Chapter 9
Learning Objectives
(part 1 of 2)
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Explain the advantages of prequalification
Describe the different types of
mortgages available
Ascertain how much you could afford to
pay for a house
Decide how much of a down payment
you would like to make
Learning Objectives
(part 2 of 2)
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Estimate your closing costs
Evaluate whether it would be profitable
to refinance your current mortgage
Describe the process by which property
taxes are determined
Evaluate automobile financing choices
Analyze an auto lease proposal.
Advantages of Prequalification
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Identifies maximum mortgage one
would be able to obtain
Reduces uncertainty about qualifying
for a mortgage
Adds creditability to a bid (if two bids
are otherwise equal, the one with the
prequal. letter should be chosen
Different types of mortgages
(1 of 2)
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fixed rate mortgage
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15-year
30-year
Adjustable rate mortgage (ARM)
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1/1, 3/1, 5/1, 7/1, 10/1
5/25, 7/23
Different types of mortgages
(1 of 2)
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Conventional mortgage
FHA-insured mortgage
VA-guaranteed mortgage
Jumbo mortgage
Reverse annuity mortgage (RAM)
Elements of an ARM
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Teaser rate
Convertibility
Margin
Index tied to, & availability of index
Caps
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Per each change
Lifetime
Obtaining a mortgage
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Get as many quotes as possible
Lock period & application fees
Miscellaneous fees
Maximum size of mortgage
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Ultimately, lender’s choice, but they all
follow certain rules
PITI not exceed 28% of gross income
PITI and other monthly debt payments
not exceed 36% of gross income
Selection of down payment (1
of 2)
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Standard is 20% of purchase price
If less, then will need some form of
default insurance
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Any form of insurance is expensive
If income constraints are a problem
then a larger down payment may make
it easier to get a mortgage
Selection of down payment (2
of 2)
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Putting more down is equivalent to
investing money risk-free at the
mortgage rate
Putting more down may create a
liquidity problem later, that could only
be solved with a home equity loan or
through refinancing
Closing Costs
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Prepaid interest (for first month)
Title insurance
Start escrow account
Tax Stamps
Credit report
Survey
Potentially many more
Choosing a mortgage (1 of 2)
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Fixed vs. ARM depends on risk
tolerance, income constraints, expected
period of occupancy
15-year vs. 30-year depends on
reduction in interest rate vs.
opportunity cost of money
Choosing a mortgage (2 of 2)
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Paying points to get a lower rate
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Great if paid by employer
Foolish if occupancy less than five years
(typically)
Depends on opportunity rate of return
Reduces the value of refinancing the
mortgage should interest rates drop
Refinancing a mortgage
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Sometimes done to get at equity in the
house
Popular rule of thumb of 2% reduction
vastly overstates when it can be
profitably done
Depends on closing costs and the
magnitude of reduction in the monthly
payment
Appraised vs assessed value
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Appraised value = what an appraiser
thinks a home would sell for
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Required by all lender’s before a mortgage
is closed
Required for any home-equity loan or
HELOC
Assessed value = an arbitrary value
assigned to a home to set property
taxes. Unrelated to appraised value.
Property Taxes
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Assessed valuation established
Each taxing authority establishes a
millage rate (property tax per $1,000
assessed valuation
Some states establish state equilization
factors
Financing a Car
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Rebate or below market interest rate:
both are built in price adjustments, and
true value of BMIR needs to be
estimated
Amount of down payment
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Opportunity cost of money
Reduction in liquidity
May affect ability to obtain a loan
Factors in a lease rate
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Selling price of vehicle
Expected value of vehicle at end of
lease
Money factor (interest rate)
Monthly depreciation charge
Other taxes and fees
Down payment on a lease
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Destination charge
Acquisition fee
Security deposit
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refundable
Borrow & buy vs. lease
decision
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Monthly down payments lower with a
lease
Leases usually require less out of
pocket cash
Time Value of Money analysis usually
favors a purchase