Chapter 7 Selecting and Financing Housing McGraw-Hill/Irwin Copyright 2010 by The McGraw-Hill Companies, Inc. All rights reserved. Selecting and Financing Housing Chapter Objectives 1. Assess costs and benefits of renting 2. Implement the home-buying process 3. Determine costs associated with purchasing a home 4. Develop a strategy for selling a home 7-2 Objective1 Assess Costs and Benefits of Renting Evaluating Renting and Buying Alternatives Your lifestyle and your choice of housing How you spend your time and money Every buying decision = lifestyle statement Personal preferences vs. financial factors Traditional financial guidelines: Spend no more than 25-30% of take-home pay on housing, or No more than 2 1/2 times your annual income 7-3
Renting vs. Buying Housing Choice should be based on: Lifestyle Financial Factors Mobility vs. permanence Renting = less costly in the short run Home ownership =long-term financial advantage 7-4 Rent vs. Buy RENTING vs. BUYING Advantages Disadvantages Renting Easy to move No tax benefits Fewer responsibilities for maintenance Limitations regarding remodeling Minimal financial commitment Restrictions regarding pets, etc Pride of ownership Financial benefits Lifestyle flexibility Buying Financial commitment Higher living expenses than renting Limited mobility 7-5 Housing Rental Activities 7-6
Rental Activities Selecting a rental unit Apartment or house Advantages of renting Easier to move Fewer maintenance responsibilities Minimal financial commitments Disadvantages of renting No tax benefits Limitations regarding remodeling Restrictions regarding pets and other activities 7-7 Selecting an Apartment 7-8 Legal Details of a Lease Description and address of property Name and address of the owner/landlord (lessor) Name of tenant (lessee) Effective date and length of the lease Amount of security deposit Amount and due date of rent Date and amount for late rent payments List of included utilities, appliances, etc. Restrictions on certain activities The right to sublet the unit; transfer clause Conditions under which landlord may enter the rental unit 7-9
Costs of Renting Security deposit Usually one month s rent Held against damages to the property Returned at end of lease if unit undamaged Any deductions must be documented Utilities not covered in rent payment Water frequently covered in apartment rent If renting a house no utilities included Renter s insurance Covers contents of rented property 7-10 Objective 2 Implement the Home-buying Process 7-11 Step 1: Determine Homeownership Needs Evaluate Home Ownership Stability of residence American dream/norm Financial benefits Deduct property taxes and mortgage interest Potential increase in value of your home Building an equity in your home Lifestyle flexibility - express your individuality 7-12
Drawbacks of Homeownership Financial uncertainty Obtaining money for the down payment Obtaining mortgage financing Home values could drop Limited mobility Can take time to sell your home Higher living costs Maintenance, repainting, repairs, and home improvements Rising real estate taxes 7-13 Types of Housing Available Single-family dwelling Multi-unit dwelling Duplex (two homes) Townhouse (2, 4, or 6 units) Condominium Individual ownership of a unit in a building Condominium a type of building structure Condominium = a form of homeownership 7-14 Types of Housing Available Cooperative housing Units owned by a non-profit organization Shareholders purchase stock for the right to live in a unit in a building with multiple units Manufactured homes Fully or partially assembled in a factory, and then moved to the housing site Prefabricated = components factory-built and assembled at the site Mass production under factory conditions keeps costs lower than site built homes 7-15
Types of Housing Available Mobile homes A type of manufactured home, often <1,000 sq. ft. Same features as a conventional house Safety is debated Tend to depreciate 7-16 Types of Housing Available Building a custom home: Does the contractor have needed experience? Does contractor have a good working relationship with - Architect - Suppliers - Electricians - Plumbers - Carpenters and others? 7-17 Building a Custom Home What assurance do you have about quality? What are payment arrangements? What delays will be considered legitimate? Is the contractor licensed and insured? Are there any complaints about this contractor? Contract should have a time schedule, cost estimates, description of work, and a payment schedule 7-18
Determine What You Can Afford Consider both price and quality Look at your income, your current living expenses, and how much you have for a down payment Have a loan officer prequalify you Purchase what you can afford - you can always move up Buy a fixer-upper at a lower price, if you have the time, skills, and money to fix it up 7-19 Step 2: Find and Evaluate a Home Select a location, location, location Be aware of zoning laws Assess the school system if you have children Services of real estate agents Will show homes that meet your needs, present your offer, negotiate the price, assist in obtaining financing, and represent you at the closing Commission paid by seller; built into price Seller s agent, Dual agent or Buyer s agent 7-20 Step 2: Find and Evaluate a Home The Home Inspection Conduct a home inspection or hire an inspector Mortgage company will require an appraisal 7-21
Step 3: Price the Property Determine the home price Price affected by selling prices in the area Current demand for housing Time home has been on the market Owner s need to sell Financing options Features and condition of the home 7-22 Step 3: Price the Property Negotiate the purchase price Counteroffers are common Earnest money Portion of the price deposited as evidence of good faith Contingency clause Offer dependent on certain events: Obtaining financing Sale of current home 7-23 Objective 3 Determine Costs Associated with Purchasing a Home The Finances of Home Buying Step 4: Obtain Financing Determine down payment amount Mortgage insurance if < 20% down (PMI) Automatic PMI termination when equity =>22% Required by Homeowners Protection Act 7-24
The Mortgage Long-term loan on a specific piece of property Usually 10, 15, 20, 25, or 30 years Three main phases 1. Complete application and meet with lender to provide evidence of qualification 2. Lender obtains credit report and verifies application 3. Mortgage is approved or denied Approval usually locks rate for 60-90 days 7-25 The Mortgage Qualifying for a mortgage includes: Income Debts Credit history (700+ score) Down payment amount Length of the loan Current mortgage rates Points = prepaid interest as a % of loan amount Each point =1% of the loan amount Premium paid to obtain a lower mortgage rate 7-26 The Mortgage Loan for which you qualify will be greater when rates are lower Calculating the monthly principal and interest payment: Exhibit 7-7 = Mortgage payment factors (page 230) Example: 30-year, 7%, $223,000 mortgage Monthly payment = 223 X $6.65 = $1,482.95 Payment = Principal repayment + interest PITI = payment + taxes + insurance 7-27
Types of Mortgages Fixed-Rate, Fixed-Payment Mortgage Fixed rate, fixed payment, amortized 5%, 10% or 20% down 15, 20 or 30 years of fixed payments Government-guaranteed financing programs Veterans Administration (VA) Federal Housing Authority (FHA) Lower down payment than conventional 7-28 Types of Mortgages Adjustable rate mortgage (ARM) Flexible-rate or variable-rate mortgage Interest rate varies over the life of the loan Rate cap restricts amount of change in rate Payment cap restricts amount of change in payment Can result in negative amortization 7-29 Creative Financing Convertible ARM Allows conversion to a fixed rate during a certain period Balloon mortgage Fixed monthly payments Large final payment after 3, 5, or 7 years Growing-equity mortgage (GEM) Payments increase to allow loan to be paid off more quickly Interest-only mortgage Lower payments for the first few years Payments go towards interest only 7-30
Other Financing Options Shared appreciation mortgage (SAM) Borrower gets a lower interest rate Agrees to share appreciated value of home with the lender Second mortgage Home equity loan Home = collateral Interest may be tax deductible 7-31 Other Financing Options Reverse mortgages Home equity conversion mortgage Provides homeowners who are 62+ with tax-free income based on home equity Refinancing Consider costs of refinancing in decision Making extra payments Reduces payoff time & interest paid 7-32 Step 5: Close the Purchase Transaction Make arrangements for a walk through Last-minute items for negotiation Closing Meeting including buyer, seller and lender Document signing Last-minute details settled Closing costs = settlement costs Real Estate Settlement Procedures Act Requires buyers be given closing costs estimate before the closing 7-33
Closing Costs Title insurance and search fee Attorney s and appraisers fees Property survey Pest inspection Recording fees Transfer taxes Credit report Lender s origination fee Escrow account for tax and insurance reserve Pre-paid interest Real estate broker s commission 7-34 Closing Cost Components Title Insurance Title company defines boundaries of property Title search to insure property is free of claims Protects against future defects in title Deed Document that transfers ownership Warranty deed guarantees the title is good Seller is true owner with right to sell the property No outstanding claims against the title Escrow Account Money deposited with lending institution for payment of taxes and insurance 7-35 Objective 4 Develop a Strategy for Selling a Home Preparing your home Repair, repaint, clean, reduce clutter When showing home, Stage It : Turn on lights Open draperies Bake bread or make coffee for a welcoming smell Ideas from HGTV: Designed to Sell Get It Sold 7-36
Selling Your Home Determining the selling price Appraisal = estimate of the current value For Sale by Owner Use a lawyer or title company Time consuming for seller Listing with a Real Estate Agent Consider agent s knowledge of the community Various services and marketing efforts Screens potential buyers 7-37