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

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

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

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.

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

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

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

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

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

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.

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

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

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.

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.

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

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

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?

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

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

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

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?

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

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

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.

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.

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

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

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

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.

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.

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.

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

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

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

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

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

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

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

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

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.

End of Chapter 8 Slides