10 the home decision i 11may10 new

8/6/2019 10 the Home Decision I 11May10 New

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TheHome

Decision I

Personal Finance:

Another Perspective


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2

Objectives

A. Understand how a house fits into your personal

financial plan and our leaders counsel on home

buying

B. Understand the advantages and disadvantages ofrenting,buying,building, and renovating

C. Know the process on buying a home

D. Know how to compare different types of loans with

different fees E. Understand my recommendations in obtaining a

home


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3

Personal Financial Plan

There are no financial plan assignments for this

section

However, since you will likely be buying a home

soon, you should learn this material and learn itwell

If learned and followed well, it can save you

thousands of dollars over your lifetime


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A. Understand how a house fits into your

Personal Financial Plan

Is a house important?

Its likely the largest single purchase you will ever

make.

What does it provide:

A good location for raising children, teaching them

to work, good neighbors, etc.

A convenient location to minimize travel time

A place to reflect your personal tastes

What are the risks?


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Risks in Home Ownership

Youbuy a house you cant afford

Your other financial goals are not attained

Youbuy a fixer-upper without the necessary skills

It stays a fixer upper

Youbuy the wrong type of house for your lifestyle

You must pay others to keep it up

Youbuy a house without the necessary inspections

You pay dearly for your mistakes

You are too far in debt and you lose yourjob

You lose the house and your self-respect


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Our Leaders Counsel on Buying a Home

President James E. Faust stated:

Over the years the wise counsel of our leaders has

been to avoid debt except for the purchase of a

home or to pay for an education. I have not heardany of the prophets change this counsel. (Doing

the Best Things in the Worst Times, Ensign,

August 1984, 41.)


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Our Leaders Counsel (continued)

President Gordon B. Hinckley commented:

We havebeen counseled again and again concerning self-

reliance, concerning debt, concerning thrift. When I was a

young man, my father counseled me to build a modesthome, sufficient for the needs of my family, and make it

beautiful and attractive and pleasant and secure. He

counseled me to pay off the mortgage as quickly as I

could so that, come what may, there would be a roof over

the heads of my wife and children. I was reared on thatkind of doctrine. (Gordon B. Hinckley, The Times in

Which We Live,Ensign, Nov. 2001, 72.)


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He further counseled:

I recognize that it may be necessary to borrow to get a

home, of course. But let us buy a home that we can afford

and thus ease the payments which will constantly hangover our heads without mercy or respite for as long as 30

years. I urge you to be modest in your expenditures;

discipline yourselves in your purchases to avoid debt to

the extent possible. Pay off debt as quickly as you can.

Thats all I have to say about it, but I wish to say it withall the emphasis of which I am capable (Gordon B.

Hinckley, To the Boys and to the Men,Ensign,Nov.

1998, 51).


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Finally, President J. Reuben Clark said:

Let every head of every household aim to own his own

home, free from mortgage. Let every man who has a

garden spot, garden it; every man who owns a farm, farm

it (Conference Report, April 1937, p. 26).

The challenge then becomes one to determine what is a

modest home.

In the Handbook for Families, it recommends:

Avoid spending more than 25 to 40 percent of your

take-home pay for the total house payment, including

insurance, taxes, and maintenance costs (Preparing

for Emergencies,Ensign, Dec. 1990, 59).


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Questions

Do you understand how a house fits into your

financial plan and our leaders counsel on

homes?


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Renting (continued)

Disadvantages

Lack of permanence & pride of ownership

Rents may increase unexpectedly

Possible restrictions

No tax benefits

No potential for property appreciation


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Buying

Advantages Permanence & pride of ownership

You get what you see (usually)

Taxbenefits Generally a fixed monthly mortgage payment

Leverage

Canborrow against equity

Minimal time commitment relative to building Mature landscaping & neighborhood

Few surprises in terms of neighborhood, schools,shopping, etc

Can negotiate favorable price and terms


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Buying (continued)

Disadvantages

Low mobilityLow liquidity so difficult to sell if

needed (must make 6-7%just to break even after

realtor fees) Significant upfront costs

Higher living expenses

Large financial commitment

Possible decrease in value Possible mortgage default


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Building

Advantages

Canbuild exactly what you want

Sometimes cheaper to build than buy (depending

upon market conditions) New appliances and housing systems

Can pick the location


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Building (continued)

Disadvantages

Interpretingbuilding plans (size of rooms, etc.) can

cause difficulty if you are unused to it

Often overbudget and delays

Unanticipated additional expense for yard and

fencing

Combined construction loan interest and rental

expense High monitoring costs!!!

High Stress!!

High Risk!!


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Renovating

Advantages

May get what you want faster than building

Can see what you want generally

May be cheaper to buy and renovate than build,particularly if you can do much of the work

yourself (sweat equity)

There may not be available lots in a desired area


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Renovating (continued)

Disadvantages

May be more expensive than to build it new

Often overbudget and delays. The rule of thumb is

to double you budget and then double that again Unanticipated additional expenses for yard and

fencing depending on what was renovated

Combined construction loan interest and rental

expense May have other major problems not noted before

High monitoring costs!!! It will take you

significant amounts of time to make decisions

High Stress and High Risk!!


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Questions

Any questions on your options in the housing

decision?


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C. Understand the Home Buying Process

Purchasing a house is a four-step process:

Step 1. Understand your limits

Know yourself , what you can afford and what

you need now and in the future Step 2. Find your home

Know what you want, and go and find it

Step 3. Negotiate your loan

Know what lenders need and want, so you canbe ready to get the best loan for you, and

Step 4. Enjoy home ownership

Realize you are a steward over all God has

blessed you with. Take good care of your home20


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Step 1. Understand your Limits

Understand yourself and your limits relates to 8

areas:

a. Know yourbudget and how much you can

afford b. Know your credit score

c. Calculate your front and back-endbank ratios

d. Calculate yourbank ratios for LDS

e. Choose your preferred loan type and term f. Know what you need for a down payment and

upfront costs

g. Have two years of copies of taxes

h. Get pre-approved21


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1.a. Know Your Budget and

How Much You Can Afford

You must have and live on a Budget

President Spencer W. Kimball said: Every family

should have a budget (in Marvin J. Ashton, One

for the Money, Intellectual Reserve, 1992, insidecover).

Know your lifestyle

Make sure yourbudget is representative of your

lifestyle Take into account likely lifestyle changes,

i.e., taxes,babies, new job, new city

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Budgeting: The Old Way

Available for

Savings

Personal Goals

Income ExpensesTithing

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Budgeting: A Better Way

Income Expenses

Personal Goals

Other

Savings

Pay the

Lord

PayYourself

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1b. Know Your Credit Score

Know your Credit History

Review your credit history every year from all three

agencies

Three major credit reporting agencies Experian (www.experian.com), Equifax

(www.equifax.com), and Transunion

(www.tuc.com)

You can get a free copy of your credit reportfrom each agency each yearby going to:

www.annualcreditreport.com

Fill out the info and you can get a copy online

Make sure it is correct25


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Your Credit Score (continued)

Get your Credit Score

After checking your credit report for errors, order a

copy of your credit score. I recommend a FICO

score. You can order it directly from FICO atwww.myfico.com for $15.95 (less with coupons)

What determines your Credit Score or lending risk?

Payment History: What is your payment record?

Amounts Owed as % of Limit: How much do youowe as a percent of your available limit?

Length of Credit: How long have you had credit?

New Credit: Are you taking on more debt?

Types of Credit Use: Is it a healthy mix?26


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1c. Know your Affordability Ratios:Front-end and Back-end

Know the rules for lendersyour affordability ratios

Take into account your savings and tithing when

you calculate these ratios

Ratio 1: Housing Expenses or Front-end Ratio This ratio calculates what percent of an your

income is used to make mortgage payments.

Housing expenses shouldbe less than 28% of your

monthly gross income. The formula is:Monthly PITI*


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Affordability Ratios (continued)

Ratio 2: Debt Obligations or Back-end Ratio

This ratio calculates what percent of your income

is used for housing expenses plus debt obligations.

It should not exceed36%

of your monthly grossincome. The formula is:

Monthly PITI* and other debt obligations < 36%

Monthly Gross Income

Debt obligations include mortgage payments, creditcard, student loan, car, and other loan payments

*PITI = Principal, interest, property taxes, and

property insurance

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1d. Calculate YourRatios for LDS

As members of the Church, we have other important

obligations that we also pay, i.e., tithing and paying

ourselves, i.e., saving

As such, should have smaller houses (at least lessexpensive),because we pay the Lord first and

ourselves second.

For a spreadsheet that takes into account the fact that

we pay the Lord first and ourselves second within this

front-end andback-end ratio framework, see:

Teaching Tool 7: Maximum Monthly Mortgage

Payments for LDS Spreadsheet (from the

website)29


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1e. Choose your Preferred

Loan Type and Loan Term

Choose your preferred loan type.

Thebest type of loan takes into account your:

Goals,budget, income stream, down payment,

and view on risk There are a number of different types of mortgage

loans available. These include:

Fixed Rate (FRMs) - RECOMMENDED

Variable or Adjustable Rate (ARMs) Interest Only Options: Variable or Fixed Interest

There are also special loans (if you can get them)

FHA (best for students) or VA (if military)30


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Recommended Loan Term (continued)

Choose your loan term

Generally, I recommend a 30 year fixed rate loan

However, I recommend you make additional

payments on principal to pay off the loan soonerif possible

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1f. Determine Down Payment

and Upfront Costs

Know what you will need for a down payment and

upfront costs, andbegin saving for it

Down payments:

You will need a larger down payment to get intoyour home now versus two years ago

Begin saving for that now

Conventional loans 20% recommended,

but you can get in with5%

FHA loans 3.5%

VA loans 0% down payment required

Once you realize how hard it is to save, it

will help you not to spend too much32


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Up-front Costs (continued)

Upfront costs include closing costs and points

Down payment (3-20 percent of the loan amount)

Closing costs including points (3-7 percent)

Closing costs include:

Title insurance

Attorneys fee

Property survey

Recording fees

Lenders origination fee

Appraisal

Credit report

Termite inspection

Prepaids (property insurance& taxes, mortgage interest)

Points

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Know your impound/escrow/reserve accounts

These accounts are that portion of a the monthly

payments held by the lender or servicer to pay for:

Taxes Hazard insurance

Mortgage insurance

Lease payments, and

Other items as they become due

These are for payments for items above which are

over and above your monthly mortgage payments of

principle and interest. Plan for them!

These may or may not be required


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What are points?

One percent or one hundred basis points of the loan

This money is paid to the mortgage broker (not the

lender), is deducted from the loan proceeds (youstill must pay it back), and is essentially another fee

for helping you arrange the loan (minimize points)

Why do lenders charge points?

To recover costs associated with lending, toincrease their profit, and provide for negotiating

flexibility

Do I have to pay points?

Origination points (likely), buy-down points (no) 35


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1g. Have Copies of Two Years of

Tax Returns

Lenders want confirmation that you can pay back the

loan. As such, they generally want to see two years of

tax records

Have copies of your last two years of taxrecords, even though you were a student

If you have a confirmed job letter with salary, that

may also be helpful as well

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Step 2. Find Your Home

There is a six step process to finding your

home

a. Determine what is important to you

b. Develop a plan for finding a home

c. Use a team approach to find a home in your price

range

d. Once you are serious about a home, get a home

inspection (you can make offers contingent on thehome inspection results)

e. Determine any CCRs/fees for potential homes

f. Negotiate the home price38


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2a. Determine What is Important To You

Determine what is important to you and what

you will and will not do without!

This may include:

Location

Home style and layout

Number ofbedrooms, garages, fireplaces, etc.

Future plans, i.e., kids, work, schools, etc.

Realize that you will probably move within five to

seven years (if you are like the average US family)

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2b. Develop a Plan

Establish a Plan for finding your home

Once you know your limits, what you can afford,

where you want to be, and what you want (your

Plan): Start driving around

Start looking in earnest

But keep to your Plan

Use Zillow.com or other resources to find referencehome values in areas you may be interested in

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Develop a Plan (continued)

Be Patient and take your time

Estimate the time you will be in the house

If it is less than 3-5 years, look into renting

You must make 6-7% on your house price just tobreak even when you sell it (realtor fees are 6-

7%)

You will be in the house for yearsdont make the

decision to quickly It will likely be your largest financial

commitment you will make for a long time

Often renting a luxury apartment for6 months will

give you time to search thoroughly 41


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2c. Use a Team Approach

Do your homework and footwork

Get a good realtor--one who knows the ins and outs

of the areas you are interested in looking at

While realtors are working for sellers, it may bewise to have a buyers broker that works for you

Take matters into your own hands

Be proactivetalk with friends and others

Use the internet and other tools that may help Stay true to your Plan and have patience

Be liquid and ready to react quickly

Be creative if necessary42


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Team Approach (continued)

Use a team approachget lots of good help

Get others to help

Buyersbroker

Appraiser Attorney

Dontbecome emotionally attached to a potential

house

Be willing to walk away That is often yourbest negotiating tactic

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2d. Have a Home Inspection

Once you have found the home you like, can afford,

and is where you want to live, have a home inspection

This may alert you to potential problems with the

home

Many shouldbe fixedby the seller prior to

purchase

Dontbuy someones problems

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2e. Determine any CCRs/Fees

Look to potential homes and potential costs

Look through all Covenants, Conditions and

Restrictions (CCRs) for a potential home

These can be quite restrictive as to what you canand cannot do with your home

If you cannot live with the CCRs, dontbuy

there

There also may be lane or other monthly fees

For condos or town homes, determine the amount of

the transfer/setup fees

Understand any other homeowners/association fees

for potential homes and what they include 45


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2f. Negotiate the Price of the Home

Use the best available resources to negotiate a price

for the home

Use wisdom andjudgment in determining what

you can and should pay for the home

Realize yourbest negotiating technique is

walking away

This is a negotiation processdo not be afraid to

haggle

Realize that closing costs, things that need to be

fixed, and other things can all be part of the

negotiated price

Most things are negotiable46


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Step 3. Negotiate the Loan

9. Lender audits the

documents, verifies all

conditions are filled, and

funds the loan!

1. Youve found a home

that suites your lifestyle

andbudget, using

resources such as a

realtor.

2. The realtor refers you

to a mortgagebroker.

3. The broker pulls

credit, determines your

needs and tries to find

lenders among the

competition to meet

those needs.

4. Each lender has unique

programs. Lender and

broker negotiate points,

rates, fees, PPP, and other

features of the loan.

5. Broker recommends the

best loan to the consumer,

reviewing the features

agreed upon. Consumer

makes the final decision.

6. Lender takes the loanpackage, structures the loan

and conditions for any

additional information they

need to close the deal.

7. Broker, Title, Escrow, and

Lender work to fill all

conditions

8. Lender sends out the

documents to escrow for

signing

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Know the Underwriting Process

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The Underwriting Process

From http://upload.wikimedia.org/wikipedia/commons/0/08/Borrowing_Under_a_Securitization_Structure.gif on 7Oct08


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3a. Choose Multiple Lenders

and Get Good Faith Estimates

You will get a lower interest rate when lenders

compete for yourbusiness

Work with multiple lenders

Talk with friends and others who have gonethrough the process for their favorite brokers

Holdbrokers accountable for what they say

Get Good Faith Estimates (GFE) from each lender

(notjust a Summary)

These are the costs you will likely pay

Compare GFEs from each lender

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3b. Calculate your Effective Interest Rate

Estimate how long you will be in the home

This is important as it helps determine over what

period you can allocate points and other costs

Calculate your effective interest rate for each loan Your effective interest rate is the interest rate you

will pay after all your points, costs, and fees are

taken into account

Get yourbest rate

Your lowest effective interest rate is the best

indicator that you got a good rate on your loan

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3c. Negotiate with Your Favorite Lender

for the Best Rate

The key now is to find the lowest rate

Once you have multiple offers from multiple

lenders, then you have bargaining power

Determine your lowest rate, which includes points,fees, and the loan APRafter evaluating each of the

offers from the various lenders

You can take that offer if you want

Or, you can that offer to your favorite lender

Then ask them to beat it by 1/8 to 1/4 percent

and you will go with them

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Step 4. Enjoy Home Ownership

Enjoy home ownership

Maintain it well

Take care of your purchase and it will take care

of you Generally it will take roughly 1-2% of the

homes value annually for upkeep.

Put this amount into your annualbudget

A professional cleaning a few times a yearcan help retain a homes value

Now keep the value of your home up!

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D. How to Compare Different Types of Loans

with Different Rates and Fees

The cost of a mortgage loan is based on points,

up-front costs and expenses, escrow costs, and

principle and interest costs

It is critical that you understand each of these areas Understand these costs, and you can calculate a

comparable rate on loans with different points, fee

structures and up-front fees

It will save you lots of money overall


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Key Points on Points

What are points?

One percent or one hundred basis points of the loan

Why do lenders charge points?

To recover costs associated with lending. Origination points are not tax deductible (line

801))

To increase the effective interest rate

Discount points are tax deductible over the lifeof the loan

To provide for negotiating flexibility (in a market

where interest rates fluctuate), or to adjust for

differences in riskbetween loans


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More Points (continued)

What is the relationshipbetweenborrowing

costs and mortgage choice?

Lenders offer many choices on interest rates and

points Your challenge is to minimize your effective

cost ofborrowing and get the least expensive

loan

How do you differentiate between different loans? Remember, the lender retains the amount attributed

to points when distributing the loan proceeds;

however, the monthly payment will be based on the

entire loan amount


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Good Faith Estimates

What is a good faith estimate (GFE)?

It is a document providedby the mortgage lender or

broker which includes an itemized list of all up-

front fees and costs associated with your loan. Fees include loan fees, fees paid in advance,

reserves (escrow), title charges, government

charges, and additional charges.

Why is a GFE important?

It is used to compare different offers or quotes from

different lenders and brokers

What does a GFE look like?


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A Good Faith Estimate First Half


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A Good Faith Estimate Second Half


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Getting the Best Loan:

Calculating the Effective Interest Rate

What is the differencebetween the APRand the

Effective Interest Rate? (Note: this is different from

the effective annual interest rate!)

The APR is a rate that is generated from a precise

calculation specified in Regulation Z

The Effective Interest Rate is the precise interest

rate the borrower is paying after all fees and costs

are taken into account. We assume all costs come

out of the loan or are paid backby the loan If no prepayment or other costs, the EIR= APR

It is important as it will allow you to quickly

compare rates from various lenders with various

schedules and costs and fees


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Effective Interest Rate (continued)

This is the effective rate to the borrower after

all costs and fees are taken into account

The lender retains the amount from points while the

payment is based on the entire loan amount. Note that the borrower pays many additional fees and

costs (out-of-pocket) over and above costs that are

included in the loan documents

How do you account for these additional out-of-pocket costs in your calculations?


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What about Prepayment?

What is prepayment?

Prepayment is when you repay the loan early

How do you calculate your effective interest rate when

you plan to prepay the loan before maturity? The process is similar, except that you must

calculate yourbalance remaining as of the

prepayment date, i.e. the balloon payment

To get yourbalance remaining orballoonamount, take your payment as PMT, N as the

number of years remaining after your

prepayment, and your interest rate as I, and solve

for your Present Value. The PV is the present

value of all the payments you will eliminate


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Prepayment (continued)

With expected prepayment:

1. Calculate your payment = PMT

2. Calculate your amount received = -PV

3. Calculate yourbalance remaining after youprepay (the balloon amount). This balance

remaining will be your FV

4. Set your number of years before prepayment as

your = N, yourbalance remaining as your FV,amount received as your PV, and solve for I =

your effective interest rate


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Questions

Any questions on how to compare loans from

different lenders with different APRs, points,

and fees?


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D. Final Recommendations: Buying

Before youbegin looking

Spend a significant amount of time trying to

understand your needs and requirements

What is important to you, to your spouse, and toyour children?

How important are schools, shopping, work?

How long are you willing to commute each day?

Generally, this will require you to rent for a periodof time. Use this time wisely.

Try to rent in your preferred area first

Check into rental houses. They can be a good

intermediarybetween renting andbuying.


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Recommendations: Buying (continued)

When planning to buy:

Calculate how much you can afford to spend on ahome

Dont spend so much on this goal that you arecrimped in your other personal goals.

Calculate into your spending the fact that youwillbe paying tithes and offerings and saving 10-20% each month for savings.

Dontbuy a fixer-upper unless you have thetime and the inclination to do it.

Remember your first priority is to do well at work.

Having a beautiful house may not advance yourcareer (although your spouse may love it).


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Recommendations: Buying (continued)

Once you have decided on a home:

Dont scrimp on home inspectionsthey are good

investments

Dont let the current owners discourage youfrom doing inspections.

Beware of the hidden costs of home ownership.

Keep room in yourbudget for these.

Get pre-approved for your loan

Dont spend your maximum amount.

Keep good records of improvements

These can increase the cost basis of your homeand reduce taxes when you sell


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Final Recommendations: Building

If you decide to build:

The key decision is your contractor. He will eithermake it extremely easy or difficult for you.

Choose wisely. Interview his past clients, andcheck financial condition and license.

Ensure permit repairs have final inspections

Know what you want and put it on the plans.

Have friends review plans to make sure you have

not forgotten anything. Changes are four times asexpensive after plans are completed.

Work with the contractor (but a penalty clause forcompletion may be useful).

Keepback5% of the price until all problems are

fixed.


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Final Recommendations: Renovating

If you decide to renovate:

Make sure you have your vision of the house, andmake sure that vision is on paper.

For every change, ensure a change order is drawn.

Keep a running tally of all past, current, andestimated costs to complete the project. Review thisweekly with the contractor.

You might even put in a clause that if the

contractor goes over the planned amount, hemakes no new money on the excess over theplanned amount.

Be aware of the large time commitment necessary torenovate.


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Review

A. Do you understand how a house fits into your

personal financial plan?

B. Do you understand the advantages and

disadvantages of renting, buying,building, andrenovating?

C. Do you know the process on buying a home?

D. Can you compare different types of loans with

different fees?

E. Do you understand my recommendations on

getting a home?


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Case Study #1

Data

Bill and Brenda make $60,000 per year. Theydecided that they have outgrown their small house,and found the house they wanted for $225,000. Theyhave agreed to a 30-year fixed rate loan, and estimate

property taxes and insurance costs will be $200 permonth, and estimate they can get a fixed ratemortgage loan for6.5%. They have a car loan of$270 per month and student loan of $50 per month.

Calculations

Calculate Bill and Brendas front-end ratio andback-end ratio (28% and 36%, respectively).

Application

What is the amount that most banks will lend (mostbanks will lend to the lower of the two ratios)?

Salary $60 000 $225 000 house 6 5% interest rate Property taxes and


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Salary $60,000, $225,000 house, 6.5% interest rate, Property taxes and

insurance $200/month, car loan of $270/month + student loan of $50 / month.

Calculate the front end (28%) andback-end ratios (36%)


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Case Study #1 Answers

Calculations:

1. Front-end Ratio Calculations at 6.5%

PITI / Gross Income

Monthly Income $5,000

times 0.28% 1,400

Real estate tax (T) and insurance payments (I)- 200

Maximum Monthly Mortgage Payment of

Principle (P) and Interest (I) 1,200

Set 6.5% = I, Pmt = 1200, N=30, PV = ?

Maximum Amount Bank will lend: $189,853


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Case Study #1 Answers (continued)

2. Back-end Ratio Calculations at 6.5%

(PITI+ Debt expenses) / Gross Income

Monthly Income $5,000

36% 1,800Real estate tax (T) and insurance payments (I) - 200

Monthly debt payments: Car payment - 270

Student Loan - 50

Maximum Monthly Principle (P) and Interest (I) 1,280Set 6.5% = I, Pmt = 1280, N=30, PV

Maximum Amount Bank will lend: $202,510


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Case Study #1 Answers (continued)

Applications:

Since the bank will generally lend the lesser of the two

ratios, they would likely be allowed $189,853.


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Case Study #2

Data

Trent and Jen,both 24, have decided on their dream

house (well, at least their first house). In discussions

with their mortgage broker, they have the choice

between two $200,000 fixed rate loans,both which areamortized over30 years. Loan A is for6.0% with no

points or loan origination fees, and loan B is for5.75%

with a $1,500 loan fee and 1 point.

Calculations

Assuming Trent and Jen plan to stay in the house for30

years, which loan is more advantageousbased on the

Effective Interest Rate (EIR) and assuming annual

payments?

L A $200 000 6 0% i f 30


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Loan A $200,0006.0% no points, no fees, 30 years

Loan B $200,000 5.75% 1 points, $1,500 fees , 30 years


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Note: Loan A has an EIRof6% as there are no fees

and costs

1. Calculate payment for loan B

N=30, I=

5.75%

, PV = -$200,000 PMT = ? PMT = $14,143.25

2. Calculate the amount you received after all fees

$200,000 1 point ($2,000 * 1) - 1,500 = ?

$196,500 3. Calculate your effective interest rate

Set your PMT= $14,143.25, N = 30, PV = -

$196,500, Solve for I

I = 5.91% Loan B is the cheaper loan


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Case Study #4

Data

Jensbroker has said that for 1 more buy down

point (for a total of2 points with the same $1,500

fees), he can give her loan C with an interest rate of5.50%.

Calculations

Calculate the EIR for Loan C. How much did that

extra point save Jen in terms of the effective interest

rate over Loan A and Loan B?

Application

Assuming the same 12 year prepayment plan, which

loan should Trent and Jen take?

Prepay after 12 years: Loan C $200 000 5 5% 2 points $1 500


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Prepay after 12 years: Loan C $200,000 5.5%, 2 points, $1,500

fees , 30 years. How much did the 2nd point save?


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1. Calculate payment for loan C

N=30, I=5.5%, PV = -$200,000 PMT = $13,761.08

2. Calculate amount received after all fees (2 points)

$200,000 2 points ($2,000 * 2) - 1,500 = $194,500

3. Calculate the balance owed after 12 years (18 yearsremaining) The PV of 18 years of the PMT is:

N=18, I=5.5%, PMT= -$13,761.08, PV =$154,758.11

4. Calculate effective interest rate to lender Set your FV at year 12 to = $ 154,758.11, PMT= $

13,761.08, N = 12, PV = -$194,500, Solve for I = ?

I = 5.85%

Loan C saves .15% and .13% over Loans A and B


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Case Study #5

Data Bill has taken a job that he expects to be at for3-5

years until he goes back to graduate school. He andhis wife are debating whether to rent orbuy. She

really wants to buy, and you are unsure. She hasfound a house in a nice neighborhood near yourschool that she thinks is perfect.

Application

Are there any other tools or sources of informationthat may be helpful to them to help in this decision?

Will live there 3-5 years until graduate school. Have found a nice


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house in a nice neighborhood. Any other tools to help in the

decision making process?


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There are two additional pieces of information that maybe useful as they study it out in their mindbeforethey make a final decision may be:

1. Talk with a realtor about the neighborhood. Find the

average days on the market (or DOM) for the area.If houses are selling quickly 90-120, it is difficultto sell homes now and may be difficult in the future.

2. Talk with a realtor and get the data on the average

annual appreciation of the houses in that neighborhood.If they have continued to appreciate over the last fewyears, there may be support for continued appreciationin the future. If not, they may be more difficult to sellin the future.


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Teaching Tools

Please note that I have prepared three teaching toolswhich may be helpful as you work on buying a home.They are:

TT19 Home Loan Comparison with Prepayments

(for3 different loans), and

TT09 Debt Amortization and Prepayments

TT11 Maximum Mortgage Payments for LDS

Please note that while they are helpful, they cannot be

used for quizzes or exams.For another good source of information, see

www.mtgprofessor.com

10 the home decision i 11may10 new

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