1. The Housing Expenditure

2. Objectives
Discuss the options available for rented and owned housing and whether renters or owners pay more for housing.
Determine how much buyers can afford for housing.
Discuss the various mechanisms for financing a home.

3. Objectives
Identify the numerous costs of buying a home, including principle, interest, and closing costs.
List and describe the steps in the home-buying process.

4. Young Couple, No Children Couple, Children No Longer At Home
Housing Decision
Young Single
Rental housing has limited maintenance and offers mobility.
Purchase a home or a condominium for financial and tax benefits.
Single Parent
Rental housing can provide suitable environment for children and some degree of housing security.
Purchase low-maintenance housing to meet financial and social needs of family.
Young Couple, No Children
Rental housing offers convenience and flexibility of lifestyle.
Purchase housing for financial benefits and to build long-term financial security.
Couple, Children No Longer At Home
Rental housing for convenience, flexibility for changing needs and financial situation.
Purchase housing that requires minimal maintenance and meets lifestyle needs.
Couple, Young Children
Rental housing can provide facilities for children in a family-oriented area.
Purchase a home to meet financial and other family needs.
Retired Person
Rental housing meet financial, social, and physical needs.
Purchase housing that requires minimal maintenance, offers convenience, and provides needed services.

5. Renting Your Residence
Advantages
Mobility
Fewer responsibilities
Lower costs initially
More amenities
Disadvantages
Few financial benefits
Restricted lifestyle
Cost of renting - deposits
Legal concerns of a lease

6. Largest Physical Capital Investment Made by a Family is a HOUSE.
Home Ownership rates 2014:
US = 64% (last peak was 69.1% in 2005)
Midwest = 68.3%
West = 58.6%
Since 1900, home ownership has been in excess of 40% in the U.S.

7. Housing Prices are determined by Supply & Demand
Average household size down
Average income up
Availability of substitutes down
Life cycle stage of housing
Childhood home, apartment, starter home, family home, empty nest home, retirement home, institutionalization or back to family, burial vault
Supply
Business cycle

8. Advantages of Owning Pride of ownership American dream/norm
Reduced income taxes
deduct property taxes
deduct mortgage interest

9. Advantages of Owning Build an equity pay down the loan
(continued)
Build an equity
pay down the loan
price appreciation
Builds your credit rating
Forced savings-portion of mortgage payment goes toward building up equity.
Hedge against inflation
Lifestyle flexibility
can express your individuality

10. Disadvantages of Owning
Financial risk
need down payment
home prices could drop
Opportunity cost of money tied up in purchase.
Limited mobility
can take time to sell
Higher living costs
maintenance
repairs & improvements
utilities & insurance
real estate taxes

11. Renting vs. Owning Your Home
WHO PAYS MORE:
Based on cash flow, renters appear to win
After taxes and appreciation, owners usually win

12. A Cost-Benefit Approach (CBA) to the home ownership decision
1. What is the time period over which the household plans to own/rent?
2. What are the one-time fixed costs associated with purchasing the home?
down payment
closing costs (e.g., points, fees)
Do you pay these costs if you are renting?

13. A Cost-Benefit Approach (CBA) to the home ownership decision
3. What are the recurring (i.e., monthly) NET costs associated with owning compared to renting?
How much more does it cost you to own than to rent every single month? You want to get that money back at the end…
Sum of owning costs (mortgage payment, property taxes, hazard insurance, operating and maintenance expenses) minus tax savings
Sum of renting costs (rent, operating expenses)
4. What will the outstanding loan balance be at the end of the time period?
You have to pay off your loan when you sell
5. What will the estimated selling costs be at the end of the time period?
You need to pay a realtor, and you want to get those dollars back

14. A Cost-Benefit Approach (CBA) to the home ownership decision
6. Place all of these costs into future value dollars using 3% real interest rate
Remember, all of our dollars have to be at one point in time – we are putting all of our dollars in to the future
One-time costs (because these costs are one-time costs):
FV=PV(1+r)n
Recurring costs (because these costs happen every single month):
Loan balance (already in future dollars; do not need to use a formula):
Selling costs:
Add up the one-time costs, recurring costs, loan balance, and selling costs, for the total costs expressed in future value terms
This equals the minimum required future value of the home, or the break even price
This is how much you have to sell your home for in the future in order to get back all of the dollars that you have spent

15. A Cost-Benefit Approach (CBA) to the home ownership decision
7. Compute the interest rate
This interest rate is the annual rate of appreciation that will have to occur if you are to break even on purchasing a house rather than renting for n years.
This converts the dollar amount into an interest rate, so that you can compare your housing investment with other types of investments

16. DECISION RULE -
If the forecasted rate of housing appreciation is greater than the calculated interest rate, then economic benefits of home ownership outweigh the economic costs.
So, buy the house
If the forecasted housing appreciation rate is less than the calculated interest rate, then the economic costs of home ownership outweigh the economic benefits.
So, rent

17. Example Original Purchase Price = $100,000 1. Time period = 8 years
2. One-time fixed costs:
Down Payment = $10,000
Closing Costs = $3,000
Total = $13,000
3. Recurring Net costs
Sum of owning costs – tax savings = $1200
Sum of renting costs = $900
Net Costs = $ $900 = $300
4. Loan balance: $81,900 (from amortization table)
5. Selling Costs: $6,000

18. Example 6. FV of one-time costs FV=13000(1+.03)8 =$16,468
FVA of recurring costs (with monthly compounding) =
=$16,468
= $32,504

19. Example 7. Now, add up all of the future costs:FV
FVA
Loan Balance
Selling Costs
= $16,468 + $32,504 + $81,900 + $6,000
= $136,872

20. Example 7.
= 0.04 or 4%

21. Example
Decision = if forecasted housing appreciation rates are higher than 4%, you should buy this house

22. Housing Options for Home Buyers
Single-family dwelling
tract housing
built on speculation by builder
built to your specifications
previously lived in home
manufactured home
mobile home

23. Home Buying Process Step 1: Determine Ownership Needs
How much you can afford
down payment
loan amount
size and quality
handyman’s special
sweat equity

24. Home Buying Process Step 2: Finding and Evaluating a Property to Purchase
Select a location
Zoning laws
Covenants, codes and restrictions
Using a real estate agent
Property appraisal
Conducting a home inspection
9-15

25. Home Buying Process Step 3: Pricing the Property
Determining the price to offer
Negotiating the purchase price
seller’s or buyer’s market
earnest money
Contingency clauses
home passes structural inspection
able to get a loan

26. Estimating Mortgage Loan Payments for Principal and Interest
(Monthly Payment per $1,000 Borrowed)
Payment Period (Years)
Interest
Rate (5) 15 20 25 30
4.5
$7.6499
$6.3265
$5.5583
$5.0669
5.0
7.9079
6.5996
5.8459
5.3682
5.5
8.1708
6.8789
6.1409
5.6779
6.0
8.4386
7.1643
6.4430
5.9955
6.5
8.7111
7.4557
6.7521
6.3207
7.0
8.9883
7.7530
7.0678
6.6530
7.5
9.2701
8.0559
7.3899
6.9921
8.0
9.5565
8.3644
7.7182
7.3376
8.5
9.8474
8.6782
8.0523
7.6891
9.0
8.9973
8.3920
8.0462
9.5
9.3213
8.7370
8.4085
10.0
9.6502
9.0870
8.7757
Note: To use this table to calculate a monthly mortgage payment, divide the amount borrowed by 1,000 and multiply by the appropriate figure in the table where the interest rate and the time period for the loan intersect. For example, a $150,000 loan for 30 years at 9 percent would require a payment of $1, [($ /1,000) x ]; over 15 years it would require a payment of $1,

27. Effect of Down Payment Down Payment Amount Of Loan Monthly $5,000
Effect of Down Payment Size on Monthly Payment for a $150,000 Home
(7 Percent Mortgage Loan for 30 Years)
Down
Payment
Amount
Of Loan
Monthly
$5,000
$145,000
$964.69
10,000
140,000
931.42
15,000
135,000
898.16
20,000
130,000
864.89
25,000
125,000
831.63

28. How do households finance the purchase of a house?
Down payment
typically 10% of selling price, but 20% is the magic number
Mortgage
loan to pay the seller the difference between the purchase price and the down payment
Mortgage choices impact the economic cost of a home

29. Type of Mortgages Conventional fixed rate, amortized
5, 10 or 20 percent down
15, 20 or 30 years of fixed payments
Government guaranteed
Veterans Administration
Federal Housing Administration
Adjustable rate mortgages
varies with the prime rate but has a rate cap

30. Type of Mortgages Graduated payment payments start lower and go up
(continued)
Graduated payment
payments start lower and go up
for persons whose income will increase
Balloon
fixed monthly payments plus one large payment, usually after 3, 5 or 7 years
Growing equity
payment increases to allow loan to be paid off more quickly

31. Type of Mortgages Shared appreciation
(continued)
Shared appreciation
borrower agrees to share appreciated value of the home with the lender
Home equity loans
a second mortgage
home is collateral and interest may be tax deductible
Reverse
a loan based on the home equity
Refinancing

32. Economic Advantages and Disadvantages of Fixed Rate Mortgage?
future housing costs are known with relative certainty (only possible changes are property taxes, insurance, and utilities)
can choose 15-year, 20-year, 25-year, 30-year, 40-year, or 50-year loan time
interest deductions from income taxes are high during the early years of the loan

33. Economic Advantages and Disadvantages of Fixed Rate Mortgage?
more difficult for young households (with lower incomes) to qualify
Locked in to the fixed rate.
Tax advantages lessen over time (typically at the point where household income and the marginal tax rate are both rising)

34. Fixed rate FHA or VA mortgage
Federally insured mortgages
If the borrower defaults, the lender still gets the money.
Advantages:
interest rates frequently lower on FHA or VA mortgages than on conventional mortgages
qualifying is typically easier
FHA/VA loans are assumable
down payment requirements are typically lower

35. Fixed rate FHA or VA mortgage
Disadvantages:
loan limits (2008 = $729,750 in SLC, Summit, and Tooele Counties; $323,750 in Utah County; $271,050 most everywhere else)
insurance fees (1.5% upfront, % per year of the loan amount – can be financed)
typically pay additional points (one-time, fixed costs)
Rates on 10/30/08
30 year fixed is 6.46%, with 0.7 points
15 year fixed is 6.19%, with 0.7 points
May take longer to process

36. Self-amortizing, Adjustable Rate Mortgage (ARM)
Interest rate and monthly payment are both variable (e.g., adjustable).
Example:
loan amount = $200,000
interest rate = 6.0% initially
time period = 30 years
initial monthly payment: $

37. More about the ARM interest rate
Index - market interest rate that is not directly controlled by the lender. It is used to initially set and periodically adjust the interest rate on the loan
Spread - the amount that is added to the index to arrive at the the ARM interest rate.

38. More about the ARM interest rate
Frequency of rate change - how often the lending institution can change the ARM interest rate.
Rate cap - limitations on either the increase or the decrease in the ARM interest rate that can occur at a point in time.
Frequency of payment change - how often monthly payments can change (typically the same as frequency of rate change -- if not, there is the possibility of negative amortization)

39. Economic Advantages and Disadvantages of an Adjustable Rate Mortgage?
Initial interest rates are typically lower
If you are buying when mortgage rates are high, but expected to fall in the future
Disadvantages:
Greater uncertainty about what future mortgage payments will be

40. Graduated Payment Mortgage (GPM)
Interest rate is fixed but the monthly payment rises over time -- supposedly as the household’s income rises.
Example:
loan amount = $200,000
interest rate = 7.0%
time period = 30 years
monthly payment at first is $800 (rather than $ )
After 2 years, payment goes to $1000
After another 2 years, payment goes to $1200
Then payment is $ for the rest of the loan (24 years)

41. Interest Payments on a Graduated Payment Mortgage
Month 1:
payment = $800.00
interest owed: $200,000(.07/12) = $
loan increased by: $ $800 = $366.67
Month 2:
interest owed: $200,366.67(.07/12) = $
loan increased by: $ $800 = $368.81
This is an example of negative amortization

42. Economic Advantages and Disadvantages of a Graduated Payment Mortgage?
Easier to qualify for lower income households
lower monthly payments early in the mortgage
Disadvantages:
Loan amount is larger than with a conventional, fixed rate mortgage
Payments will be higher in the later stages of the loan (must be confident that income will rise or else this may present a problem)

43. Reverse Equity Mortgages (REM)
A reverse mortgage is a loan against your home that you do not have to pay back for as long as you live there.
It can be paid to you all at once, as a regular monthly advance, or at times and in amounts that you choose.
You pay the money back plus interest when you die, sell your home, or permanently move out of your home.
Reverse mortgage loans typically require no repayment for as long as you live in your home.
Your house must be paid off (or close to it)
You must be over 62

44. REMs Advantages: Disadvantages:
Way to access your home equity without having the burden of repayment
Creates income
Disadvantages:
Reduces the value of your estate
Your home must be sold after your death to repay the REM, if liquid assets are not available to pay off the REM

45. Interest Only Your payment only covers the interest owed on the loan
Then you have a balloon payment after a specified # of years (e.g. 7 or 12) with the principal balance due
Or your loan will amortize over a shorter amount of time
E.g. 40 yr IO – pay IO for 10 years, and then amortized over 30 yrs
Advantages:
Lower monthly payments
Maybe good for rental properties and/or high-equity growth areas
Disadvantages:
Negative amortization may occur
No gain in equity from principal reduction
Very risky

46. Life cycle stage Business cycle stage Risk tolerance Liquidity needs
Summary: Economic Costs and Economic Benefits of Various Mortgage Instruments Depend Upon...
Life cycle stage
Business cycle stage
Risk tolerance
Liquidity needs

47. How do those mortgages stack up?
Loan Type
Interest Rate
Monthly Pmt
Compared to a 30-yr
r pd in 5 yrs
Equity created in 5 yrs
5/1 Interest Only
6.29%
$1,572.50
($367.32)
$94,350 $0
15-yr fixed
6.32%
$2,583.73
$643.91
$84,415
$70,609
30-yr fixed
6.72%
$1,939.82
$97,922
$18,467
40-yr fixed
6.97%
$1,857.76
($82.06)
$103,220
$8,245
50-yr fixed
$1,798.18
($141.64)
$103,908
$3,983

48. How to reduce the amount of interest paid on your mortgage
Pay extra principal every month
Pay next month’s principal this month
Pays off a 30-year mortgage in about 15 years and 8 months
Pay bi-weekly
Pay 26 half payments a year, or 13 monthly payments
Cuts about 7 years off of 30 year mortgage
Pay semi-monthly
Pay 24 half payments a year
Cuts about 5 years off of 30 year mortgage, without ever paying extra

49. Is this a good deal?
Currently 8 years left on a mortgage, paying 7.35% with a payment of $642
Refinance to a 15 year mortgage at 5.25% with a payment of $450
Answer = NO
Under current payment plan, will pay 642(8)(12) = $61,632 over next 8 years
Under refinance, will pay 450(15)(12) = $81,000 over next 15 years
More out of pocket, and more opportunity costs

50. Home Buying Process Step 4: Obtaining Financing
Determine the amount of down payment
mortgage insurance
Qualifying for a mortgage
can be pre-qualified based on income, assets, debts, credit history and length of loan
purpose of “points” (prepaid interest)
The home loan application process
fixed or adjustable rate mortgage
locking in an interest rate - search Web

51. Qualifying for a Mortgage
Amount available for down payment
Amount of income
Amount of other debts
Credit rating
Current mortgage rates
Length of loan desired

52. Home Buying Process Step 5:
Closing the Purchase Transaction
Title insurance and search fee
Attorney’s and appraisers fees
Property survey
Recording fees; transfer taxes
Credit report
Termite inspection
Lender’s origination fee
Tax and insurance reserves
Pre-paid interest
Real estate commission
Closing Costs

53. The Main Elements of Buying a Home
Location
Down payment
Mortgage application
Points
Closing costs
TIPI (taxes, insurance, principal, interest)
Maintenance costs