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Garman/Forgue
Personal FinanceNinth Edition
Chapter 9
Buying a Home
9 | 2
Learning Objectives
1. Decide whether renting or owning is better, both financially and personally.
2. Explain the up-front and monthly costs of buying a home.
3. Describe the steps in the home-buying process.
4. Distinguish among the traditional and alternative ways of financing a home and list the advantages and disadvantages of each.
5. Identify the important aspects of selling a home.
9 | 3
Introduction
• Mortgage Loan: Loan to purchase real estate in which the property itself serves as collateral.
9 | 4
“Your Rental Rights” How to Get Your Security Deposit Back
• Make a list of all damages and defects before you move into the unit. Have the landlord sign this list.
• 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 to request the return of your security deposit and to inform the landlord of your new address.
• Use small-claims court, if necessary, to obtain a court-ordered refund.
9 | 5
• Evaluating Your Alternatives– What influences your choice of housing?• Mobility vs. Permanence; Lifestyle
• Financial factors
• Guideline: monthly housing < 36% of gross monthly income
Advantages of renting Fewer maintenance and repair
responsibilities Easier to move Lower initial costs
Disadvantages of renting No tax / financial benefits Limitations regarding
remodeling Restrictions regarding pets
and other activities Legal concerns of a lease
Advantages of buyingPride of ownershipFinancial benefitsLifestyle flexibility
Disadvantages of buyingFinancial commitmentHigher expensesLimited mobility
9 | 6
Who Pays More? • Short-term: renters win
• Long-term, when income taxes and appreciation are considered: homeowners win
• What does it cost to buy a home? Most up-front costs are due at the closing (PG 238)
– Closing costs: 2-10% of loan
– Down payment
– Points
– Attorney fees
– Home inspection
– Appraisal fee
– … and many more!
9 | 7
Consider the tax consequences of buying your home…
What 2 items are deductible on federal and (most) state income tax returns?
Homes (normally) appreciate in value; capital gains (your profit) are not taxable in many cases.
For first-time home buyers, money being saved to buy a home can be in a tax-sheltered account such as a Roth IRA. See page 237
9 | 8
• Points
– A way for homebuyers to “buy down” the interest rate on their loan
– 1 point = 1% of the total mortgage loan amount
– Homebuyer pays for points at closing
– Lender receives money upfront as compensation for offering a lower rate
– When does it make sense for a buyer to do this?
9 | 9
Monthly Costs Include Principal & Interest
• PITI
• How are property taxes determined? (See page 241)
• Escrowing of property taxes & homeowners insurance
• PMI (See page 241)
9 | 10
Amortization Table for Fixed Rate Loans
Month Payment Loan
BalanceInterest Principal
1 790$ 677 1132 790$ 124,887 676 1143 790$ 124,773 676 1144 790$ 124,659 675 1155 790$ 124,544 675 1156 790$ 124,429 674 1167 790$ 124,313 673 1178 790$ 124,196 673 1179 790$ 124,079 672 118
10 790$ 123,961 671 11911 790$ 123,842 671 11912 790$ 123,723 670 12024 790$ 122,240 662 12860 790$ 117,169 635 155
120 790$ 106,185 575 215180 790$ 90,996 493 297360 790$ 786 4 786
9 | 11
Financing a Home: The mathematics of mortgage loans
• A mortgage is a collateralized loan
– Lender has a lien on the real estate
– Foreclosure if borrower defaults
• A mortgage is an amortized loan
• Equity: market value of home – loan balance
• How are monthly payments divided between P & I?
9 | 12
Factors Affecting the Monthly Payment
• The Amount Borrowed
• The Interest Rate
– SHOP AROUND! Even tiny increments make a HUGE difference
• The Term of the Loan
• The Type of Mortgage
– Conventional Fixed-Rate
– ARMs (variable-rate loans)
• Teaser Rate
• Rate Caps
<= where is the risk?
9 | 13
• Fixed-Rate, Fixed-Payment Mortgage– Various terms: 10, 15, 20 or 30 years
– fixed interest rate, fixed monthly payment
– Each payment consists partly of principle and interest
– Payments made in early years mainly go toward interest, with very small reductions in loan principal
• Adjustable-rate mortgages (ARMs)– Interest rate varies over life of the loan
– Why are the initial interest rates typically lower than most fixed-rate mortgages to start?
• Hint: What does risk have to do with the interest rate borrowers pay?
– Caps helps to reduce some risk
– Considerations when evaluating Fixed vs. ARMs:
– What’s the best choice for you?
The Main Types of Mortgages
9 | 14
9 | 15
• Growing Equity • Goal is to reduce interest costs by paying off loan early
• Bi-weekly mortgage option
– Reverse Mortgage
– Second Mortgage • Home Equity Loan
• Home Equity Line of Credit
• “Eating one’s house”
– Mortgage Refinancing
Alternative Mortgages
Traditional limit for HELs and HELOCs:
80% of MV less loan balance.
9 | 16
Steps in theProcess of Buying a Home
9 | 17
• Determine your own affordability first:
Front-end ratio:
– PITI compared to gross income
– PITI should not exceed 25-29% of gross income
Back-end ratio:
– PITI + all other monthly debt (car, student loans, etc)
– Should not exceed 33-41% of gross income
–Most people base affordability on combined incomes
– Why might this be a bad idea?
–Prequalify for a mortgage by arranging financing