chapter 9 - housing & mortgages

Many people believe that location is the most important factor to consider when selecting a home

true

Despite the restricted lifestyle, there are multiple financial benefits to renting

true

The purpose of a rate cap in an adjustable rate mortgage is to limit the amount the interest rate can change at a given time (typically annually and for the life of the loan)

truw

A $500,000 mortgage on a new house with 1 point costs $5,000. This amount is fully

deductible on Schedule A.

true

“PITI” does not include HOA fees

true

A common financial risk of home ownership is that:

A. interest rates may change with a conventional mortgage.

B. property values may decrease.

C. mortgage interest is not tax deductible.

D. only a portion of real estate taxes are tax deductible

b

The amount of mortgage a person is eligible for would be increased by:

A. higher interest rates.

B. a lower down payment.

C. high debt obligations.

D. a low family income.

E. lower interest rates.

e

Calculate the payment on a 30-year, $575,000 mortgage at 6%:

A. $3,275.46

B. $3,447.42

C. $3,273.56

D. $20,687.88

B

how to solve:

End mode

PMT/yr= 12

N= 360

I=6

PV= 575,000

Solve for PMT= -$3447.42

You intend to purchase a house valued at $575,000. You plan to make a 15% down payment and take out a 30 year mortgage on the remaining balance. If the mortgage has a 6% rate, what will be the monthly payment:

A. $2,930.30

B. $3,275.46

C. $3,447.42

D. $3,102.67

A

how to solve:

End mode

PMT/yr= 12

N= 360

I=6

PV= 488,750= 575,000*.85

Solve for PMT= -$2,930.30

Which of the following would increase the speed of equity growth for a homebuyer?

A. making a down payment of 10 percent instead of 20 percent

B. obtaining a mortgage interest rate of 9 percent instead of 8 percent

C. obtaining a 15-year mortgage instead of a 30-year mortgage

D. making larger deposits to the escrow account

c

Todd Foley is applying for a $100,000 mortgage. He can get a $800 monthly payment for principal and interest and no points, or a $700 monthly payment with 3 points?

How many months will it take Todd to cover the cost of the discount points if he takes the lower monthly payment?

A. 6

B. 10

C. 18

D. 30

E. 48

d

how to solve:

100,000 x .03= 3,000/100= 30 months

A renter is required to pay a security deposit of $800, on which 4 percent interest will be paid.

What amount would the person earn each year?

A. $100

B. $64

C. $32

D. $16

E. $4

c

how to solve:

800 x .04= $32

If closing costs of $1,400 are associated with the refinance of a mortgage that would reduce the monthly payment from $980 to $870 refinance, it would take approximately ____ months to cover these costs.

A. 6

B. 9

C. 13

D. 17

E. 22

c

how to solve:

1400/110= 12.73

Round up to 13 months

A bank advertises a 30 year $200,000 fixed rate mortgage at a 4.50% rate. If the bank charges fees of $650,

What is the APR?

A. 4.47% APR

B. 4.50% APR

C. 4.53% APR

D. 4.62% APR

E. There is not enough information to answer the question

c

how to solve:

End mode

PMT/yr= 12

N= 360

I=4.5

PV=- 200,000

Solve for PMT= -1,013.37

End mode

PMT/yr= 12

N= 360

PV= 200,000-650

PMT= 1,013.37

Solve for I=4.53

Assume the following mortgage: Amount borrowed = $200,000, Annual interest rate = 6%, Term = 15 years.

What is the monthly payment and how much of the payments in year 4 goes toward principal?

A. Payment: $687.71; Principal: $1,899.28

B. Payment: $1,687.71; Principal: $10,151.79

C. Payment: $13,872.87; Principal: $190,025.84

D. Payment: $1,687.71; Principal: $8,483.34

b

how to solve:

End mode

PMT/yr= 12

N= 180

I=6

PV=-200,000

Solve for PMT= -$1,687.71

Hit shift AMORT 4 times until you see 37-48 OR

Hit 37 INPUT 48 2nd AMORT scroll to PRIN= $10,151.79

A buyer has a principal and interest (PMT) payment of $1,300/month, annual taxes of $6,000, homeowner’s insurance of $85/month, utilities of $200/month, and a lawn service of $25/month.

What is the PITI?

A. $1,300

B. $1,885

C. $2,085

D. $2,110

B

how to solve:

$1,300 + $500 taxes + $85 insurance

A buyer is considering a house with a PITI of $3,000/month,

What must his/her annual income be to qualify if the lender uses a housing expense ratio of 28%?

A. $10,714.29

B. $95,000

C. $128,571.43

D. There is insufficient information to answer question

C

how to solve:

$3,000/.28 times 12 months

A buyer is considering a house with a PITI of $2,500/month. The buyer has credit card
payments of $200/month, student loans of $150/month, car payments of $300/month, and
a cell phone bill of $50/month. What must his/her annual income be in order to qualify
for a loan with a total debt ratio of 43%?
A. $79,534.88
B. $83,720.93
C. $87,906.98
D. $89,302.33

C

how to solve:

$3,150 of debt payments excluding cell phone divided by .43 times 12 months

If a buyer has a gross monthly income of $8,000, student loans of $200/month, and car

payments of $225/month, what is the maximum monthly PITI loan he or she could get if

the lender has set a total debt ratio of 38%?

A. $2,615

B. $2,815

C. $2,840

D. $3,040

A

how to solve:

$8,000 x 38% minus $200 and $225

Which of the following statements is FALSE?

Mortgage interest on a primary residence is

fully deductible for new mortgages up to $750,000

Points paid on a new mortgage are fully deductible

in the year incurred

Points paid on a refinancing are fully deductible

in the year incurred

In most cases, interest on a home equity loan

is fully deductible in the year incurred if the proceeds are used to improve the property

Points paid on a refinancing are fully deductible

in the year incurred

Which of the following monthly payments go to an escrow account?

a) Principal

b) Interest

c) Property taxes

d) Homeowners insurance

e) Answers c and d are correct

e) Answers c and d are correct

Bill and Hillary each buy a house and take out a $100,000 loan. His house is in New York and her house is in Washington D.C. Bill takes out a conventional 30 year fixed rate mortgage, and Hillary opts for a conventional 15 year fixed rate mortgage.

Which of the following correctly summarizes how Bill's mortgage is different from Hillary's (all other things being equal)?

A. It builds equity more slowly than Hillary's mortgage.

B. Hillary's 15 year mortgage has a higher interest rate, higher monthly payments and higher overall interest payments.

C. It builds equity more slowly than Bill's mortgage.

D. Bill's 30 year mortgage has a lower interest rate, lower payments and lower overall interest payments. It builds equity more quickly than Hillary's mortgage.

E. None of the answers are correct

B

Bill's 30 year mortgage has a higher interest rate, lower monthly payments and higher overall interest payments.

What is a disadvantage of using an adjustable rate mortgage (ARM) compared to a fixed rate mortgage?

a) If interest rates rise, ARM interest rates will also increase after the lock in date.

b) If interest rates fall, ARM interest rates will decrease after the lock in date.

c) Initial interest rates for ARMs are higher than fixed rate mortgages.

d) Your mortgage payments (principal and interest) are not fixed for the term of the loan with an ARM as they are with a fixed rate mortgage.

e) Answers a and d are both disadvantages.

Answers a and d are both disadvantages.

Be sure you review the sample problems found in the word doc in Module 9 before attempting the last three questions.

A bank offers you a thirty year $175,000 mortgage at 6.75% with two points payable at closing. The monthly payment is $1,135.05.

What is the effective interest rate on this loan?

7.0%

6.95%

6.85%

6.75%

6.55%

6.95%

Assume you receive the following mortgage: Amount borrowed = 175,000 Annual interest rate = 6.5% Term = 30 years.

What is the monthly payment and how much of the payments in year 5 go toward interest?

A. Monthly payment = $1,106.12

Interest in year 5 = $10,568.62

B. Monthly payment = $1,106.12

Interest in year 5 = $10,738.39

C. Monthly payment = $1,106.12

Interest in year 5 = $9,894.77

D. Monthly payment = $1,160.21

Interest in year 5 = $12,455.39

E. Monthly payment = $1,160.21

Amount of interest year 5 = $15,692.90

B. Monthly payment = $1,106.12

Interest in year 5 = $10,738.39

A homeowner plans to refinance his/her house. He/she will pay $1,880 to refinance, and the mortgage payment will drop by $65/month. The term of the new mortgage is 20 years. The new interest rate is 5.25%

Using TVM break-even, how many months must the homeowner stay in the house to break even on the refinancing?

30 days

31.0 months

27.5 months

30 years

68.2 months

31.0 months

A buyer is considering a house with a PITI of $2,600/month. The buyer has credit card payments of $250/month, student loans of $200/month, car payments of $350/month, and a cell phone bill of $50/month.

What must his/her annual income be in order to qualify for a loan with a total debt ratio of 43%?

$85,116.28

$89,302.33

$94,883.72

$96,279.07

$94,883.72

what are the pros and cons of renting vs owning a home

renting pros:

• mobility

• fewer maintenance responsibilities

• lower initial costs

renting cons:

• few financial benefits

• restricted lifestyle

• legal concerns of a lease

• extra costs (security deposit, utilities, renter’s insurance)

owning pros:

• pride

• build equity by paying down loan and 3-5% appreciation on house worth

• builds credit score

owning cons:

• financial uncertainty (home values could drop)

• limited mobility/time to sell

• higher living costs (maintenance, real estate taxed, homeowners insurance)

price per square foot calculations

Example: $189,000 house

1,800 sq. ft. under air

What’s the $/ sq ft?

everything under “air”

• excludes garage, patio, porch

$189,000 / 1,800

= $105 / sq ft

what impacts the value of a home

• how old the house is

• how big the house is

• condition of house

• neighborhood appeal

• health of housing market

what are the types of financing and when do you use them?

Conventional (conforming):

• fixed rate, fixed payment

• 5%, 10% or 20% down

• 15, 20, or 30 years of fixed payments

Adjustable Rate Mortgage (ARM)

• interest rate varies with the prime rate but has a rate cap, more interest on buyer.

Government guaranteed financing programs:

• Veterans Administration (VA)

• Federal Housing Authority (FHA)

Review points and tax aspects interest and of points paid (new mortgage vs. refinancing). Calculate a mortgage payment, and balance on a mortgage after x years.

Paying points will lower your interest rate

• one point equals 1% of a mortgage and represents prepaid interest at closing ( in exchange for a lower interest rate ) 2pt = 2%

Calculate a break-even on a refinancing using TVM or simple payback (e.g. pay $1,000 in closing to save $100/month = a 10 month break-even using simple payback). Also calculate the present value of savings when refinancing and compare to the cost of refinancing and the amount of time you would need to stay in a house after a refinancing in order to get your closing costs back.

escrow accounts

Financial arrangement where a neutral third party holds funds and documents on behalf of a buyer and seller during a transaction,

so that all conditions are met before the transaction is finalized

escrowed balances accumulate during the year and are used to pay annual tax and insurance bills when due

credit life requirements for down payments less that 20%

When a down payment on a home is less than 20%,

Lenders often require private mortgage insurance (PMI) to protect them if the borrower defaults, adding to the monthly mortgage payment.

Insurance paid by you that reimburses the lender if you default on your home loan (less than 20% down)

(Defaulting on a loan - failing to meet the agreed-upon terms of repayment, (ex. missing payments or failing to comply with other loan conditions)

Illustration:

$200,000 house

$180,000 loan (10% down)

FICO score = 740

0.44% x $180,000 = $792/year or $66/month (varies by FICO)

For a 4% mortgage, this increases the effective rate to 4.44%

• NOT tax deductible

• Stops when loan balance is ~ 80% of FMV (20% equity)

• Track and ask lender when balance hits 80%

what are the steps to sell a home

• prepare your property,

• determine a listing price,

• hire a real estate agent

• market your home,

• negotiate offers

• close the sale

what are the pros and cons of using an agent

• Real estate agents are most helpful finding a house, a lender, and with negotiations

• Agents are paid by seller ~6%, so there was a conflict of interest, see new rules!

• Not allowed to take commission for referrals

• Shop around for closing cost items

• Standardized contract will be used

New rules: Buyers must negotiate fee with their agent

read over this whole bomboclatt ppt

Fixed rate vs. ARMs

if rates are going down vs up, which is best

Adjustable Rate Mortgage (ARM):

• Normally lower initial interest rates compared to fixed

• Rates will move up or down when interest rates change after set period (1yr/3yr/5yr) subject to caps (can be risky)

• If rates go up later, could refinance another ARM

• Recurring closing costs can add up over time

• If home value falls, unable to refinance

Fixed:

• Higher initial rates

• Total payment will not vary

• No increase if rates go up

• No decrease if rates go down (requires refinancing)

if rates are going up, fixed is best.

if rates are going down, ARM is best.

Calculate the monthly mortgage payment for the following:

$200,000 house

Amount of down payment = 10%

Annual interest rate = 6.85

Term = 30 years with monthly payments

What is the balance on the mortgage at the end of year 3, and how

much of the payments in year 3 went toward principal and interest?

Clear keys

End mode

P/yr = 12

PV = 200,000 times 90% financed (180,000)

N = 360

FV = 0

Interest = 6.85

Solve for Pmt = (1,179.47)

You are applying for a $200,000 mortgage with a 30 years term, with

monthly payments.

Your lender offers you two options;

6% mortgage with no points

or

5.8% mortgage with 1.25 points paid at closing

Which is the better option?

First calculate the payment on each mortgage:

For the 6% no points mortgage:

Clear keys

End mode

Pmt/yr = 12

PV = 200,000

N = 360

FV = 0

Interest = 6.00

Solve for Pmt = (1,199.10)

For the 5.8% mortgage with points:

Clear keys

End mode

P/yr = 12

PV = 200,000

N = 360

FV = 0

Interest = 5.80

Solve for Pmt = (1,173.51)

To solve for the effective interest rate, adjust the mortgage for the points and recalculate interest:

Points paid = 200,000 times .0125 = 2,500

Clear keys

End mode

P/yr = 12

PV = 200,000 minus 2,500 of points = 197,500

N = 360
FV = 0
Pmt = (1,173.51)
Solve for interest = 5.92, the effective interest cost after points (which is higher than
the 5.8% rate due to the points.

You would have to live in the house for 30 years to realize the savings of paying
2,500 of points at closing. What is more meaningful in this situation is the break-
even point, which is solved as follows

Clear keys

End mode

P/yr = 12

PV = (2,500) the points paid

Pmt = 25.59 the difference in payments 1,199.10 minus 1,173.51

FV = 0

Interest = 5.92 your lower effective interest rate with points

N = 133.65 the number of months you need to live in the house to pay for

the points

Assume that you can refinance your current mortgage at a new rate of 5.50% for the next25 years and save $75.00 per month. If it costs $3,000 to refinance, is this a good deal, and what is the break-even in months

Clear keys

End mode

Pmt/yr = 12

N = 25 years times 12 = 300

Pmt = 75

Interest = 5.50

Solve for PV = (12,213.24)

this is the present value of the savings, which exceeds the closing cost of 3,000, so this is a good deal assuming you stay in the house for the full 25 years.

To calculate the break-even:

Clear keys

End mode

Pmt/yr = 12

PV = (3,000) the amount you spend today in closing costs

Pmt = 75 the amount you save per month if you refinance

FV = 0

Interest = 5.50 the new interest rate is the appropriate rate here

Solve for N = 44.29 months the amount of time you need to stay in the house to

recover your money.

Assessed vs. Appraised value

Appraised:

• true value of house based on appraisal

Assessed:

• tax appraises adjusts value of house to assessed value used for property tax purposes slightly lower the appraised value

cost per square foot formula

cost of house / sq ft under air

$3000 closing cost

save $75 month by going to a refinanced rate of 4% 30/year mtg

1) Break even TVM

End Mode

P/yr = 12

PV = - 3000

Pmt = 75

Int = 4

N = 43 months

2) Breakeven simple payback

$3000/75 = 40 months

Simple payback does not consider the lost interest on your money, and will always be a lower # than TVM breakeven, which includes the time it takes to get your money back with interest