Keown_PF5_CH08

Report
The Home and
Automobile Decision
Learning Objectives
1. Make good buying decisions.
2. Choose a vehicle that suits your needs
and budget.
3. Choose housing that meets your needs.
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Learning Objectives
4. Decide whether to rent or buy housing.
5. Calculate the costs of buying a home.
6. Get the most out of your mortgage.
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Introduction
 Buying a home is the single biggest
investment most people will make.
 Buying a car is another major purchasing
decision.
 Must fit lifestyle and wallet.
 Probably need a loan making dramatic
impact on personal finances.
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Smart Buying
Step 1: Differentiate Want From Need
Step 2: Do Your Homework
Step 3: Make Your Purchase
Step 4: Maintain Your Purchase
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Checklist 8.1
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Checklist 8.2
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Figure 8.1
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Smart Buying in Action:
Buying a Vehicle
 Choices to consider:
 Buy new
 Buy used
 Leasing
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Smart Buying in Action:
Buying a Vehicle
Step 1: Differentiate Want From Need
 Features and qualities wanted
 Features and qualities needed
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Smart Buying in Action:
Buying a Vehicle
Step 2: Do Your Homework
 How much can you afford?
 Down payment
 Monthly payment
 Which vehicle is right for you?
 Comparison shop—price and attributes
 Operating and insurance costs, and
warranty.
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Smart Buying in Action:
Buying a Vehicle
Step 3: Make Your Purchase
 Get a fair price:
 Know the dealer cost or invoice price.
 Dealer holdback—2 to 3% that
manufacture gives the dealer on the sale
of an automobile
 Approach dealers and get quotes
 Negotiate
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Checklist 8.3
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Checklist 8.4
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Smart Buying in Action:
Buying a Vehicle
Step 3: Make Your Purchase
 Financing Alternatives:
 Cheapest—cash
 Investigate all financing options before
buying.
 Keep financing out of the negotiations.
 The shorter the term, the higher the
monthly payments.
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Smart Buying in Action:
Buying a Vehicle
Step 3: Make Your Purchase
 Leasing: ideal for financially stable, want
new car every few years, drive less than
15,000 miles annually, good credit, no
down payment
 Closed-end or walk-away lease
 Purchase option
 Open-end lease
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Checklist 8.5
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Smart Buying in Action:
Buying a Vehicle
Step 3: Make Your Purchase
 Keys to getting a good lease:
 Negotiate value for car before signing lease
 Minimum down payment
 Warranty—define “normal wear and tear”
 Termination fee
 Depreciation factor
 Rent or finance charge
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Figure 8.2
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Smart Buying in Action:
Buying a Vehicle
Step 4: Maintain Your Purchase
 Keep vehicle in best running condition.
 Don’t ignore signs of trouble.
 Your first line of protection is the warranty.
 Know your rights under the Lemon laws.
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Figure 8.3
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Smart Buying in Action:
Housing
 Many people equate home ownership with
financial success.
 Housing costs can take up over 25% of after-tax
income.
 Home ownership is also an investment – biggest
investment you will ever make.
 Use smart-buying approach.
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Your Housing Options
 A House:
 Most potential for capital appreciation.
 Cooperatives and Condominiums:
 Homeowner’s fee
 Planned unit developments
 Apartments and other rental housing
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Smart Buying in Action:
Housing
Step 1: Differentiate Want From Need
 What about the house is important?
 Know what you want before you look.
 Affordability, location, neighborhood,
conveniences, schools
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Smart Buying in Action:
Housing
Step 2: Do Your Homework
 Investigate the potential home and all that
goes along with it:
 Neighborhood, community lifestyle,
satisfy needs.
 How much you can afford to pay?
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Smart Buying in Action:
Housing
One-time Costs:
 Down payment
 Closing/settlement costs
 Points
 Loan origination fee
 Application fee
 Appraisal fee
 Title search fee
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Figure 8.4
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Smart Buying in Action:
Housing
Recurring Costs
 Monthly mortgage payments
 PITI
Maintenance and Operating Costs:
 repairs, renovations, upgrades,
landscaping
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Table 8.1
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Renting Versus Buying
 Decision based on lifestyle
 Renting advantages:
 Financial and lifestyle flexibility
 Compare costs for each alternative
 Buying advantages:
 Longer stay and appreciation, itemized
taxes, forced savings
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Figure 8.5
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Figure 8.6
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Determining What You
Can Afford
 What is the maximum amount the bank
will lend me?
 Financial history
 Ability to pay
 Appraised home value
 Calculating your mortgage limit
 Should I borrow up to this maximum?
 How big a down payment can I afford?
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Figure 8.7 Worksheet for calculating the maximum
size mortgage loan you qualify for
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Financing the Purchase—The
Mortgage
Sources of mortgages:
 S&Ls and commercial banks
 Credit unions, mutual savings banks
 Mortgage bankers—originate mortgage
loans, sell to banks, pension funds,
insurance companies and collect payments
 Mortgage brokers—middlemen comparison
shop for a fee to secure mortgage loans
for borrowers but do not originate the
loans
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Conventional and GovernmentBacked Mortgages
 Conventional loans—from a bank or S&L
secured by the property.
 Government-backed loans—loan from
traditional lender but insured by
government—FHA and VA loans:
 lower interest rate, smaller down
payment, less strict financial
requirements
 more paperwork, higher closing costs,
limited funding
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Fixed-Rate Mortgages
 Monthly payment doesn’t change
regardless of market interest rate changes.
 Can lock in low rates for the life of the
loan.
 An assumable loan can be transferred to a
new buyer.
 Prepayment privilege allows early cash
payments to be applied to principal.
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Adjustable-Rate Mortgages
(ARM)
 Interest rate of ARM fluctuates with level
of current interest rates.
 Initial Rate—”teaser rate”—low for only a
short time period then adjusted upward.
 Interest rate index—rates on ARMs are tied
to an index not controlled by the lender,
such as 6- or 12-month U.S. Treasuries.
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Adjustable-Rate Mortgages
 Margin – the amount over the index rate
that the ARM is set.
 Adjustment Interval – how frequently the
rate can be reset.
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Adjustable-Rate Mortgages
 Payment Cap – sets dollar limit on how
much the monthly payment can increase
during any adjustment period.
 If interest rates go up, the monthly
payment may be too small to cover the
interest due—negative amortization.
 Unpaid interest is added to the unpaid
loan balance, increasing its size.
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Adjustable-Rate Mortgages
ARM Innovations:
 Convertible ARM—to fixed-rate loan
 Reduction-option ARM—one time
opportunity to adjust interest rate.
 Two-step ARM—combined aspects of fixedrate and ARM.
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Adjustable-Rate Versus
Fixed-Rate Mortgages
ARMs:
 low interest rate in early years.
 can get larger loan because PITI is lower.
 reset interest rates push ARM payments
upward
Fixed-rate mortgages:
 In general, fixed-rate better than ARM.
 Payments never change.
 Allows for control and planning.
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Specialty Mortgage Loan
Options
 Balloon Payment Mortgage Loan – small
monthly payments for 5-7 years, then
entire loan due.
 Graduated Payment Mortgage – payments
set in advance, rising for 5-10 years, then
level off.
 Growing Equity Mortgage – designed to let
homebuyer pay off mortgage early.
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Specialty Mortgage Loan
Options
 Shared Appreciation Mortgage – borrower
receives below-market interest rate, lender
receives a portion of future appreciation.
 Interest Only Mortgage – interest only
payment for initial set period, then pay
both interest and principal for remainder of
loan.
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Specialty Mortgage Loan
Options
 Option Payment ARM Mortgages – can
make different types of mortgage
payments each month
 Options include:
 Amount less than interest due
 Interest only
 Payment amount of 150- or 30-year
fixed-rate loan
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Risks Associated with Specialty
Mortgages
 Big jump in monthly payments if interest
rates rise
 Read fine print.
 Know how much your monthly payment
could increase, when, and whether you
could afford them
 Penalties
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Beware of Subprime Mortgages
and Predatory Lending
 Subprime mortgages—mortgages taken
out by borrowers with low credit scores.
 Predatory lenders take advantage of these
lenders.
 Abusive loans—high-cost loans with little
chance of paying off
 Avoid predatory loans with knowledge.
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Figure 8.8 Common Predatory Mortgage Lending
Practices
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Mortgage Decisions: Length or
Term of the Loan
 15- or 30-year maturity on mortgage?
 Prepayment opportunities
 Size of monthly payment
 Interest rate
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Figure 8.9 The Portion of Each Payment That Goes
Toward the Principal and Interest on a 30-Year, 8%
Fixed-Rate Mortgage for $80,000
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Table 8.2
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Figure 8.10 Comparing a Shorter- Versus LongerTerm Loan
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Smart Buying in Action:
Housing
 Coming up with the down payment
 Save, gifts from family and friends
 At least 5% of closing costs have to
come from homebuyer
 “Gift letter”
 Private Mortgage Insurance
 Prequalifying—have maximum amount
you’ll qualify for confirmed by a lender
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Smart Buying in Action:
Housing
Step 3:Make Your Purchase
 Comparison shop
 Traditional real estate agent
 Independent or exclusive buyer-broker
 Get it inspected
 Make an offer and haggle
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Smart Buying in Action:
Housing
 Contract
 Earnest money
 Closing
 Settlement or closing statement
Step 4: Maintain Your Purchase
 Refinancing
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Figure 8.11 Worksheet for Refinancing Analysis
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Summary
 Separate needs from wants, compare
products, negotiate, maintain product, and
resolve complaints.
 Lease or buy a vehicle that fits both your
personal and financial needs.
 Choose housing that meets your needs,
preshop, comparison shop home and
financing, and maintain if your purchase.
 Get the most out of your mortgage.
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All rights reserved. No part of this publication may be reproduced,
stored in a retrieval system, or transmitted, in any form or by any means,
electronic, mechanical, photocopying, recording, or otherwise, without
the prior written permission of the publisher. Printed in the United States
of America.
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