 30-year loan requires a $959.28 monthly payment for a total of $11,511.36 (12 × $959.28) paid in one year. On a biweekly basis with payments of $479.64 ($959.28 ÷ 2), the total amount paid each year would be $12,470.64 ($479.64 × 26). The difference of $959.28 ($12,470.64 − $11,511.36) is equivalent to one extra monthly payment per year and is applied to the principal of the loan. Under the biweekly repayment plan, a loan will be repaid in approximately 20 years, rather than the 30 years dictated by the monthly payment plan.
biweekly mortgage A form of growing-equity mortgage (GEM) that calls for payments of half of the normal payment to be made every two weeks; the borrower thus makes 26 payments a year and reduces the principal amount by one full payment each year; this reduces the mortgage term to about 20 years on a 30-year mortgage.
Turn Bad Habits into Good Ones
Do You Do This?
Think a verbal lease for renting is just fine
Move into an apartment without inspecting for defects and damages
Make your rent payment late from time to time
Hope, rather than plan, to buy a home
Want a home just like your parents' home
Do This Instead!
Get all terms in writing
Make a written list of all defects and damages at both move-in and move-out and get lists co-signed by landlord
Make all payments on time; your landlord may report patterns to a credit bureau
Start saving for a down payment as soon as you get a job after graduation
Recognize that buying a small starter home is just fine
Reasons Not to Pay Off a Mortgage Early
Many people want to pay their mortgage off as soon as possible, but is this a good idea? Perhaps not if you:
1. Can invest the money and get a better rate of return on your money than the after-tax interest rate you pay on your mortgage.
2. Are paying a higher interest rate on other debts you owe.
3. Have an inadequate amount of emergency funds.
4. Are not contributing the maximum amount allowed in your 401(k) accounts at work or an IRA account.
5. Are not adequately covered by property, liability, disability, and life insurance.
Moreover, consider taking any excess money available and spend it on these five unmet alternatives instead of paying off your mortgage loan early.
All mortgages use the declining-balance method of calculating interest (see Chapter 7 page 214), thus permitting payment of additional amounts toward principal at any time. Thus, you can voluntarily pay additional amounts on the principal without being locked into it as you would with a growing equity mortgage.
Assumable Mortgage With an assumable mortgage, the buyer pays the seller a down payment generally equal to the seller's equity in the home and takes responsibility for the mortgage loan payments for the remaining term of the seller's existing mortgage loan. The buyer's goal is to obtain the loan at the original interest rate, which should be below current market rates. This approach will work only if the original mortgage loan agreement does not include a due-on-sale clause. Such a clause requires that the mortgage loan be fully paid off if the home is sold. It can impose a burden on the seller because it prohibits a buyer from assuming the mortgage loan.
Seller Financing Seller financing occurs whenever the seller of a home agrees to accept all or a portion of the purchase price in installments rather than as a lump sum. Usually seller financing is a short-term arrangement, however, with payments based on amortization occurring over perhaps 20 years but with a final single balloon payment of the total remaining unpaid principal that is due after perhaps five years. Since, the remaining debt is due all at once, the buyer might typically take out a conventional mortgage to finish paying off the purchase.
About Second Mortgage Loans
A second mortgage is an additional loan on a residence besides the original mortgage. Because the amount owed on the original mortgage must be paid first the interest rate on a second mortgage is often 2 to 3 percentage points higher than current market rates for first mortgages.
Historically, people have used second mortgages to pay for major remodeling projects, finance college costs for children, pay off medical bills, or start a business. Some people use these funds for everyday living expenses, an unwise practice dubbed “eating one's house.”
Two types of second mortgages exist:
• The home-equity installment loan, where a specific amount of money is borrowed for a fixed time period with fixed monthly payments.
• The home-equity line of credit, where a maximum loan amount is established and the loan operates as open-ended credit, much like a credit card account. These line-of-credit loans often have variable interest rates and flexible repayment schedules.
The credit limit on a second mortgage loan is usually set at 80 to 90 percent of the home's appraised value minus the amount owed on the first mortgage. For example, a person with a home appraised at $200,000 with a balance owed of $100,000 on a first mortgage might be allowed to take out a $60,000 second mortgage [($200,000 × 0.80) − $100,000].
When You Should Refinance Your Mortgage
It is sometimes advantageous to refinance an existing mortgage when interest rates decline. In mortgage refinancing, a new mortgage is obtained to pay off and replace an existing mortgage. Most often it is undertaken to lower the monthly payment on the home by taking out a loan with a lower interest rate.
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The example here illustrates how to determine whether refinancing your mortgage is a wise choice. The original mortgage for $160,000 was obtained seven years ago at a 5.5 percent interest rate for 30 years. The monthly payment is $908. After seven years, the principal owed has declined to $142,100. If interest rates for new mortgages have declined to 4.5 percent, the owner could take out a new mortgage at the lower rate for a monthly payment of $827. Borrowing $142,100 for 23 years at 4.5 percent saves approximately $81 per month ($908 − $827). However, refinancing may have some up-front costs, including a possible prepayment penalty on the old mortgage and closing costs for the new mortgage. The question then becomes, will these costs exceed the monthly savings gained with a lower payment?
The following worksheet provides a means for estimating whether refinancing offers an advantage. It compares the future value of the reduced monthly payments (line 5) with the future value of the money used to pay the up-front costs (estimated here at 2%) of refinancing (line 8). The homeowner would need to estimate the number of months he or she expects to own the home after refinancing. Given an estimate of four years in this example, the net savings would be $977 (subtracting line 8 from line 5), and refinancing would benefit the owner. In this example, planning to live in the home only three more years would result in it not being financially advantageous to refinance. A similar worksheet can be found at www.bankrate.com/calculators/mortgages/refinance-calculator.aspx .
|
Decision Factors |
Example |
Your Figures |
|
1. Current monthly payment |
$ 908 |
_________ |
|
2. New monthly payment |
827 |
_________ |
|
3. Monthly savings (line 1 – line 2) |
81 |
_________ |
|
4. Additional years you expect to live in the house |
4 |
_________ |
|
5. Future value of an account balance after 4 years if the monthly savings were invested at 3% after taxes (using the calculator on the Garman/Forgue companion website) |
4,175 |
_________ |
|
6. Prepayment penalty on current loan (0%) |
0 |
_________ |
|
7. Points and fees for new loan (2%) |
2,842 |
_________ |
|
8. Future value of an account balance after 4 years if the prepayment penalty and closing costs ($4263) had been invested instead at 3% after taxes (using the calculator on the Garman/Forgue companion website) |
3,198 |
_________ |
|
9. Net saving after 48 months (line 5 – line 8) |
$ 977 |
_________ |
It may also be possible to borrow more than the current balance owed on the existing loan, thereby utilizing some of the equity built up in the home. Borrowers refinancing for more than the amount owed should understand that rebuilding the equity to its previous level may take many years. This also is dangerous because if home prices decline the borrower will owe more on the home than it is worth.
In most seller financing, the buyer obtains the title to the property when the deal is closed and the contract is signed. In contrast, a land contract (or contract for deed) brings greater risk for the buyer because all terms in the contract (including payment of the debt) must be satisfied before transfer of tide will occur. As a result, if you move before paying off the contract in full, you forfeit all money paid in installments to the seller and any appreciation in the home's value. You build no equity until the contract is completed.
Reverse Mortgage A reverse mortgage , also known as a home-equity conversion loan , allows a homeowner older than age 61 to borrow against the equity in a home that is fully or mostly paid for and to receive the proceeds in a lump sum or a series of monthly payments. The contract allows the person to continue living in the home. Essentially, the borrower trades his or her equity in the home in return for the funds. The most likely prospects for such loans are elderly people who have paid off their mortgages but need income. The mortgage does not have to be paid back until the last surviving owner sells the house, moves out permanently, or dies. There are some worries in this industry, so for more information on reverse mortgages, go to www.hud.gov/offices/hsg/sfh/hecm/rmtopten.cfm .
reverse mortgage/home-equity conversion loan Allows a homeowner older than age 61 to continue living in the home and to borrow against the equity in a home that is fully paid for and to receive the proceeds in a series of monthly payments, often for life.
CONCEPT CHECK 9.4
1. Explain why the portions of a monthly mortgage payment that are allocated toward interest and toward principal will vary as the loan is repaid.
2. Distinguish between a conventional mortgage loan and an adjustable-rate loan.
3. Identify the two ways that homebuyers build equity in their property.
LEARNING OBJECTIVE 5
Identify some key considerations when selling a home.
While most of this chapter deals with buying a home, important considerations also arise when you are selling a home. It is extremely important to do minor painting, cleaning, and repairing before listing your home for sale. When selling your home, you may be obligated to disclose problems that could affect the property's value or desirability using a state required defect disclosure form . In most states, it is illegal to fraudulently conceal major physical defects in your property such as a basement that floods in heavy rains. And many states now require sellers to take a proactive role by making written disclosures about the condition of the property.
defect disclosure form A state required form that discloses problems that could affect the property's value or desirability, such as a basement that floods in heavy rains.
9.5a Should You List with a Broker or Try to Sell a Home Yourself?
Knowing that the sales commission to a broker on a $200,000 home could be $12,000 to $14,000 provides motivation for some homeowners to consider selling their homes themselves. The key to success in a FSBO (for sale by owner; commonly pronounced “fizbo”) is to know what price to ask for your home. Asking too little could cost you much more than the commission paid to a broker. Setting the price too high keeps potential buyers away.
FSBO For sale by owner; commonly pronounced “fizbo”; home sold directly by the homeowner to save on sales commission paid to a real estate broker.
Many homeowners begin by contacting a few real estate agents to get their opinions on how much the home is worth. Agents are often quite willing to give their opinions because the homeowner might list the home with them if it does not sell quickly. Placing a for-sale sign on your lawn and spending about $500 on advertising the property should keep your telephone ringing with inquiries. If your home does not sell after a few months while other similar properties are selling, you might want to list it with a broker. For more information on selling your own home, visit www.fsbo.com , or www.forsalebyowner.com .
Brokers require that homeowners sign a listing agreement permitting them to list the property exclusively or with a multiple-listing service. A multiple-listing (or open-listing) service is an information and referral network among real estate brokers allowing properties listed with a particular broker to be shown by all other brokers. Brokers “qualify” prospective buyers—distinguishing between serious buyers and people who are just looking or cannot afford the home. If your broker cannot find a buyer within 60 days, consider signing an agreement with another broker who might prove more aggressive in advertising and selling your property. If a sale occurs (or begins) during the time period of the listing agreement, you must pay a commission to the broker for any sale to a buyer not listed as an exception in the listing agreement.
listing agreement Agreement that brokers require homeowners to sign that permits the broker to list the property exclusively or with a multiple-listing service.
How to Sell a Home in a Hurry
What if you want to sell your home in a declining market with lots of properties that have further depressed home values? Tell your real estate agent that you are willing to pay a commission of 8 or even 10 percent rather than 6 percent. This will motivate the agent to show your home by bringing lots of people to see it. The agent's broker will also insist that all his or her agents show the property because the broker will earn more money too. The extra you pay in commission (about $4000 to $6000 on a $200,000 house) is probably much less than the money you would lose if you are forced to reduce your asking price one, twice, or even more.
FSBOs can save a home seller money but usually take longer to sell.
9.5b Selling Carries Its Own Costs
The largest selling cost is the broker's commission . These commissions often amount to 6 to 7 percent of the selling price of the home. Sellers are often unaware that brokers may negotiate their commission. Smart sellers also pay for a title search, a professional appraisal, and their own home inspection.
broker's commission Largest selling cost in selling a home; these commissions often amount to 6 percent of the selling price of the home.
Most mortgage loans are paid off before maturity because people move and sell their homes. Mortgage loan contracts sometimes have a clause that specifies a prepayment fee or prepayment penalty. A prepayment penalty on a mortgage essentially charges you extra if you pay off the mortgage early. What is considered early, however, will be laid out in your loan documents and therefore must be scrutinized carefully. Not all mortgages come with them, and they are certainly not required. Prepayment penalties can range from 1 to 3 percent of the original mortgage loan. On a $160,000 mortgage loan, for example, the charge might vary from $1200 to $4800. Usually, the penalty is only for an early payoff in the first 2–5 years of the loan for the purposes of refinancing rather than because the home was sold.
Local communities may assess real estate transfer taxes. These taxes are paid by the seller and also possibly the buyer, and they are usually based on the selling price of the home. These tax rates can be as high as 2 or 4 percent, that is, $4000 or $8000 on a $200,000 home but are typically less than 1 percent. When paid by the seller, they may affect the offer that the seller is willing to accept for the home.
Your Worst Financial Blunders in Obtaining Affordable Housing
Based on others' financial woes, you will make mistakes in personal finance when you:
1. Take out a mortgage loan with payments that you really cannot afford.
2. Fail to take steps to increase your credit score in the months prior to applying for a mortgage loan.
3. Fail to request that private mortgage insurance be canceled when the LTV ratio drops to 80 percent.
CONCEPT CHECK 9.5
1. List some disadvantages of trying to sell a home yourself.
2. List one advantage and one disadvantage of using a real estate broker to sell a home.
3. Describe two costs associated with selling a home in addition to the real estate commission.
DO IT NOW!
You know more about personal finance after reading this chapter, so get started right now by:
1. Talking to family members or friends who have bought a home to obtain their insights into the process including any not-so-pleasant surprises.
2. Exploring the housing market at www.realtor.com for the geographic area where you might live if you get a job offer in that location.
3. Setting a reasonable goal for a down payment amount and calculating how much you would have to save per month to reach it at www.bankrate.com/calculators/savings/saving-goals-calculator.aspx .
WHAT DO YOU RECOMMEND NOW?
Now that you have read the chapter on buying housing, what do you recommend to Shelby Clark regarding:
1. Buying or renting housing in the Denver area?
2. Steps she should take prior to actively looking at homes?
3. Finding a home and negotiating the purchase?
4. The closing process in home buying?
5. Selecting the type of mortgage to fit her needs?
6. Things to consider regarding the sale of her home should she ultimately be promoted to a position in another of the four regions?
BIG PICTURE SUMMARY OF LEARNING OBJECTIVES
LO1 Decide whether renting or owning your home is better for you.
When choosing housing, renters must consider the costs of rent, a security deposit, and renter's insurance. Home buyers can choose among single-family dwellings, condominiums, cooperative housing, manufactured housing, and mobile homes. Renters generally pay out less money in terms of cash flow in the short run, whereas owners enjoy tax advantages and generally see an increase in the market value of their homes, making them better off financially in the long run.
LO2 Explain the up-front and monthly costs of buying a home.
Home buyers understand that they will make a down payment and then make monthly principal and interest payments on their mortgage. What many don't understand is that closing costs for interest points and other aspects of the purchase can add 2–7 percent or more to the amount needed up front at the closing. Similarly, monthly charges for private mortgage insurance (PMI), homeowner's insurance, and real estate property taxes can add 25 percent or more to their monthly payment.
LO3 Describe the steps in the home-buying process.
The home-buying process includes (a) getting your finances in order, (b) prequalifying for a mortgage, (c) searching for a home online and in person, (d) agreeing to terms with a seller, (e) formally applying for a mortgage loan, (f) preparing for the closing, and (g) signing your name on closing day.
LO4 Understand the mathematics of mortgage loans and distinguish among ways of financing the purchase of a home.
Mortgage loans for homes are amortized. Amortization is the process of gradually paying off a mortgage through a series of periodic payments to a lender, with a portion of each payment going toward the principal and another portion going toward the interest owed. The mathematics of buying a home shows how loan payments are calculated and how the portion of each monthly payment that goes toward interest declines, resulting in the portion that goes toward the principal increasing with each subsequent payment.
Conventional mortgages and adjustable-rate mortgages are the most common types of housing loans. Growing appreciation mortgages are designed for early pay-off.
LO5 Identify some key considerations when selling a home.
When selling a home, it is wise to consider the pros and cons of listing with a real estate broker versus selling the home yourself, the transaction costs of selling, and the pitfalls of seller financing.
LET'S TALK ABOUT IT
1. The Housing Collapse. How has the foreclosure crisis and collapse in home values in the last decade affected your thinking about buying a home someday?
2. Renting Versus Buying. What do you see as the advantages and the disadvantages for you of renting or buying housing at the current time? How might your feelings change in the future, such as within five years?
3. Feelings About Long-Term Debt. In the early years of the standard 30-year mortgage loan, as little as 10 percent of the monthly payment actually goes toward repaying the debt. As a result, it takes many, many years for the loan balance to come down to any significant extent. Explain how that affects your feelings about taking on such a long-term obligation.
4. Alternative Mortgages. Would you prefer a conventional mortgage, an adjustable-rate mortgage, or one of the other alternatives described in this chapter to finance a home purchase? Why?
5. Negotiating the Purchase of a Home. Almost all closing costs on a home purchase are negotiable. Would you feel comfortable entering into a discussion of these items? Why or why not?
DO THE MATH
1. Deciding to Buy. Adam and Laura Jensen of Atlanta, Georgia, both of whom are in their late 20s, currently are renting an unfurnished two-bedroom apartment for $880 per month, plus $130 for utilities and $34 for insurance. They have found a condominium they can buy for $170,000 with a 20 percent down payment and a 30-year, 5 percent mortgage. Principal and interest payments are estimated at $730 per month, with property taxes amounting to $150 per month and a homeowner's insurance premium of $720 per year. Closing costs are estimated at $3200. The monthly homeowners association fee is $275, and utility costs are estimated at $160 per month. The Jensens have a combined income of $57,000 per year, with take-home pay of $4100 per month. They are in the 15 percent tax bracket, pay $225 per month on an installment loan (ten payments left), and have $39,000 in savings and investments outside of their retirement accounts.
(a) Can the Jensens afford to buy the condo? Use the results from the Garman/Forgue companion website or the information on page 264 to support your answer. Also, consider the effect of the purchase on their savings and monthly budget.
(b) Adam and Laura think that their monthly housing costs would be lower the first year if they bought the condo. Do you agree? Support your answer. Assume that they currently have $10,000 in tax deductible expenses.
(c) If they buy, how much will Adam and Laura have left in savings to pay for moving expenses?
(d) Available financial information suggests that mortgage rates might increase over the next few months. If the Jensens wait until the rates increase 1 more percent, how much more will they spend on their monthly mortgage payment? Use the information in Table 9-4 or the Garman/Forgue companion website to calculate the payment.
2. Mortgage Affordability. Seth and Alexandra Moore of Berrien Spring, Michigan have an annual income of $78,000 and want to buy a home. Currently, mortgage rates are 6 percent. The Moores want to take out a mortgage for 30 years. Real estate taxes are estimated to be $4800 per year for homes similar to what they would like to buy, and homeowner's insurance would be about $1500 per year.
DO IT IN CLASS PAGES 263 AND 264
(a) Using a 28 percent front-end ratio, what are the total annual and monthly expenditures for which they would qualify?
(b) Using a 36 percent back-end ratio, what monthly mortgage payment (including taxes and insurance) could they afford given that they have an automobile loan payment of $470, a student loan payment of $350, and credit card payments of $250? (Hint: Subtract these amounts from the total monthly affordable payments for their income to determine the amount left over to spend on a mortgage.)
(c) If mortgage interest rates are around 5 percent and the Moores want a 30-year mortgage, use the information in the Did You Know box on page 264 to estimate how much they could borrow given your answer to part a. (Hint: Subtract the monthly real estate taxes and homeowner's insurance from your part a answer first.)
3. Rent Versus Buy. Alex Guadet of Forrest City, Arkansas, has been renting a small, two-bedroom house for several years. He pays $900 per month in rent for the home and $300 per year in property and liability insurance. The owner of the house wants to sell it, and Phillip is considering making an offer. The owner wants $130,000 for the property, but Phillip thinks he could get the house for $125,000 and use his $25,000 in 3 percent certificates of deposit that are ready to mature for the down payment. Alex has talked to his banker and could get a 5.5 percent mortgage loan for 25 years to finance the remainder of the purchase price. The banker advised Alex that he would reduce his debt principal by $2200 during the first year of the loan. Property taxes on the house are $1800 per year. Phillip estimates that he would need to upgrade his property and liability insurance to $800 per year and would incur about $1500 in costs the first year for maintenance. Property values are increasing at about 2.5 percent per year in the neighborhood. Alex is in the 25 percent marginal tax bracket.
DO IT IN CLASS PAGE 254
(a) Use Table 9-4 to calculate the monthly mortgage payment for the mortgage loan that Phillip would need.
(b) How much interest would Alex pay during the first year of the loan?
(c) Use the Run the Numbers worksheet, “Should You Buy or Rent?” on page 254 to determine whether Alex would be better off buying or renting.
4. Refinancing a Mortgage. Kevin Tutumbo of Middle-town, Ohio, has owned his home for 15 years and expects to live in it for five more years. He originally borrowed $105,000 at 6 percent interest for 30 years to buy the home. He still owes $65,750 on the loan. Interest rates have since fallen to 5.0 percent, and Kevin is considering refinancing the loan for 15 years. He would have to pay 2 points on the new loan with no prepayment penalty on the current loan.
DO IT IN CLASS PAGE 278
(a) What is Kevin's current monthly payment?
(b) Calculate the monthly payment on the new loan.
(c) Advise Kevin on whether he should refinance his mortgage using the Run the Numbers worksheet, “When You Should Refinance Your Mortgage” on page 278.
5. Illustrating Amortization. Heather Mcintosh of DeKalb, Illinois, recently purchased a home for $165,000. She put $25,000 down and took out a 25-year loan at 5.4 percent interest.
DO IT IN CLASS PAGE 271 AND 273
(a) Use Table 9-4 to determine her monthly payment.
(b) How much of her first payment will go toward interest and principal and how much will she owe after that first month?
(c) How much will she owe after three months. Hint: Use the logic of Table 9-2 on page 271.
FINANCIAL PLANNING CASES
CASE 1
The Johnsons Decide to Buy a Home
Belinda Johnson's parents and maternal grandmother have combined their finances and presented Harry and Belinda with $35,000 with which to purchase a home. The Johnsons have shopped and found a house in a new housing development that they like very much. They could either borrow from the developer or obtain a loan from one of three other mortgage lenders. The financial alternatives and data for the home are summarized in the table below.
(a) Which plan has the lowest total up-front costs? The highest?
(b) What would be the full monthly payment for PITI and PMI for each of the options?
(c) If the Johnsons had enough additional cash to make the 20 percent down payment, would you recommend lender 1 or lender 2? Why?
(d) Assuming that the Johnsons will need about $3000 for moving costs (in addition to closing costs), which financing option would you recommend? Why?
Financing Details on a Home Available to the Johnsons
Price: $190,000. Developer A will finance the purchase with a 10 percent down payment and a 30-year, 5 percent ARM loan with 2 interest points. The initial monthly payment for principal and interest is $917.96 ($171,000 loan after the down payment is made; 171 × $5.3682). After one year, the rate rises to 5.5 percent, with a principal plus interest payment of $961.15. At that point, the rate can go up or down as much as 2 percent per year, depending on the cost of an index of mortgage funds. There is an interest-rate cap of 5 percent over the life of the loan. Taxes are estimated to be about $1800, and the homeowner's insurance premium should be about $700 annually. A mortgage insurance premium of $88 per month must be paid monthly on the two 10 percent down options.
Home: Price, $190,000; Taxes, $1800; Insurance, $700
CASE 2
Victor and Maria Hernandez Learn About Real Estate Agents
Victor and Maria have been thinking about selling their home and buying a house with more yard space so that they can indulge their passion for gardening. Before they make such a decision, they want to explore the market to see what might be available and in what price ranges. They will then list their house with a real estate agent and begin searching in earnest for a new home.
(a) What services could a real estate agent provide for the couple, and what types of agents could represent them as they sell their current home?
(b) A friend has advised them that they really need a buyer's agent for the purchase of a new home. Explain to the Hernandez the difference between buyer's and seller's agents.
CASE 3
Julia Price Contemplates Buying a Home
Julia has been thinking about buying a home. For several months, she has been watching real estate shows on television and visiting open houses in her community. She thinks it is time to take the plunge and buy a much larger home since she can genuinely afford it. She also thinks that housing prices will rise substantially in the next five years. She has explored the interest rates currently being charged for mortgages and has calculated the amount of money she can afford to pay given her income. She is thinking that her next step would be to call a real estate agent and begin looking in earnest. Offer your opinions about her thinking.
CASE 4
Michael and Maggi Weigh the Benefits and Costs of Buying Versus Renting
Michael Joseph and Maggi Lewis of Biloxi, Mississippi, are trying to decide whether to rent or purchase housing. Michael favors buying and Maggi leans toward renting, and both seem able to justify their particular choice. Michael thinks that the tax advantages are a very good reason for buying. Maggi, however, believes that cash flow is so much better when renting. See whether you can help them make their decision.
DO IT IN CLASS PAGE 254
(a) Does the home buyer enjoy tax advantages? Explain.
(b) Discuss Maggi's belief that cash flow is better with renting.
(c) Suggest some reasons why Michael might consider renting rather than purchasing housing.
(d) Suggest some reasons why Maggi might consider buying rather than renting housing.
(e) Is there a clear-cut basis for deciding whether to rent or buy housing? Explain why or why not.
CASE 5
Jeremy Decides to Sell His Home Himself
Jeremy Jorgensen of Tucson, Arizona, is concerned about the costs involved in selling his home, so he has decided to sell his home himself rather than pay a broker to do it.
(a) How would you advise Jeremy if he asked you whether he should sell the house himself or list with a broker? Explain your answer.
(b) Would Jeremy really save money by selling his home himself if he considers his time as part of his costs? Why or why not?
(c) Can you suggest any ways that Jeremy might reduce his selling costs without doing the selling himself? Explain.
BE YOUR OWN PERSONAL FINANCIAL MANAGER
1. Are You Ready to Buy a Home? Review the material in the Run the Numbers worksheet “Should You Buy or Rent?” on page 254. Then using dollar amounts that fit your situation, complete Worksheet 37: Should I Rent or Buy Housing from “My Personal Financial Planner.”
2. Save to Buy a Home. Review the material on “Financial Goals Follow From Your Values” on page 68–69 and on “Be a Better Saver” on page 150 and then complete Worksheet 14: Monthly Savings Needed to Reach My Goals from “My Personal Financial Planner,” which allows you to determine the monthly savings amount you would need to reach a goal of having a down payment on a home.
3. Can You Afford a Mortgage? Review the material on “The Income Needed to Qualify for a Mortgage” on page 264. Then using dollar amounts that fit your situation, complete Worksheet 38: Income Needed to Qualify for a Mortgage from “My Personal Financial Planner.” What price range of home could you afford given the results of your analysis?
4. Shop for a Mortgage. If you are ready to buy a home, review the material on “The Conventional Mortgage and Adjustable Mortgage Loans” and “Other Housing Financing Arrangements” on pages 274–279. Then using that information complete Worksheet 39: Mortgage Shopping Worksheet from “My Personal Financial Planner” to begin your search for a mortgage.
5. Should You Refinance Your Mortgage? Do you have an existing mortgage? Review the material on “When You Should Refinance Your Mortgage” on page 278. Then using dollar amounts that fit your situation, complete Worksheet 42: Should I Refinance My Mortgage? from “My Personal Financial Planner.”
ON THE NET
Go to the Web pages indicated to complete these exercises.
1. Current Interest Rates. Visit the website for Bankrate. com ( www.bankrate.com/mortgage.aspx ), where you will find information on mortgage interest rates around the United States. View the information for the lenders in a large city near your home. How does the information compare with the interest rates on your own credit card account(s)? How do the rates in the city you selected compare with other rates found in the United States?
2. Can You Afford to Buy? Visit the website for Bankrate .com, where you will find a calculator ( www.bankrate.com/calculators/mortgages/new-house-calculator.aspx ) that helps you determine the amount you can afford for the purchase of a home given your income and funds available for a down payment, closing costs, and other home-buying expenses. Enter the data requested for your current situation. What does the calculator tell you about your housing affordability? Change the entered data for some point in the future when you project a better financial situation for yourself. How do the results change?
3. Searching for a Home to Buy. Visit the website for the National Association of Realtors ( www.realtor.com ), where you can search for owned housing in various locales around the United States. Look for housing in your community. Were you able to find housing that meets your price range and other criteria? Also search for similar housing in the San Fransico, CA (high-cost) and Ocala, FL (low-cost) metropolitan areas. Compare these cost results with the housing found in your area.
ACTION INVOLVEMENT PROJECTS
1. Do Some Home Shopping. Realtors often open homes for sale to the public on Sunday afternoons. Spend an afternoon looking at housing that is for sale in a neighborhood near your campus. Gather the information sheets that are provided at the homes and take notes during your visits. Prepare a brief report that summarizes what you have learned about housing costs, features, and locations in the community.
2. Comparing Leases. Survey five of your friends who live in rental housing about their feelings about written leases. For those who have written leases, compare some of them for the rights and responsibilities of tenants outlined in the leases. Write a summary of your findings.
3. Assess the Real Estate Market. Make an appointment to talk with a real estate agent in your community. Ask whether home sales are slow or brisk, how long it typically takes for buyers to find a desirable home, whether home values are rising or declining, and tips the agent would give to people in your situation who hope to own their own homes one day. Write a summary of your findings.
4. See How Others Go About Buying a Home. Ask friends and relatives for the names of one or two people who have bought a home in recent years. Contact the home-buyers and ask them for an interview in person or over the phone to discuss how they went about buying a home and their feelings about how the process turned out for them. Compare their procedures and experiences with what you have learned in this chapter.
Visit the Garman/Forgue companion website at www.cengagebrain.com .