Personal finance 6th madura chapter 10 purchasing and financing at home
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Personal Finance
SIXTH EDITION
Chapter 10
Purchasing and
Financing a Home
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Chapter Objective (1 of 2)
10.1 Describe the factors that determine how much
you can afford when buying a home
10.2 Explain how to select a home to purchase
10.3 Explain how to conduct a valuation of a home
10.4 Describe the transaction costs of purchasing a
home
10.5 Describe the characteristics of a fixed-rate
mortgage
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Chapter Objective (2 of 2)
10.6 Describe the characteristics of an adjustablerate mortgage
10.7 Show how to compare the costs of purchasing
versus renting a home
10.8 Describe special types of mortgages
10.9 Explain the mortgage refinancing decision
10.10 Explain how a mortgage fits within your
financial plan
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How Much Can You Afford? (1 of 3)
• Usually need 10-20% down payment
• Typical mortgages are fixed-rate and 30 years
• Home price should be no more than 2.5 times
your total gross annual household income
• Monthly mortgage payment should not exceed
28% of gross monthly income
• Monthly debt payments (including the mortgage)
should not exceed 40% of gross monthly income
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How Much Can You Afford? (2 of 3)
• Affordable down payment
– What is the market value of the assets you will convert
to cash and use for your down payment?
– You also need to allow for closing costs and some
liquidity for unanticipated bills
• Affordable monthly mortgage payments
– Refer to your cash flow statement
– Your mortgage payment may replace a rent payment
but there are other expenses to consider
– Allow for continued saving
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How Much Can You Afford? (3 of 3)
– Lessons learned from others’ mistakes
Don’t go for the maximum you can afford
Don’t buy above what you can afford
Home values don’t always rise over time, values can also drop
Consider current economic conditions and job stability
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Selecting a Home (1 of 3)
• Purchasing a home may be the single biggest
investment you will ever make and requires
serious consideration
• Decide on a price range and then identify a home
you want
• Compare the cost of buying to the cost of renting
• Consider a condominium
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Selecting a Home (2 of 3)
• Relying on a real estate agent
– Listen to their input, but make your own decisions
• Using online realtor services
– Not available in all areas but may save commissions
– www.ziprealty.com is an example
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Selecting a Home (3 of 3)
• Criteria used to select a home
– Price
– Convenient location
– Maintenance
– School system
– Insurance
– Taxes–usually between 1% and 2% of market value of home
– Homeowner’s Association
– Resale value–consider real estate commission
– Personal preferences
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Financial Planning Online (1 of 6)
• Go to www.calculatorweb.com
• This Web site will allow you to estimate how much
you could borrow to finance a home, based on
your income and other financial information.
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Financial Planning Online (2 of 6)
• Go to the real estate section of Yahoo.com
• This Web site provides sales prices of homes on a
street in a city that you specify over a recent
period. It can also provide a list of homes in the
city you specify that sold within a certain price
range.
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Valuation of a Home (1 of 7)
• Market analysis: an estimate of the price of a
home based on the prices of similar homes in the
area
– Usually based on price per square foot
– Information can be obtained from a real estate broker
or appraiser
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Valuation of a Home (2 of 7)
EXHIBIT 10.1 Using a Market Analysis to Purchase a Home
House Size
Price
Price per Square Foot
1,300 square feet
$120,000
$120,000/1,300 = $92
1,200 square feet
$104,100
$104,100/1,200 = $87
1,100 square feet
$94,000
$94,000/1,100 = $85
Average price per square foot = ($92 + $87 + $85)/3 = $88
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Valuation of a Home (3 of 7)
• Economic impact on home values
– Economic conditions affect the valuation of homes
– As demand for homes increase, prices rise
– When economic conditions weaken, and demand
declines resulting in lower home prices
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Valuation of a Home (4 of 7)
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Financial Planning Online (3 of 6)
• Go to />• This Web site provides a listing of homes for sale
in an area that you specify and homes in the price
and size range that you specify.
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Valuation of a Home (5 of 7)
• Impact of the financial crisis on home values
– Mortgage defaults
– Impact on home prices
– Resolving the crisis
Housing and Economic Recovery Act of 2008
– Lessons from the crisis
– Correcting the mortgage application process
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Valuation of a Home (6 of 7)
• Effects on business activity and zoning laws
– Business activity nearby increases demand for housing
in an area
– Zoning laws may affect desirability
• Obtaining a second opinion on your valuation
– Remember that brokers represent sellers!
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Valuation of a Home (7 of 7)
• Negotiating a price
– Most sellers will accept less than their asking price
– Seller may accept your offer, reject it, or suggest a
revision
– A contract will stipulate the agreed upon price and any
other conditions
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Transaction Costs of Purchasing a
Home (1 of 2)
• Down payment
– Usually 10 to 20 percent
– Serves as collateral
– Lower down payment may be required for government
backed loans
Federal Housing Administration (FHA)
Veterans’ Administration (VA)
Maintenance of an escrow account required
– Private mortgage insurance (PMI) may be required if
your down payment is less than 20% of the home’s
value
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Transaction Costs of Purchasing a
Home (2 of 2)
• Closing costs
– Loan application fee—from $100 to $500
– Points: a fee charged by the lender when a mortgage
loan is provided; stated as a percentage of the
mortgage loan amount
– Loan origination fee—about 1% of the mortgage
amount
– Appraisal fee—from $200 to $500
– Title search and insurance
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Financing with a Fixed-Rate Mortgage (1 of 9)
• Fixed-rate mortgage: a mortgage in which a fixed
interest rate is specified until maturity
• Preferred when interest rates are expected to rise
• May be assumable under some conditions
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Financial Planning Online (4 of 6)
• Go to the mortgage rate section of Yahoo.com
• This Web site provides national averages for
mortgage rates, as well as average rates for
specific regions and states.
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Financing with a Fixed-Rate Mortgage (2 of 9)
• Amortization table
– Basis for monthly mortgage payment amount for a
fixed-rate mortgage
– Allocation of the mortgage payment—each payment
represents a partial payment of principal and a partial
payment of interest
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Financing with a Fixed-Rate Mortgage (3 of 9)
EXHIBIT 10.3 Amortization Schedule for a 30-Year (360-Month)
Fixed-Rate Mortgage for $100,000 at a 5% Interest Rate
Month
Payment
Principal
Interest
Balance
1
$537
$120
$417
$99,880
2
537
121
416
99,343
98,775
10
537
125
412
96,841
25
537
133
404
93,483
49
537
147
390
100
87,086
537
173
364
200
360
65,822
537
263
275
537
534
3
Note: Numbers are rounded to the nearest dollar.
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