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FIN 200: Personal Finance

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 3 rd ed. Learning Objectives. Find the valuation of a house. ▪

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FIN 200: Personal Finance

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  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 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 5.96% 15 yr 5.67% 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 Loan Amount $200,000 Interest Rate 5.96% Maturity 30 yr Payments Monthly Payment $1,193.96 Total Monthly Payments $429,826.52 Total Interest Payments $229,826.52 (53.47%) Total Principle Payments $200,000.00 (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 5.92% 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 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 $1,193.96 + $106.04 = $1,300.00 Payment Comparison Interest Payment Savings $50,837.60 Payments end in 24 years 4 months Check for possible prepayment penalty.
  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?
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