CHAPTER7 Selecting and Financing Housing Or Home, Sweet, Home! A third of Americans now spend at least 30 percent of their income on housing − the federal definition of an “unaffordable” housing burden (The Washington Post)
Evaluating Housing Alternatives • Your lifestyle and your choice of housing • How you spend your time and money, your lifestyle, affects your housing choice • Personal preferences are modified by financial factors • Traditional financial guidelines suggest you spend no more than 25-30% of take-home pay on housing, or no more than 2 1/2 times your annual income for a home • “Ha! Ha! Ha! Ha! Ha! Ha!” The authors obviously don’t live in San Diego!!
Rent or Own?Evaluating Housing Alternatives • Advantages of renting • Mobility • Fewer maintenance responsibilities • Lower initial costs • Disadvantages of renting • Few financial benefits – “Not always true!” • No growth of equity • Restricted lifestyle • Legal concerns of a lease • Costs including a security deposit, utilities & renter’s insurance Don’t forget renter’s insurance!
Housing Rental Activities • The search • Select an area and rental cost for your needs • Compare costs of units • Talk to current and past residents • Before signing a lease • Make sure the lease dates, costs and facilities are clearly represented • Talk to a lawyer about unclear lease aspects (?) • Note in writing, signed by the landlord, the condition of the rental unit • Either person who signs lease can be held responsible for the full rent
Legal Details of a Lease • Description and address of property • Name and address of the owner/landlord • Name of tenant • Effective date and length of the lease • Amount of security deposit • Amount and due date of rent • Location where rent is due • Date and amount for late rent payments • List of included utilities, appliances • Restrictions on certain activities • The right to sublet the unit • Conditions under which landlord may enter the rental unit The lease exists to protect the Landlord!
Housing Rental Activities (continued) • Living in rental property • If you can demonstrate that you are a good tenant, sometimes the landlord will keep your rent increases to a minimum • A good tenant is worth the lower rent to a landlord • At the end of the lease • Clean and leave unit in same condition you got it • Provide landlord with new address for deposit • Require than any deductions from your deposit be documented
Advantages of Owning • Pride of ownership • The American Dream(Dreams can turn into nightmares) • Reduced income taxes • Deduct mortgage interest • Deduct property taxes & state income taxes • Build equity by paying down the loan and by price appreciation • Protection against inflation • Builds your credit rating • Lifestyle flexibility– express your individuality
Disadvantages of Owning • Financial uncertainty • Get down payment and financing • Home values could drop (“Yeah, right?” “Yeah, right!”) • Limited mobility • Can take time to sell • A home is not a liquid investment • Zoning and CCR’s • Higher living costs • Maintenance, repairs & improvements • Real estate taxes
“But my house is the best investment I have ever made!” • “Of course, it is pretty much the only investment that I have ever made, • Except for that penny stock my brother-in-law, the ex-stockbroker, conned me into buying… • But that is worthless now • And those gold coins I bought back when the first Gulf War started back in ’91 • What did I do with those things, anyway?” Bottom Line: A House is a Home First, an Investment Second
“But what about San Diego?!” • Prices in San Diego have gone down in the past • They seem to be still going up now • But the near-term outlook is still uncertain • Consider: It is not as though San Diego is all of a sudden becoming an undesirable place to live • But if you plan on staying here, by all means, buy whatever you can afford • San Ysidro and National City are two of the best values in the region, by the way • Imperial Beach is also a great beach value
Speaking of inSane Diego… Do you own your own home? • Yes • No
Speaking of inSane Diego… Of those who do not own, do you plan on purchasing a home in San Diego? • Yes, I am determined to do it • Maybe, but not for many years • No, I will continue to rent here in San Diego • No, I am moving to a cheaper area
Sign seen over a desk in a San Diego office, circa 1993 “Please, God, let there be another real estate boom and I promise I won’t piss it all away this time!”
The Main Elements of Buying a Home • “Location, Location, Location” • Down payment • Parent, Grandparents – Equity Sharing? • Mortgage application • Get pre-approved at a credit union or broker • Points – Each point is 1% of the loan amount • Closing costs • Close your eyes and sign • PITI (principal, interest, taxes, insurance) • Escrow account • Maintenance costs
Assess Types of Housing Than Can be Purchased • Single-family dwelling (SFR) • Multi-unit dwelling • Duplex • Townhouse • Condominium • You own your unit in a building of units • It is not a type of structure but a form of ownership • Cooperative housing • Members own shares in and rent a unit in a building with multiple units • East Coast
Assess Types of Housing Than Can be Purchased (continued) • Manufactured homes • Fully or partially assembled in a factory and then moved to the housing site • Prefabricated type has components built in the factory and assembled at the site • Lower cost than site built homes • Mobile homes • A type of manufactured home often less than 1,000 square feet • Offer same features as a conventional house • Safety is debated and they usually depreciate if you don’t own the land underneath the home
Assess Types of Housing Than Can be Purchased (continued) • Tips for Mobile and Manufactured homes • Avoid buying a “complete package” • You will usually end up overpaying • Find the site first – buy the land if you can afford to • Get a warranty on the installation of the home as well as the manufacturing of the home • The installation often is the most troublesome aspect • If dealer will not provide a warranty, walk away • Arrange your own financing • This is where the dealers make the most money. They will want you to finance at a very high rate relative to the mortgage market. Credit union!
Assess Types of Housing Than Can be Purchased (continued) • If building a home, consider… • Does the contractor have needed experience? • Does contractor have a good working relationship with architect, suppliers, electricians, plumbers, carpenters and others? • What assurance do you have about quality? • What are payment arrangements? • What delays will be considered legitimate? • Is the contractor licensed and insured?
Home Buying Process Step 1: Determine Homeownership Needs • Determine how much you can afford • Consider both price and quality • Get pre-qualified • Price and down payment • Available funds for a down payment • Your income and living expenses • Your ability to make the payments • Size and quality • As you move to a second and third home you can include more of the features you want • Look at the condition of the home
Home Buying Process Step 2: Finding and Evaluating a Property to Purchase • Select a location • Be aware of zoning laws (Can you park your RV?) • Assess the school system if you have children • Using a real estate agent • They present your offer, negotiate the price, assist you in obtaining financing, represent you at the closing, and… • Stab you in the back if you are not careful! • Get a good referral • Obtain an appraisal(This will happen anyway) • Conduct a home inspection
Home Buying Process Step 3: Pricing the Property • Determining the home value • Check the neighborhood & recent transactions • Negotiating the purchase price • Buyer agents • (Normally, the agent works for the seller! Always keep this in mind.) • Is it a Seller’s or a Buyer’s market? • “Earnest money” • Contingency clauses • Buyer can obtain financing • Sale often contingent on the sale of the buyer’s current home
Home Buying Process Step 4: Obtaining Financing • Determine the amount of the down payment • Mortgage insurance (PMI) if less than 20% • Apply and qualify for the mortgage • If you have not already pre-qualified • Can be pre-qualified based on income, assets, debts, credit history, mortgage rate, and length of loan • Evaluating points (prepaid interest) • “Buy-down” a lower interest rate • Good idea if you intend on living in the house for a long time
Private Mortgage Insurance (PMI) • Private Mortgage Insurance protects the lender from financial loss due to default on the loan • Notice that it protects the lender but the borrower pays for it –What a scam, uh… deal! • Usually required if the homebuyer puts down less than 20% on the home • When the equity builds to 20%, it is supposed to end automatically • But do not wait for the lender to get around to stopping it – Get rid of it as soon as you can! • Some borrowers avoided it by taking 2 loans • 80% fixed – 15% HELOC – 5% down
Types of Mortgages • Conventional • Fixed rate, fixed payment, amortized • 5%, 10% or 20% down • 15, 20 or 30 years of fixed payments • Adjustable rate mortgages • Interest rate varies but usually has a rate cap • Interest rate tied to prime rate or other industry rate • Sometimes come with a “negative amortization” provision – Beware the Option ARM! • Government guaranteed financing programs • Veterans Administration • Federal Housing Authority
Types of Mortgages (continued) • Graduated payments • Payments start lower and go up • For persons whose income is expected to increase • Typical characteristic of Option ARM mortgages • Interest-only loans (a.k.a. IO, pronounced “eye-owe”) • Balloon • Fixed monthly payments plus one large payment, usually after 3, 5 or 7 years • Advertised as… • “30 due in 7” or “30/7” • “30 due in 5” or “30/5”
Types of Mortgages (continued) • A second mortgage • Home is collateral and interest is normally tax deductible (Schedule A) • Home equity loan is an example • Reverse mortgages • Provides elderly with tax-free income based on the home equity – Careful! Get a lawyer! • Shared appreciation (a.k.a. equity sharing) • Borrower agrees to share appreciated value of the home with the lender – Careful! • Refinance – To getting a better interest rate
Financing & Mortgage Fees • It used to be almost impossible to compare “apples-to-apples” when shopping for a loan • A lower interest rate was usually a “come on” in exchange for being soaked with “garbage fees” • Loan applicants often were not made aware of these extra fees until the day of the closing! • It is much easier and safer now • New rules forbid “bait ’n’ switch” maneuvers that used to be commonplace In 2003, there was an effort to create a standardized method for pricing home loans. The industry shot it down. But after the recent debacle in the home loan industry, the home loan reform advocates finally got their way. http://www.latimes.com/business/la-fi-perfin29-2009nov29,0,6612155.column
Should I have a large down payment? Should I pay off my mortgage early? • The two are really the same question • “How much equity should I have in my house?” • Real estate agent sez, “No, you should buy a new house every 4 or 5 years.” • So she can make another commission… • Financial representative sez, “No, you should invest the extra in a mutual fund.” • So he can make another commission… • I sez, “If you intend on staying in your house for more than a few years, YES!” • “Make Love, Not Loan$!”
Should I refinance? • When interest rates trend lower, many homeowners consider refinancing their mortgage and getter a lower interest rate • Payments usually go down as a result • But you can incur points and closing costs all over again as when you purchased the house • You essentially sell your house back to yourself • The rule of thumb is: “If you can get your rate down by 2%, then go ahead and refinance” • BUT, if you can find a no-cost or low-cost refinance, as long as your rate goes down, even if not by much, it makes sense to refinance
Home Buying Process Step 5: Closing the Purchase Transaction • Title insurance and search fee • Escrow fee • Attorney’s and appraiser’s fees • Property survey • Recording fees; transfer taxes • Credit report • Termite inspection • Lender’s origination fee • Tax and insurance reserve • Pre-paid interest • Real estate commission Closing Costs Insist on a “walk-through”
Title Insurance • Title insurance guarantees… • That the seller owns the property • That the seller and buyer are who they say they are • That there are no liens or other encumbrances on the property • If your home was purchased or refinanced within the past few years, you can ask for (and should get) a discount on the title insurance policy It definitely pays to shop around for title insurance. Do not assume the company your real estate agent suggests will give you the best price.
Selling Your Home • Preparing your home – white picket fence • Determining the selling price • Appraiser – $350 • Realtor – Free (???) • Check the neighborhood for current prices • For sale by owner • To save $42,000, I will get my real estate agent’s license if I have to! (But I have sales experience…) • Listing with a real estate agent – 6% • Be careful – Keep your back to the wall!
Selling Your Home (continued) • Tax consequences • Single – $250,000 tax free capital gains • Married – $500,000 tax free capital gains • Once every two years • Some folks are buying “fixer-uppers” • Fixing them up in two years and selling them with no capital gains taxes • No capital losses on homes allowed
30-Year versus 15-Year Mortgage On a $300,000 mortgage, you can spend $147,798 less with a 15-year loan. But that means coming up with an extra $699 each month.
Mortgage Exercises Let’s do some more exercises. Don’t get too depressed…