Chapter 9

Learning Objectives (part 1 of 2) Explain the advantages of pre- qualification Describe the different types of mortgages available Ascertain how much you could afford to pay for a house Decide how much of a down payment you would like to make

Learning Objectives (part 2 of 2) Estimate your closing costs Evaluate whether it would be profitable to refinance your current mortgage Describe the process by which property taxes are determined Evaluate automobile financing choices Analyze an auto lease proposal.

Advantages of Pre- qualification Identifies maximum mortgage one would be able to obtain Reduces uncertainty about qualifying for a mortgage Adds creditability to a bid (if two bids are otherwise equal, the one with the prequal. letter should be chosen

Different types of mortgages (1 of 2) fixed rate mortgage 15-year 30-year Adjustable rate mortgage (ARM) 1/1, 3/1, 5/1, 7/1, 10/1 5/25, 7/23

Different types of mortgages (1 of 2) Conventional mortgage FHA-insured mortgage VA-guaranteed mortgage Jumbo mortgage Reverse annuity mortgage (RAM)

Elements of an ARM Teaser rate Convertibility Margin Index tied to, & availability of index Caps Per each change Lifetime

Obtaining a mortgage Get as many quotes as possible Lock period & application fees Miscellaneous fees

Maximum size of mortgage Ultimately, lender’s choice, but they all follow certain rules PITI not exceed 28% of gross income PITI and other monthly debt payments not exceed 36% of gross income

Selection of down payment (1 of 2) Standard is 20% of purchase price If less, then will need some form of default insurance Any form of insurance is expensive If income constraints are a problem then a larger down payment may make it easier to get a mortgage

Selection of down payment (2 of 2) Putting more down is equivalent to investing money risk-free at the mortgage rate Putting more down may create a liquidity problem later, that could only be solved with a home equity loan or through refinancing

Closing Costs Prepaid interest (for first month) Title insurance Start escrow account Tax Stamps Credit report Survey Potentially many more

Choosing a mortgage (1 of 2) Fixed vs. ARM depends on risk tolerance, income constraints, expected period of occupancy 15-year vs. 30-year depends on reduction in interest rate vs. opportunity cost of money

Choosing a mortgage (2 of 2) Paying points to get a lower rate Great if paid by employer Foolish if occupancy less than five years (typically) Depends on opportunity rate of return Reduces the value of refinancing the mortgage should interest rates drop

Refinancing a mortgage Sometimes done to get at equity in the house Popular rule of thumb of 2% reduction vastly overstates when it can be profitably done Depends on closing costs and the magnitude of reduction in the monthly payment

Appraised vs assessed value Appraised value = what an appraiser thinks a home would sell for Required by all lender’s before a mortgage is closed Required for any home-equity loan or HELOC Assessed value = an arbitrary value assigned to a home to set property taxes. Unrelated to appraised value.

Property Taxes Assessed valuation established Each taxing authority establishes a millage rate (property tax per $1,000 assessed valuation Some states establish state equilization factors

Financing a Car Rebate or below market interest rate: both are built in price adjustments, and true value of BMIR needs to be estimated Amount of down payment Opportunity cost of money Reduction in liquidity May affect ability to obtain a loan

Factors in a lease rate Selling price of vehicle Expected value of vehicle at end of lease Money factor (interest rate) Monthly depreciation charge Other taxes and fees

Down payment on a lease Destination charge Acquisition fee Security deposit refundable

Borrow & buy vs. lease decision Monthly down payments lower with a lease Leases usually require less out of pocket cash Time Value of Money analysis usually favors a purchase