FIN102-Chapter 7 - Housing

Finance 102 - Personal Finance
Financial and Self-Reliant Principles
FIN102 PERSONAL FINANCE

FIN 102-Personal Finance Chapter 7
CHAPTER 7 - HOUSING PAGE |2
Chapter 7
Housing
Location, Location, Location
“Organize yourselves; prepare every needful thing, and establish a

house, even a house of prayer, a house of fasting, a house of faith, a
house of learning, a house of glory, a house of order, a house of
God.” D&C 109:18
Objectives
1. Evaluate housing alternatives.
2. Compare the cost of renting versus owning a home.
3. Determine the price of a home you can afford.
4. Make good home-buying decisions.

Housing Alternatives
For college students, living at home with parents may be the best financial option.
However, when you move from home to attend school, get married or are invited
to leave, most people start out renting an apartment. The American dream is to
own one’s home so living in an apartment is generally viewed as a temporary
step while you save enough money for a down payment on a home and/or
become more established in a specific location. Other alternatives include
renting a home or owning a condominium. While each alternative has
advantages and disadvantages depending on your stage of life, income, and
other circumstances, it is generally true that purchasing a home and paying it off
as quickly as possible is one of the best methods for increasing individual wealth.
Renting Versus Home Ownership

Renting provides more flexibility, lower maintenance costs, and less up-front cash
(security deposit versus down payment) than home ownership. Home ownership
provides tax benefits and increasing equity, or net worth, through appreciating in
value and decreasing the loan principal.
In the USA, the Federal and State governments offer tax benefits to those who
purchase a home. Based on your tax rate, the government reduces your overall
tax burden by the amount of interest you paid on a home, and the property tax
you paid. The interest paid and the property tax paid are multiplies by your
individual tax rate to determine the financial benefit from taxes of owning a
home. While these tax benefits would never justify the purchase of a home by
themselves, they are another component of the benefits of home ownership.
Lifestyle advantages are also available with home ownership. Exhibit 12 provides
a financial comparison of renting versus buying (without operating costs
included); provides a format to calculate the annual cost of operating a
household and provides a format to calculate the annual cost of renting an
apartment.
What Can You Afford?

It is generally accepted that you:
• Should not spend more than 25 to 30 percent of your take-home pay on

housing.
• Can afford a home valued at about 2 ½ times your annual income.

While these are very general guidelines, your individual budget and
circumstances will indicate if you can afford more or less than these suggested
guidelines. As always, the best way to know what you can afford is to “Run the
Numbers.” The requirements in qualifying for a mortgage loan will be a key factor
in calculating what you can afford.
Qualifying for a Mortgage

Following are the major considerations in qualifying for a mortgage:
Down The ideal down payment is 20% or more of the price of the home.
payme However, few first-time homebuyers have that much in savings.
nt
The alternative is making a smaller down payment plus purchasing
private mortgage insurance (PMI). This insurance protects the lender
if you default on the loan. The PMI is paid monthly as part of your
mortgage payment and can be eliminated when the loan to value
of your home reaches 80%. The loan to value ratio is the loan
amount divided by the current appraised value of your home. The
premium amount depends on the loan to value ratio. When the
loan to value reaches 80%, you no longer need to pay the PMI.
Income With a down payment of at least 10%, lenders use 28% of your
monthly gross income as a guideline to determine the amount of
principal, interest, taxes, and insurance (PITI) that you can afford.
Lenders also use a guideline of 36% of your monthly gross income for
the total of PITI plus all other debts. After deducting monthly debt
payments and an estimate of property taxes and homeowner’s
insurance, you will have your affordable mortgage payment.
Your affordable mortgage loan amount can be determined by

calculating the Present Value (PV) of this monthly payment based
on the mortgage term in months and the monthly interest rate. You
can determine the affordable home purchase price by dividing the
mortgage amount by the percent you will be financing, such as 90%
if you make a 10% down payment. Exhibit 15 provides an example
of this calculation.

Credit As was discussed in Chapter 4, you will need a good credit rating to
Rating qualify for a mortgage. Making all payments on time will establish
your credit character. Having a steady job with secure income
history will establish capacity and condition. Your down payment will
provide the required capital and the home will serve as the
collateral.
Types of Mortgages
The following chart explains the four general types of mortgages:
Types of Explanation
Mortgages
1. Has fixed interest rate for a specified number of years. An

Conventional amortization table can be established listing each payment
and the amount paid on the principal and interest. An
example is found in Exhibit 16.
2. Is backed by the Federal Housing Administration (FHA) or the

Governme Veterans Administration (VA--for veterans only) and allows for
nt a lower down payment. However, there are points or fees that
guarantee must be paid or added to the loan that increase the overall
d (FHA or cost of the mortgage.
VA)
3. Has a lower initial interest rate but the rate can be increased
Adjustabl or decreased based on the general interest rate movement in
e- rate the economy. The borrower takes the risk of interest rate
(ARM) fluctuations.
4. Balloon Generally, has a lower interest rate and allows you to finance
your home for 15 to 30 years, but only when you agree to a
complete payoff in 5 to 10 years. If you are unable to pay off
the loan in the 5 to 10-year period, you may refinance at that
time.

Interest rates can have a rate cap, which limits the amount by which the rate
can be increased or decreased. A payment cap limits the payment amount
increases or decreases and may require payment over a longer time than
originally established. There are many variations in mortgage loan specifications
to fit individual circumstances. A few examples include:
Interest You pay only the amount of interest for the first 5 to 10 years.
only loans When that time is up, you start paying principle plus interest until
the loan is paid off.
Your payments could double, depending upon the interest rates.

This is a dangerous loan because you do not pay any principle
during the first 5 to 10 years of the loan. If the home does not
appreciate in value, you may not be able to refinance the
home.
Refinance You can take advantage of decreases in interest rates and/or to

provide funds for remodeling projects by refinancing your loan.
You need to consider the fees and closing costs if you choose to
refinance. It is a general rule that you only refinance in the first
few years of your loan and if the interest rate drops by 1% or more.
Second You can establish a second mortgage or home equity loan to

mortgage consolidate loans or provide resources for consumer purchases.
or home These loans are based on the equity you have in the home. They
equity loan are often referred to as debt consolidation loans. Interest
payments are generally deductible for income tax purposes.
Points
A “point” is a financial term that means “percentage”. You can pay points which
are based on the loan amount to “buy down” the interest rate. Points are a
percent of the loan amount. For example, a lender may quote a ½% decrease in
the interest rate (i.e., from 6% down to 5.5%) if you pay 2 points up-front. This
means you will get a lower interest rate (5.5%) for the entire life of the loan if you
pay 2% of the total loan in up-front fees. You want to carefully consider paying
points and make sure you recover the costs within the first 1 to 2 years of your loan.

Selecting a Home
The essential elements in selecting a home include:
Location Location determines value both when buying and selling. How
well the neighborhood is maintained by residents, traffic, access
to work, shopping, and schools are important factors to consider.
Condition The home’s condition is a key factor. You should make sure the
home is inspected by a professional and that an appraisal by a
certified appraiser is conducted, which will help establish the
home’s condition and current market value.
Real A reputable real estate agent can assist you in finding a home
estate you like and can afford. The agent has access to the Multiple
agent Listing Service, which lists all homes for sale through agents. Your
agent will assist you with negotiating the
price and arranging for financing. He or she represents you at the

closing. You can buy or sell a home without an agent if you
understand the process and
have the skills to function as your own agent. Real estate agent
fees range from 5% to 7% of the selling price which are usually paid
by the seller.
After selecting and setting up the financing of a home, you will then close the
loan. The closing is a meeting between buyers, sellers, and lenders to complete
the transaction. This is usually done through an independent third-party agent
(usually a title company). Closing documents establishing costs to be paid by
each of the parties are signed, and the appropriate costs are paid and the
mortgage loan is established.
Title insurance is one of the closing costs. This insurance covers the boundaries of
the property and determines that the property is free of claims, liens, or unpaid
taxes. It also protects the owner and the lender against financial loss resulting from
defects in the title or other potential claims.

Home Ownership
In addition to the monthly mortgage payment, you will be required to pay
insurance and taxes plus maintenance costs. Maintenance is an ongoing expense
including landscaping and maintaining the yard, painting, decorating, fixing, and
repairing the home as needed. An investment of equipment and time is required
for these expenses.
Buying a home is the most important and expensive financial transaction you are
likely to make. Therefore, make substantial preparations and analyze your home
purchase to ensure that it provides for your needs and that it helps secure your
future happiness and financial well-being.
Amortization Schedule
A very important component of increasing your personal wealth is to purchase a
home and then pay extra each month on your payment. This extra amount goes
directly to reduce the principal and significantly decreases the cost of credit. A
valuable tool to help you analyze the benefit of payments over time is an
amortization schedule. It can help you see the benefits of extra principal
payments, as well as help in the decision-making process when you are doing the
analysis of rent vs. purchase.
Amortization: A term that refers either to the gradual paying off of a debt in
regular installments over a period of time, or to the depreciation of the book value
of an asset over a period of time1.
Using Excel, an amortization schedule is easy to create. Exhibit 16 shows a modified

amortizationschedule that shows a 30-year summary of payments made on a home.
Without the modification for the annual summary in years 2 – 30, this Exhibit reflects
the 5 columns that are commonly found in any amortization schedule:
1. Month you are making the payment. In professional schedules, these are
often listed as the actual month and year instead of just a monthly
number.
2. The monthly payment amounts.
3. The amount of the payment applied to interest due for that month.
1
The American Heritage® New Dictionary of Cultural Literacy, Third Edition Copyright © 2005 by Houghton Mifflin
Company.Published by Houghton Mifflin Company. All rights reserved.

4. The amount of the payment applied to the principal balance.
5. The remaining balance of the loan after the principal payment for that
month.
The information you will need to create your amortization schedule will include
the original amount of the loan, the interest rate, the length of time for the loan
and the monthly payment amount. Remember that you can calculate the 4th
item if you already know the previous 3 items using Excel financial functions (See
Chapter 2).
An Amortization Schedule is useful for any type of loan, not just home loans. For
example, this is very useful to help analyze car loans, credit card loans or any other
type of loan.

CHAPTER 7 - HOUSING P A G E | 10
1. Interest for each month

is calculated by using the
previous month Loan
Balance x monthly interest
rate For example, in Month
1, the calculation is as
follows:
$126,560.00 * 7%/12 = $738.27.
2. The Principal is the

payment minus the interest.
Interest is always paid first
before any amount is
applied to the loan. In this
same example, the
Principal is:
$842.00 - $738.27 = $103.73.
3. The new Loan Balance is

calculated by subtracting
the Principal payment from
the Loan Balance of the
previous month.
$126,560.00 - $103.73 = $126,456.27
4. The process then starts

over with the next month
and the calculation of
interest on the new Loan
Balance.
The more familiar you are with creating spreadsheets in Excel, the faster you can
create Amortization Schedules. Once the formulas are created properly in the first
line or two, you can then copy that information to create the rest of the months
involved in your loan. This allows you to change the payment amount in any given
month to see the impact on the total loan.

Key questions for discussion

1. What are the advantages of renting a home or apartment?
2. What are the advantages of owning a home?
3. What types of mortgage loans are available?
4. What does loan to value mean?
5. What is PMI?
6. What does it mean to pay points?
7. What percent of your gross monthly salary should you use to determine
how much your mortgage payment plus all your other debts including taxes
and insurance should be?
8. What is the role of the real estate agent?
9. How do you define equity?
10. What are some of the fees you have to pay when getting a mortgage loan?
11. What have you learned about the importance of the amount of time you will
live in a home in the decision of whether to rent or purchase?
Possible Assignments
NOTE: Your instructor may assign any or all of the following. Check your Learning
Management System to find out what has been assigned.
1. Talk with your parents or older adults and ask what they have learned about
home ownership.
2. Talk with your parents or older adults and ask what they have learned about
renting.
3. Work through the following Sample Problems to prove that you understand
the material presented in this chapter. If you cannot answer any of the
Sample Problems, bring your questions to class. The next unit will walk through
the answers so that you can understand what you are doing wrong.

Sample Problems
Housing:
Suppose you have been transferred to Albuquerque, New Mexico.

You expect to be there for only one year. Your family consists of your
1 spouse, three children, and you. A friend told you that it is always
best to buy a house, because rental payments pay for the cost of
the house, including interest, taxes, and insurance plus a profit which
goes into the owner’s pocket. Others have told you it is better to rent,
especially for a short period of time. What should you do, rent, or buy
a house? Assume the following information:
Data Presented: Solution:
• You find a suitable house to rent.

The landlord wants you to sign a one-
year lease with a monthly lease
payment of $900.
• Annual renter’s insurance is $450.
• Assume the owner also offers to sell

you the same house for $120,000. To
buy the house, you could make a
down payment of $12,000.
SOLUTION
• In addition, you pay a loan fee of 2

points and other closing costs of
$1,000. The points and other closing
costs will be added to the amount of
the loan.
• The interest rate on the loan is 7%,

and the term of the loan is 30 years.
• Property tax on the home is $1,200

per year, fire and homeowner’s
insurance comes to $550 per year,
and repairs are $500 per year.
• Your income tax rate is 25%.

Housing:
1a How much does it cost to own the home for one year assuming you
sell it after one year for $121,000 and pay a 6% commission to the real
estate broker.
Data Presented in problem 1 above. Solution:
SOLUTION
Use FIN 102 – Exhibit 12 to

calculate solution.
Answer: $17,179.07
Housing:
1b
How much does it cost to rent for one year?

SOLUTION

calculate solution.
Answer: $11,250.00
Housing:
1c
Is it better to rent or buy when you intend to occupy a house for only
one year?
SOLUTION

calculate solution.
Answer: Rent

Housing:
Suppose you have been transferred to Albuquerque with a

reasonable expectation that you will be there for many years.
2 Assume you can lease the house in problem 1 for five years with an
average payment of $1,000 per month or you can purchase the
home with the same terms listed in Problem 1. Assume that five years
later you sell the house for $153,000 and paid a 6% real estate
commission. Assume all costs remained the same as Problem 1.
Data Presented in Problem 1&2 Solution:
SOLUTION
Housing:
2a
How much does it cost to own the home for 5 years.

SOLUTION

calculate solution.
Answer: $17,477.29
Housing:
2b
How much does it cost to rent for 5 years?

SOLUTION

calculate solution.
Answer: $62,250.00

Housing:
2c
Is it better to rent or buy when you intend to occupy a house for 5
years?
SOLUTION

calculate solution.
Answer: $44,772.73 ahead

by buying.
Housing:
2d
Would your answer change if the sell price was only $135,000?

SOLUTION
calculate solution.
Answer: No; you are still

$27,852.73 ahead by
buying.
Housing:
2e
Would your answer change if you could only sell the home for the
same amount you paid for it 5 years ago ($120,000)?

SOLUTION
calculate solution.
Answer: No; you are still

$13,752.73 ahead by
buying.

Housing:
If your monthly gross income is $4,000, how much can you afford to
pay for a house? Assume you have other consumer credit monthly
3a payments of $250, annual property tax payments of $900, and
annual insurance payments of $600. The current interest rate is 6.5%
on a 30-year mortgage. You plan to make a 20% down payment.
What is the amount of your maximum affordable monthly mortgage

payment?
Data Extracted: Solution:
Monthly gross income = $4,000 Use FIN 102 – Exhibit 15 to

calculate solution.
Other credit payments/month = $250
Answer: $1,065.00
SOLUTION
Annual property tax = $900
Annual insurance payment = $600
Interest rate = 6.5%
Length of mortgage = 30 years.
Down payment = 20%

Housing:
3b payments of $250, annual property tax payments of $900, and
What is the amount of your maximum total affordable loan amount?


calculate solution.
Answer: $168,494.52
SOLUTION
Down payment = 20%

Housing:
3c payments of $250, annual property tax payments of $900, and
What is the total purchase price of your affordable home (including

the down payment)?

calculate solution.
Answer: $210,618.15
SOLUTION
Down payment = 20%

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Finance 102 - Personal Finance

Financial and Self-Reliant Principles

FIN102 PERSONAL FINANCE

“Organize yourselves; prepare every needful thing, and establish a

2. Compare the cost of renting versus owning a home.

3. Determine the price of a home you can afford.

4. Make good home-buying decisions.

FIN102 PERSONAL FINANCE

Renting Versus Home Ownership

What Can You Afford?

• Should not spend more than 25 to 30 percent of your take-home pay on

• Can afford a home valued at about 2 ½ times your annual income.

FIN102 PERSONAL FINANCE

Qualifying for a Mortgage

Your affordable mortgage loan amount can be determined by

FIN102 PERSONAL FINANCE

1. Has fixed interest rate for a specified number of years. An

2. Is backed by the Federal Housing Administration (FHA) or the

FIN102 PERSONAL FINANCE

Your payments could double, depending upon the interest rates.

Refinance You can take advantage of decreases in interest rates and/or to

Second You can establish a second mortgage or home equity loan to

FIN102 PERSONAL FINANCE

price and arranging for financing. He or she represents you at the

FIN102 PERSONAL FINANCE

Using Excel, an amortization schedule is easy to create. Exhibit 16 shows a modified

2. The monthly payment amounts.

FIN102 PERSONAL FINANCE

4. The amount of the payment applied to the principal balance.

FIN102 PERSONAL FINANCE

1. Interest for each month

$126,560.00 * 7%/12 = $738.27.

2. The Principal is the

$842.00 - $738.27 = $103.73.

3. The new Loan Balance is

$126,560.00 - $103.73 = $126,456.27

4. The process then starts

FIN102 PERSONAL FINANCE

Key questions for discussion

2. What are the advantages of owning a home?

3. What types of mortgage loans are available?

4. What does loan to value mean?

6. What does it mean to pay points?

8. What is the role of the real estate agent?

9. How do you define equity?

FIN102 PERSONAL FINANCE

Suppose you have been transferred to Albuquerque, New Mexico.

• You find a suitable house to rent.

• Annual renter’s insurance is $450.

• Assume the owner also offers to sell

• In addition, you pay a loan fee of 2

• The interest rate on the loan is 7%,

• Property tax on the home is $1,200

• Your income tax rate is 25%.

FIN102 PERSONAL FINANCE

Use FIN 102 – Exhibit 12 to

Data Presented in problem 1 above. Solution:

Use FIN 102 – Exhibit 12 to

Use FIN 102 – Exhibit 12 to

FIN102 PERSONAL FINANCE

Suppose you have been transferred to Albuquerque with a

Data Presented in Problem 1&2 Solution:

Use FIN 102 – Exhibit 12 to

Data Presented in Problem 1&2 Solution: