1. The Home and Automobile Decision Professor Payne, Finance 4100
Chapter 8
The Home and Automobile Decision
Professor Payne, Finance 4100

2. Learning Objectives Make good buying decisions.
Choose a vehicle that suits your needs and budget.
Choose housing that meets your needs.

3. Learning Objectives Decide whether to rent or buy housing.
Calculate the costs of buying a home.
Get the most out of your mortgage.

4. Introduction
Buying a home is the single biggest investment most people will make.
Buying a car is another major purchasing decision.
Must fit lifestyle and wallet.
Will probably need a loan which will impact personal finances.

5. Smart Buying Step 1: Differentiate Want From Need
Step 2: Do Your Homework
Step 3: Make Your Purchase
Step 4: Maintain Your Purchase

9. Smart Buying in Action: Buying a Vehicle
Choices to consider:
Buy new
Buy used
Leasing

10. Smart Buying in Action: Buying a Vehicle
Step 1: Differentiate Want From Need
Features and qualities wanted
Features and qualities needed

11. Smart Buying in Action: Buying a Vehicle
Step 2: Do Your Homework
How much can you afford?
Down payment
Monthly payment
Which vehicle is right for you?
Comparison shop—price and attributes
Operating and insurance costs, and warranty

12. Smart Buying in Action: Buying a Vehicle
Step 3: Make Your Purchase
Get a fair price:
Know the dealer cost or invoice price
Dealer holdback—2 to 3% that manufacturer gives the dealer on the sale of an automobile
Approach dealers and get quotes
Negotiate

15. Smart Buying in Action: Buying a Vehicle
Step 3: Make Your Purchase
Financing Alternatives:
Cheapest—cash
Investigate all financing options before buying.
Keep financing out of the negotiations.
The shorter the term, the higher the monthly payments.

16. Smart Buying in Action: Buying a Vehicle
Step 3: Make Your Purchase
Leasing: ideal for financially stable, want new car every few years, drive less than 15,000 miles annually, good credit, no down payment
Closed-end or walk-away lease
Purchase option
Open-end lease

18. Smart Buying in Action: Buying a Vehicle
Step 3: Make Your Purchase
Keys to getting a good lease:
Negotiate value for car before signing lease
Minimum down payment
Warranty—define “normal wear and tear”
Termination fee
Depreciation factor
Rent or finance charge

20. Smart Buying in Action: Buying a Vehicle
Step 4: Maintain Your Purchase
Keep vehicle in best running condition.
Don’t ignore signs of trouble.
Your first line of protection is the warranty.
Know your rights under the Lemon laws.

22. Smart Buying in Action: Housing
Many people equate home ownership with financial success.
Housing costs can take up over 25% of after-tax income.
Home ownership is also an investment—biggest investment you will ever make.
Use smart-buying approach.

23. Your Housing Options Houses: Cooperatives and Condominiums:
Offers space and privacy
Most potential for capital appreciation
Responsible for maintenance, repair, and renovations
Cooperatives and Condominiums:
Homeowner’s fee
Planned unit developments
Apartments and other rental housing
Low maintenance

24. Smart Buying in Action: Housing
Step 1: Differentiate Want From Need
What about the house is important?
Know what you want before you look.
Affordability, location, neighborhood, conveniences, schools

25. Smart Buying in Action: Housing
Step 2: Do Your Homework
Investigate the potential home and all that goes along with it:
Neighborhood, community lifestyle, satisfy needs.
How much you can afford to pay?

26. Smart Buying in Action: Housing
One-time Costs:
Down payment
Closing/settlement costs
Points or discount points
Loan origination fee
Loan application fee
Appraisal fee
Title search fee

28. Smart Buying in Action: Housing
Recurring Costs
Monthly mortgage payments
PITI
Maintenance and Operating Costs:
repairs, renovations, upgrades, landscaping

30. Renting Versus Buying Decision based on lifestyle Renting advantages:
Financial and lifestyle flexibility
Compare costs for each alternative
Buying advantages:
Longer stay and appreciation, itemized taxes, forced savings

33. Determining What You Can Afford
What is the maximum amount that a bank will lend me?
Financial history
Ability to pay
Appraised home value
Should I borrow up to this maximum?
How big a down payment can I afford?

35. Financing the Purchase—The Mortgage
Sources of mortgages:
S&Ls and commercial banks
Credit unions and mutual savings banks
Mortgage bankers—originate mortgage loans, sell to banks, pension funds, insurance companies and collect payments
Mortgage brokers—middlemen comparison shop for a fee to secure mortgage loans for borrowers but do not originate the loans

36. Conventional and Government-Backed Mortgages
Conventional loans—from a bank or S&L secured by the property
Government-backed loans—loan from traditional lender but insured by government—FHA and VA loans:
lower interest rate, smaller down payment, less strict financial requirements
more paperwork, higher closing costs, limited funding

37. Fixed-Rate Mortgages
Monthly payment doesn’t change regardless of market interest rate changes.
Can lock in low rates for the life of the loan.
An assumable loan can be transferred to a new buyer.
Prepayment privilege allows early cash payments to be applied to principal.

38. Adjustable-Rate Mortgages (ARM)
Interest rate of ARM fluctuates with level of current interest rates.
Initial rate—”teaser rate”—low for only a short time period then adjusted upward.
Interest rate index—rates on ARMs are tied to an index not controlled by the lender, such as 6- or 12-month U.S. Treasuries.

39. Adjustable-Rate Mortgages
Margin—the amount over the index rate that the ARM is set.
Adjustment interval—how frequently the rate can be reset.

40. Adjustable-Rate Mortgages
Rate Cap—limits how much the interest rate can change
Payment Cap—sets dollar limit on how much the monthly payment can increase during any adjustment period
If interest rates go up, the monthly payment may be too small to cover the interest due—negative amortization
Unpaid interest is added to the unpaid loan balance, increasing its size

41. Adjustable-Rate Mortgages
ARM Innovations:
Convertible ARM—to fixed-rate loan
Reduction-option ARM—one time opportunity to adjust interest rate
Two-step ARM—combined aspects of fixed-rate and ARM

42. Adjustable-Rate Versus Fixed-Rate Mortgages
ARMs:
low interest rate in early years.
can get larger loan because PITI is lower.
reset interest rates push ARM payments upward
Fixed-rate mortgages:
In general, fixed-rate better than ARM.
Payments never change.
Allows for control and planning.

43. Specialty Mortgage Loan Options
Balloon Payment Mortgage Loan—small monthly payments for 5-7 years, then entire loan due.
Graduated Payment Mortgage—payments set in advance, rising for 5-10 years, then level off.
Growing Equity Mortgage—designed to let homebuyer pay off mortgage early.

44. Specialty Mortgage Loan Options
Shared Appreciation Mortgage—borrower receives below-market interest rate, lender receives a portion of future appreciation.
Interest Only Mortgage—interest only payment for initial set period, then pay both interest and principal for remainder of loan.

45. Specialty Mortgage Loan Options
Option Payment ARM Mortgages—can make different types of mortgage payments each month
Options include:
Amount less than interest due
Interest only
Payment amount of 15- or 30-year fixed-rate loan

46. Risks Associated with Specialty Mortgages
Big jump in monthly payments if interest rates rise
Read fine print
Know how much your monthly payment could increase, when, and whether you could afford them
Penalties

47. Beware of Subprime Mortgages and Predatory Lending
Subprime mortgages—mortgages taken out by borrowers with low credit scores
Predatory lenders take advantage of these lenders
Abusive loans—high-cost loans with little chance of paying off
Avoid predatory loans with knowledge

49. Mortgage Decisions: Length or Term of the Loan
15- or 30-year maturity on mortgage?
Prepayment opportunities
Size of monthly payment
Interest rate

53. Smart Buying in Action: Housing
Coming up with the down payment
Save, gifts from family and friends
At least 5% of closing costs have to come from homebuyer
“Gift letter”
Private Mortgage Insurance
Allows you to borrow more than 80% of appraised home value
Charges .3 to 1.5% of the loan amount
Prequalifying—have maximum amount you’ll qualify for confirmed by a lender

54. Smart Buying in Action: Housing
Step 3: Make Your Purchase
Comparison shop
Traditional real estate agent
Independent or exclusive buyer-broker
Get it inspected
Make an offer and negotiate

55. Smart Buying in Action: Housing
Contract
Earnest money
Closing
Settlement or closing statement

57. Smart Buying in Action: Housing
Step 4: Maintain Your Purchase
Pay attention to refinancing options
Consider refinancing if rates fall 1 percent or more
Incur closing costs again

59. Summary
Separate needs from wants, compare products, negotiate, maintain product, and resolve complaints.
Lease or buy a vehicle that fits both your personal and financial needs.
Choose housing that meets your needs, preshop, comparison shop home and financing, and maintain if you purchase.
Get the most out of your mortgage.

61. End of Chapter 8 Slides