1 (of 31) fin 200: personal finance topic 11-housing and mortgages lawrence schrenk, instructor...

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1 (of 31) 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

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Page 1: 1 (of 31) FIN 200: Personal Finance Topic 11-Housing and Mortgages Lawrence Schrenk, Instructor Note: Theses slides incorporate material from the slides

1 (of 31)

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.

Page 2: 1 (of 31) FIN 200: Personal Finance Topic 11-Housing and Mortgages Lawrence Schrenk, Instructor Note: Theses slides incorporate material from the slides

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Learning Objectives

1. Find the valuation of a house. ▪

2. Explain and calculate the purchase costs.

3. Explain the features of different mortgages.▪

Page 4: 1 (of 31) FIN 200: Personal Finance Topic 11-Housing and Mortgages Lawrence Schrenk, Instructor Note: Theses slides incorporate material from the slides

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Market Value: Yahoo Real Estate

Page 5: 1 (of 31) FIN 200: Personal Finance Topic 11-Housing and Mortgages Lawrence Schrenk, Instructor Note: Theses slides incorporate material from the slides

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Yahoo Real Estate (cont’d)

Page 6: 1 (of 31) FIN 200: Personal Finance Topic 11-Housing and Mortgages Lawrence Schrenk, Instructor Note: Theses slides incorporate material from the slides

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Yahoo Real Estate (cont’d)

Page 8: 1 (of 31) FIN 200: Personal Finance Topic 11-Housing and Mortgages Lawrence Schrenk, Instructor Note: Theses slides incorporate material from the slides

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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

Page 9: 1 (of 31) FIN 200: Personal Finance Topic 11-Housing and Mortgages Lawrence Schrenk, Instructor Note: Theses slides incorporate material from the slides

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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

Page 10: 1 (of 31) FIN 200: Personal Finance Topic 11-Housing and Mortgages Lawrence Schrenk, Instructor Note: Theses slides incorporate material from the slides

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Historical Mortgage Rates (30 yr)

30 yr Mortgage Rates

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Page 11: 1 (of 31) FIN 200: Personal Finance Topic 11-Housing and Mortgages Lawrence Schrenk, Instructor Note: Theses slides incorporate material from the slides

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Fixed Rate Mortgages

Page 12: 1 (of 31) FIN 200: Personal Finance Topic 11-Housing and Mortgages Lawrence Schrenk, Instructor Note: Theses slides incorporate material from the slides

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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

Page 13: 1 (of 31) FIN 200: Personal Finance Topic 11-Housing and Mortgages Lawrence Schrenk, Instructor Note: Theses slides incorporate material from the slides

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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%)

Page 14: 1 (of 31) FIN 200: Personal Finance Topic 11-Housing and Mortgages Lawrence Schrenk, Instructor Note: Theses slides incorporate material from the slides

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Amortization Schedule

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$1,200

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1 25 49 73 97 121 145 169 193 217 241 265 289 313 337

Months

Mortgage Amoritization Schedule

Monthly Interest Principal Repayment

Page 15: 1 (of 31) FIN 200: Personal Finance Topic 11-Housing and Mortgages Lawrence Schrenk, Instructor Note: Theses slides incorporate material from the slides

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Adjustable Rate Mortgages (ARMS)

Page 16: 1 (of 31) FIN 200: Personal Finance Topic 11-Housing and Mortgages Lawrence Schrenk, Instructor Note: Theses slides incorporate material from the slides

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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’

Page 17: 1 (of 31) FIN 200: Personal Finance Topic 11-Housing and Mortgages Lawrence Schrenk, Instructor Note: Theses slides incorporate material from the slides

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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!

Page 18: 1 (of 31) FIN 200: Personal Finance Topic 11-Housing and Mortgages Lawrence Schrenk, Instructor Note: Theses slides incorporate material from the slides

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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’

Page 19: 1 (of 31) FIN 200: Personal Finance Topic 11-Housing and Mortgages Lawrence Schrenk, Instructor Note: Theses slides incorporate material from the slides

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ARM MovementARM Rate

6m CD + 2, Annual Adjustment

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Page 20: 1 (of 31) FIN 200: Personal Finance Topic 11-Housing and Mortgages Lawrence Schrenk, Instructor Note: Theses slides incorporate material from the slides

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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

Page 21: 1 (of 31) FIN 200: Personal Finance Topic 11-Housing and Mortgages Lawrence Schrenk, Instructor Note: Theses slides incorporate material from the slides

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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

Page 22: 1 (of 31) FIN 200: Personal Finance Topic 11-Housing and Mortgages Lawrence Schrenk, Instructor Note: Theses slides incorporate material from the slides

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Prepayment and Refinancing

Page 23: 1 (of 31) FIN 200: Personal Finance Topic 11-Housing and Mortgages Lawrence Schrenk, Instructor Note: Theses slides incorporate material from the slides

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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.

Prepayment

No Prepayment Prepayment

Monthly $1,193.96 $1,300.00

Total Monthly $429,826.52 $378,988.92

Total Interest $229,826.52 (53.47%) $178.988.92 (47.23%)

Total Principle $200,000.00 (46.53%) $200,000.00 (52,77%)

Page 24: 1 (of 31) FIN 200: Personal Finance Topic 11-Housing and Mortgages Lawrence Schrenk, Instructor Note: Theses slides incorporate material from the slides

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Prepayment

$0

$200

$400

$600

$800

$1,000

$1,200

Va

lue

1 25 49 73 97 121 145 169 193 217 241 265 289 313 337

Months

Mortgage Amoritization Schedule$200,000, 30 yr, 5.96%

Monthly Interest Principal Repayment

$0

$200

$400

$600

$800

$1,000

$1,200

Va

lue

1 25 49 73 97 121 145 169 193 217 241 265 289 313 337

Months

Mortgage Amoritization Schedule (Prepayment)$200,000, 30 yr, 5.96%, $1,300

Monthly Interest Principal Repayment

Page 25: 1 (of 31) FIN 200: Personal Finance Topic 11-Housing and Mortgages Lawrence Schrenk, Instructor Note: Theses slides incorporate material from the slides

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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

Page 26: 1 (of 31) FIN 200: Personal Finance Topic 11-Housing and Mortgages Lawrence Schrenk, Instructor Note: Theses slides incorporate material from the slides

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Resources

Yahoo Real Estate

Page 27: 1 (of 31) FIN 200: Personal Finance Topic 11-Housing and Mortgages Lawrence Schrenk, Instructor Note: Theses slides incorporate material from the slides

Project Notes I

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Page 28: 1 (of 31) FIN 200: Personal Finance Topic 11-Housing and Mortgages Lawrence Schrenk, Instructor Note: Theses slides incorporate material from the slides

Project Notes II

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Page 29: 1 (of 31) FIN 200: Personal Finance Topic 11-Housing and Mortgages Lawrence Schrenk, Instructor Note: Theses slides incorporate material from the slides

Project Notes III

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Page 30: 1 (of 31) FIN 200: Personal Finance Topic 11-Housing and Mortgages Lawrence Schrenk, Instructor Note: Theses slides incorporate material from the slides

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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?