PART 2: MANAGING YOUR MONEY Chapter 8 The Home and Automobile Decision

8-2 Smart Buying Step 1: Differentiate Want From Need Smart buying requires separating wants from needs. Smart buying requires separating wants from needs. Want purchases require a trade-off. Want purchases require a trade-off. Before buying a want, determine whether the purchase will interfere with your ability to pay for your future needs. Before buying a want, determine whether the purchase will interfere with your ability to pay for your future needs.

8-3 Smart Buying Step 2: Do Your Homework After deciding to make a purchase, comparison shop. After deciding to make a purchase, comparison shop. Start your research with publications that provide unbiased ratings and recommendations such as: Start your research with publications that provide unbiased ratings and recommendations such as: Consumer Reports at Consumer Reports at Consumers Resource Handbook from the U.S. Office of Consumer Affairs at Consumers Resource Handbook from the U.S. Office of Consumer Affairs at

8-4 Smart Buying Step 3: Make Your Purchase Getting the best price might involve negotiations. Getting the best price might involve negotiations. Conduct research before haggling. Conduct research before haggling. Know the products mark-up. Know the products mark-up. This is the price dealers add on above what they paid for the product. This is the price dealers add on above what they paid for the product. Consider what fits your monthly budget. Consider what fits your monthly budget.

8-5 Smart Buying Step 4: Maintain Your Purchase Maintain your purchase after the deal is complete. Maintain your purchase after the deal is complete. Resolve complaints or issues. Resolve complaints or issues. First contact the seller, then the company headquarters that made or sold the product. First contact the seller, then the company headquarters that made or sold the product. Work with the Better Business Bureau and other local, state, and federal organizations. Work with the Better Business Bureau and other local, state, and federal organizations.

8-6 Smart Buying Checklist 8.1 Before You Buy Decide in advance what you need and can afford. Decide in advance what you need and can afford. Take advantage of sales but compare prices. Take advantage of sales but compare prices. Be aware of extra charges that increase the total price. Be aware of extra charges that increase the total price. Ask about refund or exchange policy. Ask about refund or exchange policy. Read and understand the contract before signing. Read and understand the contract before signing. Learn about your cancellation rights. Learn about your cancellation rights. Dont succumb to high pressure tactics or do business over the phone with unknown companies. Dont succumb to high pressure tactics or do business over the phone with unknown companies. Get everything in writing. Get everything in writing.

8-7 Smart Buying Checklist 8.2 Making a Complaint Keep a record of your efforts to resolve the problem. Keep a record of your efforts to resolve the problem. Contact the seller, then go to the manufacturer. Contact the seller, then go to the manufacturer. Type letters, keep copies, and send letters with return receipt requested. Type letters, keep copies, and send letters with return receipt requested. Allow time for the company to resolve the problem, then file a complaint with your local consumer protection office or Better Business Bureau. Allow time for the company to resolve the problem, then file a complaint with your local consumer protection office or Better Business Bureau. Dont give up until you are satisfied. Dont give up until you are satisfied.

8-8 Smart Buying in Action: Buying a Vehicle Vehicles are your largest purchase, next to buying a house. Vehicles are your largest purchase, next to buying a house. Choices to consider: Choices to consider: Buy new Buy new Buy used Buy used Lease the vehicle Lease the vehicle Leasing is renting for an extended period with a small down payment and low monthly rates. Leasing is renting for an extended period with a small down payment and low monthly rates.

8-9 Smart Buying in Action: Buying a Vehicle Step 1: Differentiate Want From Need Determine which features you need. Determine which features you need. Make a list of the features you want. Make a list of the features you want. Consider your employment, family, lifestyle. Consider your employment, family, lifestyle.

8-10 Smart Buying in Action: Buying a Vehicle Step 2: Do Your Homework How much can you afford? How much can you afford? Typical family spends 4-6 months of annual income on a new car. Typical family spends 4-6 months of annual income on a new car. Determine size of down payment. Determine size of down payment. Determine an affordable monthly payment. Determine an affordable monthly payment. Which vehicle is right for you? Which vehicle is right for you? Comparison shop, looking at choices and trade-offs. Comparison shop, looking at choices and trade-offs. Consider operating and insurance costs, and warranty. Consider operating and insurance costs, and warranty.

8-11 Smart Buying in Action: Buying a Vehicle Step 3: Make Your Purchase Be sure to get a fair price. Be sure to get a fair price. Know the dealer cost or invoice price. Know the dealer cost or invoice price. Research using Edmunds Car Buying Guide at or AutoSite at their web site Research using Edmunds Car Buying Guide at or AutoSite at their web site Most car dealers receive a holdback, amounting to 2-3% of the price, when selling a car. Most car dealers receive a holdback, amounting to 2-3% of the price, when selling a car.

8-12 Smart Buying in Action: Buying a Vehicle Step 3: Make Your Purchase Financing Alternatives: Financing Alternatives: Cheapest way to buy a car is with cash, but investigate all financing options before buying. Cheapest way to buy a car is with cash, but investigate all financing options before buying. Keep financing out of the negotiations. Keep financing out of the negotiations. The shorter the term, the higher the monthly payments. The shorter the term, the higher the monthly payments.

8-13 Smart Buying in Action: Buying a Vehicle Step 3: Make Your Purchase Leasing: Leasing: Appeals to those who are financially stable, like a new car every few years, drive less than 15,000 miles annually, and dont want hassle of trading in car. Appeals to those who are financially stable, like a new car every few years, drive less than 15,000 miles annually, and dont want hassle of trading in car. Popular with those with good credit but not enough up-front money to buy. Popular with those with good credit but not enough up-front money to buy. 1/3 of all new vehicles are leased. 1/3 of all new vehicles are leased.

8-14 Smart Buying in Action: Buying a Vehicle Step 3: Make Your Purchase Financing Alternatives: Financing Alternatives: Cash – cheapest way to finance. Cash – cheapest way to finance. Closed-end lease – is a walk-away lease. Closed-end lease – is a walk-away lease. Often contains a purchase option. Often contains a purchase option. Open-end lease – you might have to pay the difference between the current market value of the car compared to the value estimated in the lease. Open-end lease – you might have to pay the difference between the current market value of the car compared to the value estimated in the lease. You do not want an open-end lease. You do not want an open-end lease.

8-15 Smart Buying in Action: Buying a Vehicle Step 4: Maintain Your Purchase Keep vehicle in best running condition. Keep vehicle in best running condition. Read owners manual and follow regular maintenance. Read owners manual and follow regular maintenance. Dont ignore signs of trouble. Dont ignore signs of trouble. Listen for unusual sounds, drips, or warning lights. Listen for unusual sounds, drips, or warning lights. Your first line of protection is the warranty. Your first line of protection is the warranty. Know your rights under the Lemon laws. Know your rights under the Lemon laws.

8-16 Smart Buying in Action: Housing Many people equate home ownership with financial success. Many people equate home ownership with financial success. Housing costs can take up over 25% of after-tax income. Housing costs can take up over 25% of after-tax income. Home ownership is also an investment – likely the biggest investment you will ever make. Home ownership is also an investment – likely the biggest investment you will ever make. Consider lifestyle, wants and needs, and budget constraints when making choices. Consider lifestyle, wants and needs, and budget constraints when making choices.

8-17 Your Housing Options A House: A House: Popular choice for most individuals. Popular choice for most individuals. Offers space and privacy. Offers space and privacy. Offers greater control over style decoration and home improvement. Offers greater control over style decoration and home improvement. Requires more work than the other choices, including maintenance, repair, and renovations. Requires more work than the other choices, including maintenance, repair, and renovations. Most potential for capital appreciation. Most potential for capital appreciation.

8-18 Your Housing Options A Cooperative (Co-op) is a building owned by a corporation in which residents are stockholders. A Cooperative (Co-op) is a building owned by a corporation in which residents are stockholders. Residents buy stock, giving them the right to occupy a unit in the building. Residents buy stock, giving them the right to occupy a unit in the building. The larger the space and the more desirable the location, the more shares you have to buy. The larger the space and the more desirable the location, the more shares you have to buy. Difficult to get a mortgage. Difficult to get a mortgage. Pay monthly homeowners fee for taxes and maintenance. Pay monthly homeowners fee for taxes and maintenance.

8-19 Your Housing Options A Condominium (Condo) is an apartment complex that allows individual ownership of the unit and joint ownership of land, common areas, and facilities. A Condominium (Condo) is an apartment complex that allows individual ownership of the unit and joint ownership of land, common areas, and facilities. Allows direct ownership of the unit with a proportionate ownership in land and common areas. Allows direct ownership of the unit with a proportionate ownership in land and common areas. Pay monthly fee for interest, taxes, utilities, and grounds keeping. Pay monthly fee for interest, taxes, utilities, and grounds keeping.

8-20 Your Housing Options Apartments and other rental housing offer: Apartments and other rental housing offer: Affordability Affordability Low maintenance situations Low maintenance situations Little financial commitment Little financial commitment Chosen by young, single people. Chosen by young, single people. May be a lifestyle decision. May be a lifestyle decision. Limited upkeep and no long-term commitment. Limited upkeep and no long-term commitment. Offers lack of choice regarding pets or remodeling. Offers lack of choice regarding pets or remodeling.

8-21 Smart Buying in Action: Housing Step 1: Differentiate Want From Need Determine what you need versus what you want. Determine what you need versus what you want. Decide what is important to you: Decide what is important to you: Consider location – country, suburbs, or city Consider location – country, suburbs, or city Consider the neighborhood – safety, convenience, schools Consider the neighborhood – safety, convenience, schools

8-22 Smart Buying in Action: Housing Step 2: Do Your Homework Investigate the potential home and all that goes along with it: Investigate the potential home and all that goes along with it: Neighborhood, community lifestyle, satisfy needs. Neighborhood, community lifestyle, satisfy needs Understand how much you can afford to pay. Understand how much you can afford to pay.

8-23 Smart Buying in Action: Housing One-time Costs Down payment Down payment Closing/settlement costs Closing/settlement costs Points (point = 1% of loan) Points (point = 1% of loan) Loan origination fee Loan origination fee Application fee Application fee Appraisal fee Appraisal fee Title search Title search Recurring Costs Mortgage payments PITI includes principal, interest, taxes, insurance Maintenance and Operating Costs Repairs and maintenance items

8-24 Renting Versus Buying Buying Many up-front and one-time costs Many up-front and one-time costs Beneficial for those who itemize their deductions Beneficial for those who itemize their deductions Mortgage payments are a form of forced savings Mortgage payments are a form of forced savings Renting No large up-front costs other than a security deposit Beneficial if staying only for the short-term

8-25 Determining What You Can Afford Before house hunting, ask yourself: Before house hunting, ask yourself: What is the maximum amount the bank will lend me? What is the maximum amount the bank will lend me? Should I borrow up to this maximum? Should I borrow up to this maximum? How big a down payment can I afford? How big a down payment can I afford?

8-26 What is the Maximum Amount the Bank Will Lend Me? Lenders look at: Lenders look at: Your financial history – steadiness of income, credit report, and FICO score Your financial history – steadiness of income, credit report, and FICO score Your ability to pay – lenders use ratio of a maximum 28% PITI: monthly gross income Your ability to pay – lenders use ratio of a maximum 28% PITI: monthly gross income Appraised value of home – limit mortgage loan to 80%. Appraised value of home – limit mortgage loan to 80%.

8-27 How Much Should You Borrow? A mortgage is a large financial commitment of future earnings. A mortgage is a large financial commitment of future earnings. Look at your overall financial plan before deciding on how much to borrow. Look at your overall financial plan before deciding on how much to borrow. Prequalifying – lender confirms the loan size based on ability to pay and down payment. Prequalifying – lender confirms the loan size based on ability to pay and down payment.

8-28 Financing the Purchase: The Mortgage Sources of mortgages: Sources of mortgages: S&Ls and commercial banks are the primary sources of mortgage loans. S&Ls and commercial banks are the primary sources of mortgage loans. Mortgage bankers originate loans, sell them to banks or pension funds, have fixed rate mortgages. Mortgage bankers originate loans, sell them to banks or pension funds, have fixed rate mortgages. Mortgage brokers are middlemen who place loans with lenders for a fee but do not originate those loans. They do the comparison shopping. Mortgage brokers are middlemen who place loans with lenders for a fee but do not originate those loans. They do the comparison shopping.

8-29 Conventional and Government- Backed Mortgages Conventional loans - from a bank or S&L and secured by the property. Conventional loans - from a bank or S&L and secured by the property. If default - lender seizes property, sells it to recover funds owed. If default - lender seizes property, sells it to recover funds owed.

8-30 Conventional and Government- Backed Mortgages Government-backed loans – lender makes loan and government insures it. VA and FHA account for 25% of all mortgage loans. Government-backed loans – lender makes loan and government insures it. VA and FHA account for 25% of all mortgage loans. Advantages: Advantages: Lower interest rate Lower interest rate Smaller down payment Smaller down payment Less strict financial requirements Less strict financial requirements Disadvantages: Disadvantages: Increased paperwork Increased paperwork Higher closing costs Higher closing costs Limits amount borrowed Limits amount borrowed

8-31 Fixed-Rate Mortgages Monthly payment doesnt change regardless of changes in market interest rates. Monthly payment doesnt change regardless of changes in market interest rates. If rates are low, a fixed rate mortgage locks in the low rates for the life of the loan. If rates are low, a fixed rate mortgage locks in the low rates for the life of the loan. An assumable loan can be transferred to a new buyer. An assumable loan can be transferred to a new buyer. Prepayment privilege allows early cash payments to be applied to principal. Prepayment privilege allows early cash payments to be applied to principal.

8-32 Adjustable-Rate Mortgages With an ARM, the interest rate fluctuates based on current market interest rates within limits at specified intervals. With an ARM, the interest rate fluctuates based on current market interest rates within limits at specified intervals. Borrowers are better off with an ARM if interest rates drop. Borrowers are better off with an ARM if interest rates drop. Initial Rate - teaser rate can be deceptively low and available for only a short time period. Initial Rate - teaser rate can be deceptively low and available for only a short time period.

8-33 Adjustable-Rate Mortgages 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. 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. Margin – the amount over the index rate that the ARM is set. Margin – the amount over the index rate that the ARM is set. Adjustment Interval – how frequently the rate can be reset. Adjustment Interval – how frequently the rate can be reset.

8-34 Adjustable-Rate Mortgages Rate Cap – limits how much the interest rate can change. Rate Cap – limits how much the interest rate can change. Periodic cap – limits the amount by which the interest rate can change during any adjustment. Periodic cap – limits the amount by which the interest rate can change during any adjustment. Lifetime cap – limits the amount by which the interest rate can change during the life of the ARM. Lifetime cap – limits the amount by which the interest rate can change during the life of the ARM.

8-35 Adjustable-Rate Mortgages Payment Cap – sets dollar limit on how much the monthly payment can increase during any adjustment period; does not cap the rate. Payment Cap – sets dollar limit on how much the monthly payment can increase during any adjustment period; does not cap the rate. If interest rates go up, the monthly payment may be too small to cover the interest due. If interest rates go up, the monthly payment may be too small to cover the interest due. This results in negative amortization. The unpaid interest is added to the unpaid loan balance, increasing its size. This results in negative amortization. The unpaid interest is added to the unpaid loan balance, increasing its size.

8-36 Other Mortgage Loan Options Balloon Payment Loan – small monthly payments for 5-7 years, then entire loan due. Balloon Payment 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. Graduated Payment Mortgage – payments set in advance, rising for 5-10 years, then level off. Interest Only Mortgage – combination of interest only payment at beginning, then pay both interest and principal for remainder of loan. Interest Only Mortgage – combination of interest only payment at beginning, then pay both interest and principal for remainder of loan.

8-37 Adjustable-Rate Versus Fixed-Rate Mortgages Adjustable-Rate Primary benefit to homeowner is low initial interest rate. Primary benefit to homeowner is low initial interest rate. Qualify for larger loan because PITI is lower. Qualify for larger loan because PITI is lower. Fixed-Rate Usually a better choice over adjustable. Know your payments never change. Allows for control and planning.

8-38 Mortgage Decisions Term of the Loan 30-year maturity vs. 15-year maturity. 30-year maturity vs. 15-year maturity. 15-year mortgage: 15-year mortgage: Lower interest rate. Lower interest rate. Higher monthly payment. Higher monthly payment. Total interest payments are smaller over the life of the loan. Total interest payments are smaller over the life of the loan. Equity is built up at a faster pace. Equity is built up at a faster pace.

8-39 Mortgage Decisions Term of the Loan 30-year mortgage: 30-year mortgage: Higher interest rate. Higher interest rate. Lower monthly payment. Lower monthly payment. Total interest payments are larger over the life of the loan. Total interest payments are larger over the life of the loan. Prepayment provision allows you to mimic the payment pattern on a 15-year mortgage while maintaining financial flexibility. Prepayment provision allows you to mimic the payment pattern on a 15-year mortgage while maintaining financial flexibility.

8-40 The Down Payment Coming up with the down payment is the real challenge. Coming up with the down payment is the real challenge.

8-41 Make Your Purchase Understand the real estate agents role in the purchase. Understand the real estate agents role in the purchase. Have a professional inspect the property. Have a professional inspect the property.