1. FIN 200: Personal Finance Topic 11-Housing and Mortgages
Lawrence Schrenk, Instructor
Note: Theses slides incorporate material from the slides accompanying Madura. Personal Finance with Financial Planning Software 3rd ed.

2. Learning Objectives Find the valuation of a house. ▪
Explain and calculate the purchase costs.
Explain the features of different mortgages.▪

3. Valuation

4. Market Value: Yahoo Real Estate

5. Yahoo Real Estate (cont’d)

6. Yahoo Real Estate (cont’d)

7. Mortgages

8. Sources of Funding Conventional Loans Government Loans Seller Loans
80% of Residential Mortgages
Government Loans
20% of Residential Mortgages
Federal Insurance or Guarantee
Federal Housing Authority (FHA)
Department of Veterans Affairs (VA)
Farmer’s Home Administration (FmHA)
Seller Loans

9. Transaction Costs Down Payment (20% typical) Closing Costs
Application Fee
Points (percentage of loan amount, deductable)
Trade off with interest rate
Appraisal Fee
Title Search and Insurance

10. Historical Mortgage Rates (30 yr)

11. Fixed Rate Mortgages

12. Fixed Rate Mortgages Interest Rate Constant until Maturity
Current Average (October 2008)
30 yr %
15 yr %
30 yr. Fixed Jumbo 7.12%
Higher Rate than Adjustable
Not ‘Assumable’
Possible Prepayment Penalties
‘Jumbo’ loans exceed the limit set by Fannie Mae and Freddie Mac

13. Fix Rate Example Data Payments Loan Amount $200,000
Interest Rate %
Maturity yr
Payments
Monthly Payment $1,193.96
Total Monthly Payments $429,826.52
Total Interest Payments $229, (53.47%)
Total Principle Payments $200, (46.53%)

14. Amortization Schedule

15. Adjustable Rate Mortgages (ARMS)

16. Adjustable Rate Mortgage (ARM)
Interest Rates Adjust
Typically every 6 or 12 months
Rate tied to Economic Index
Lower Rate than Fixed (at start)
Current Average (October 2008)
5/1 ARM %
30 yr. Fixed Jumbo 7.12%
5/1 jumbo ARM 6.18%
Potentially Avoid Costs of Refinance
Can Be ‘Assumable’

17. Rate Adjustment Mechanism
Initial Rate
Can be Artificially Low (‘Teaser’)
Compare with ‘Fully Indexed Rate’
Index and Margin
Adjustment Caps
Periodic
Typical 6 Month ± 1%, Annual ± 2%
Lifetime
Typical 5-6% above Initial Rate
Always Choose an ARM with a Lifetime Cap!

18. Indices and Margins Common Indices Check Volatility of Index Margin
Treasury Hills (T-Bills)
Certificates of Deposit (CDs)
11th District Cost of Funds Index (COFI)
Moving Average
London Interbank Offered Rate Index (LIBOR)
Check Volatility of Index
Margin
Added to Index, e.g., ‘LIBOR + 2’

19. ARM Movement

20. Negative Amortization
Positive Amortization: Principal is reduced over the life of the loan
Negative Amortization
Monthly payment is less than the interest payment
Unpaid interest added to principal
Principal increases
On an ARM if the monthly payment is capped, but not the interest rate, then there can be negative amortization

21. Hybrid Loans Hybrid loans mix fixed and adjustable features
They start as fixed rate loans, e.g., for 2, 5, or 10 years.
A 5/1 ARM (also 3/1 ARM)–Initial interest rate for five years, and thereafter has an adjustment interval of one year
7/23s–There is a rate adjustment after 7 years
The initial rate will be above an ARM and below 30 yr fixed rate

22. Prepayment and Refinancing

23. Prepayment Prepay Additional $106.04 Payment Comparison
$1, $ = $1,300.00
Payment Comparison
Interest Payment Savings $50,837.60
Payments end in 24 years 4 months
Check for possible prepayment penalty.
No Prepayment
Prepayment
Monthly
$1,193.96
$1,300.00
Total Monthly
$429,826.52
$378,988.92
Total Interest
$229, (53.47%)
$ (47.23%)
Total Principle
$200, (46.53%)
$200, (52,77%)

24. Prepayment

25. Refinancing
If interest rates decline, you may choose to ‘refinance’ your house.
Pros
Lower interest rate
Cons
Refinancing Costs
Points amortized for taxes
Calculate ‘Break-Even’ Point

26. Resources
Yahoo Real Estate

27. Project Notes I

28. Project Notes II

29. Project Notes III

30. Ethical Dilemma
Sarah and Joe own a small home that they would like to sell in order to build their dream home. Their current home has a mortgage and needs extensive repairs to make it marketable. A local loan company is offering home equity loans equal to 125% of the home's value. Since Sarah and Joe have good jobs and can make the additional home equity loan payments, they easily qualify for the 125% equity home loan. It takes the entire home equity loan to complete the repairs and upgrades to the home. To their shock, they find that even after the upgrades they are unable to sell the home for enough to repay the mortgage and the home equity loan. In other words, they have negative equity in the home.
a. Comment on the finance company's ethics in making loans in excess of a home's appraised value.
b. What are Sarah and Joe's options in their current situation? Is there a way they can proceed with building their dream home?