FIN205 – Wealth Management

Topic 4- The Housing Decision

 Learning Objectives

 Make good buying decisions.

 Choose housing that meets your needs.
 Decide whether to rent or buy housing.
 Calculate the costs of buying a home.
 Get the most out of your mortgage.

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Housing Alternatives for
Different Life Situations

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 Your Housing Options

Purchase A House:
 Popular choice for most individuals.
 Offers space and privacy.
 Offers greater control over style decoration and
home improvement.
 Requires more work than the other choices,
including maintenance, repair, and renovations.
 Most potential for capital appreciation.

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 Your Housing Options

 A Condominium (Condo) is an apartment complex that

allows individual ownership of the unit and joint ownership
of land, common areas, and facilities.
 Allows direct ownership of the unit with a proportionate
ownership in land and common areas.
 Pay monthly fee for interest, taxes, utilities, and grounds
keeping.

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Your Housing Options

 Apartments and other rental housing offer:

 Affordability
 Low maintenance situations
 Little financial commitment
 Chosen by young, single people.
 May be a lifestyle decision.
 Limited upkeep and no long-term commitment.
 Offers lack of choice regarding pets or
remodeling.

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Housing Rental Activities

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Renting Your Residence

ADVANTAGES OF RENTING

 Easier to move (mobility)

 Fewer maintenance and repair responsibilities

 Lower initial costs

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 Renting Your Residence

DISADVANTAGES OF RENTING
 No tax benefits

 Limits regarding remodeling

 Restrictions regarding pets and decorating
 Costs including a security deposit, utilities,
and renter’s insurance

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 Renting Your Residence
Legal Details Of A Lease

oDescription and address of property

oName and address of the owner/landlord (lessor)
oName of tenant (lessee)
oEffective date and length of the lease
oAmount of security deposit
oAmount and due date of rent

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Renting Your Residence

o Location where rent is due

o Date and amount for late rent payments
o List of included utilities and appliances
o Restrictions on certain activities (pets,
remodeling)
o Tenant’s right to sublet the rental unit
o Charges for damages or for moving out later
(or earlier) than lease expiration date
o Conditions where landlord may enter rental
unit

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Home Buying Process

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 Valuation of a Home

 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 (cont’d)

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 Valuation of a Home (cont’d)

 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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4-16
 Valuation of a Home (cont’d)

 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 (cont’d)

 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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Smart Buying in Action:
Housing

 Determine what you need versus

what you want.
 Decide what is important to you:
 Consider location – country, suburbs,
or city
 Consider the neighborhood – safety,
convenience, schools

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 Smart Buying in Action:
Housing

One-time Costs Recurring Costs

 Down payment
 Closing/settlement costs
 Points/ Interest in advance
 Loan origination fee
 Application fee
 Appraisal fee
 Title search
 Mortgage payments
 PITI includes principal,
interest, taxes, insurance
Maintenance and
Operating Costs
 Repairs and maintenance
items

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 Decision to Own a Home
versus Rent
 Consider financial assessment before
considering personal preferences
 Estimating the total cost of renting and owning
 Renting–rent payment, security deposit
 Owning–down payment, mortgage payment,
closing costs, maintenance, taxes and insurance
• Owning also has tax advantages

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 Renting Versus Buying

Buying Renting
 Many up-front and  No large up-front costs
one-time costs other than a security
deposit
 Beneficial for those who
itemize their deductions  Beneficial if staying only
for the short-term
 Mortgage payments
are a form of forced
savings

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Rent vs Buy

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 Home Buying Process

Implement the home-buying process.

STEP 1: DETERMINE HOME OWNERSHIP NEEDS
Benefits of Home Ownership
 Pride of ownership (“American dream”)
o Stability of location
 Financial benefits
o Deduct property taxes and mortgage interest
o Potential increase in value of your home
o Building equity in your home
 Lifestyle flexibility - express your individuality (decorating)
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 Home Buying Process

 Drawbacks of Home Ownership

 Financial uncertainty
• Obtaining money for the down payment
• Obtaining mortgage financing
• Home values could drop

 Limited mobility
• Can take time to sell your home

 Higher living costs

• Home improvements
• Rising real estate taxes 4-25
 Home Buying Process

 Assess Types of Housing Available

 Single-family dwelling
 Multiunit dwelling
- Duplex, townhouse
 Condominium
- You own your individual unit in a building of units
- It is not a type of building structure but rather a legal
form of home ownership
 Cooperative housing
- Non-profit organization - members own shares and rent
a unit in a building with multiple units 4-26
Home Buying Process
• What delays in the construction process will be
considered legitimate?
• Is the contractor licensed and insured?
• Is the contractor willing to provide names,
addresses, and phone numbers of satisfied
customers?
• Are there any complaints about this contractor?
• Written contract should have a time schedule,
cost estimates, description of work, and a
payment schedule.

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Home Buying Process

STEP 2: FIND AND EVALUATE A PROPERTY TO

PURCHASE
Selecting a Location
 Be aware of zoning laws
 Assess the school system if you have children

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 Home Buying Process

 Using a real estate agent

 They present your offer, negotiate the price,
assist you in obtaining financing, and
represent you at the closing
 Conduct a home inspection or hire an
inspector
 Mortgage company will want an appraisal

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 Home Buying Process

STEP 3: PRICE THE PROPERTY

 Determining the Home Price
 Consider recent selling prices in the area, current demand
for housing, the length of time the home has been on the
market, the owner’s need to sell, financing options, and
features of the home
 Negotiating the Purchase Price
 Counter-offers are common
 Earnest money (Down-payment)
 Contingency clauses, such as...
o Buyer must be able to obtain financing
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o Sale contingent on the sale of the buyer’s current home
 Home Buying Legal Process

 The first step to purchasing property in Malaysia

is to hire a real estate lawyer to assist in the
transaction.
 Once property is selected, a Letter of
Offer/Acceptance (Letter of Intent) is signed, and
a 2% deposit is expected from the buyer.
 Within 14 days, the Sale and Purchase
Agreement is signed. The buyer must pay
another 8% deposit (Total Deposit 10%). From
the date of the signing, the buyer has a maximum
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of three months to accomplish full payment.
 Home Buying Legal Process

 The Sale and Purchase Agreement must be

stamped at the Stamp Office. After the
examination on the property of the valuation
department, Stamp Duty is paid to the Stamp
Office. The transfer must be registered at the
Land Office Registry.

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 Home Buying Process
TRANSACTION COSTS
Who Pays?
Stamp Duty 1% - 3% buyer
Lawyer/Solicitor´s
0.4% - 1% buyer
Fees
Other Fees* MYR180 (US$49) buyer
Real Estate Agent´s
3% seller
Fees
Costs paid by buyer 1.50% - 5.10%
Costs paid by seller 2.00% - 2.75%
ROUNDTRIP
TRANSACTION 3.40% - 7.85%
COSTS
Other Fees*are around MYR180. This include stamping fee (MYR10 per document),
adjudication fee (MYR10), search fee for title at land office (MYR60 ), and registration
fee (MYR100 ).

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 Legal & Other Cost
Breakdown
 Loan agreement legal fees = 1% for first RM500,000 (of loan
amount), 0.8% for the next RM500,000 and 0.5% to 0.7% for
subsequent amount
 Stamp duty for loan agreement = 0.5% of loan amount
 Loan Facility Agreement legal disbursement fee = A few
hundred ringgit
 Fee for transfer of ownership title = A few hundred ringgit
 Government tax on legal agreements = 6% of total lawyer
fees
 Bank processing fee for loan = RM50 to RM200
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 Legal & Other Cost
Breakdown
 Stamp duty for the transfer of ownership title (also known as
a memorandum of transfer or MOT) = 1% for the first
RM100,000; 2% on the next RM400,000, and 3% on the
subsequent amount
 Sale & Purchase Agreement (SPA) legal fees = 1% for first
RM500,000, 0.8% for the next RM500,000 and 0.5% to
0.7% for subsequent amount
 Stamping for SPA = Less than RM100
 SPA legal disbursement fee = A few hundred ringgit

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 Legal Fees (Who Pays?)
 If the Buyer appoints the solicitor and seller use the same
solicitor, then buyer is being protected while the seller
isn’t which means that the solicitor will focus on the
buyer’s perspective.
 If the Buyer and seller hire different solicitor’s, both
parties will be protected by their own solicitor. For
example, seller’s solicitor drafts the S&P Agreement and
the buyer’s solicitor will check on it. If there is some terms
are incorrect, the buyer’s solicitor will return its agreement
to seller’s solicitor for amendment.

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 Determining What You
Can Afford
 Before house hunting, ask yourself:
 What is the maximum amount the bank will lend
me?
 Should I borrow up to this maximum?
 How big a down payment can I afford?

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 What is the Maximum Amount
the Bank Will Lend Me?
 Lenders look at:
 Your financial history – steadiness of income, credit report, and
FICO score(Using mathematical models, the FICO score takes
into account various factors in each of these five areas to
determine credit risk: payment history, current level of
indebtedness, types of credit used and length of credit history, and
new credit.)
 Total household debt payments doesn’t exceed more than 36
percent of your gross monthly income (known as your debt-to-
income ratio).
 Your ability to pay – lenders use ratio of a maximum 28% =
PITI*/monthly gross income
(PITI* - principal, interest, taxes, and insurance) 4-38
 What is the Maximum
Amount the Bank Will Lend
Me?
 For mortgage loans, lenders look at:
 the Loan-To-Value (LTV) ratio. This assesses the lending risks before
approving your mortgage. The LTV ratio is calculated based on the
property’s net price, and not the price stated in the Sales and
Purchase Agreement (SPA), as the price in the SPA might include
promotions/rebates, which reduces the cost of owning a home.
 The LTV ratio for a homeowner’s first property determines how much
the bank will lend you (roughly about 90%), but if it’s your third home,
it’s capped at a maximum of 70%. The higher your LTV ratio, the
higher the risk is. Hence if you’re approved for a 90% financing
mortgage loan, it will cost you more.

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 How Much Should You
Borrow?

 A mortgage is a large financial commitment of

future earnings.
 Look at your overall financial plan before
deciding on how much to borrow.
 Prequalifying – lender confirms the loan size
based on ability to pay and down payment.

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 Financing the Purchase:
The Mortgage
 Sources of mortgages:
 S&Ls and commercial banks are the primary
sources of mortgage loans.
 Mortgage bankers originate loans, sell them to
banks or pension funds, have fixed rate mortgages.
 Mortgage brokers are middlemen who place loans
with lenders for a fee but do not originate those
loans. They do the comparison shopping.

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 Conventional and
Government-Backed
Mortgages
 Conventional loans - from a bank or S&L and
secured by the property.
 If default - lender seizes property, sells it to
recover funds owed.

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 Conventional and
Government-Backed
Mortgages
 Government-backed loans – lender makes loan and
government insures it. VA (Veterans Affairs) and FHA
(Federal Housing Administration) account for 25% of all
mortgage loans.
 Advantages:
 Lower interest rate
 Smaller down payment
 Less strict financial requirements
 Disadvantages:
 Increased paperwork
 Higher closing costs
 Limits amount borrowed 4-43
 Fixed-Rate Mortgages

 Monthly payment doesn’t change regardless

of changes in market interest rates.
 If rates are low, a fixed rate mortgage locks in
the 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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Financing with a Fixed-Rate
Mortgage
 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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Financing with a Fixed-Rate
Mortgage (cont’d)
 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 (cont’d)
 Impact of the mortgage amount on
the monthly payment
 The larger the mortgage amount, the
larger the mortgage payment
 Impact of the interest rate on the
monthly payment
 The larger the interest rate, the larger
the mortgage payment
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Exhibit : Allocation of Principal Versus Interest
Paid per Year on a $72,000 Mortgage (cont’d)

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Financing with a Fixed-Rate
Mortgage (cont’d)
 Impact of the mortgage maturity
on the monthly payment
 The longer the maturity, the lower the
monthly payment
 The longer the maturity, the more
interest you pay over the live of the
loan

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Financing with a Fixed-Rate
Mortgage (cont’d)

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 Characteristics of a Fixed-
Rate
Mortgage (cont’d)
 Estimating the monthly mortgage payment
 Many mortgage loan Web sites offer
mortgage calculators to estimate monthly
payments based on a specific mortgage
amount, interest rate, and maturity (USE PV
of Annuity -PV = Monthly Installment x
Annuity Factor

$60000 loan,30 yrs, 8% - Annuity Factor is

11.258 : 60,000 = Yearly installment x4-5211.258
Characteristics of a Fixed-
Rate
Mortgage (cont’d)

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 Adjustable-Rate Mortgages
(ARM) – Variable Rate
 With an ARM, the interest rate fluctuates based
on current market interest rates within limits at
specified intervals.
 Borrowers are better off with an ARM if interest
rates drop.
 Initial Rate - “teaser rate” can be deceptively low
and available for only a short time period.

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 Adjustable-Rate Mortgages
 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.
 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.
 This results in negative amortization. The
unpaid interest is added to the unpaid loan
balance, increasing its size.
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 Adjustable-Rate Mortgages
 ARM Innovations:
• Convertible ARM – convert traditional ARM to a
fixed rate loan during 2nd – 5th years.
• Reduction-option ARM – one-time optional interest
rate adjustment to market interest during 2nd – 6th
years.
• Two-step ARM – interest rate is adjusted at end of
7th year, then constant for life.
• Price level adjusted mortgage – low initial rate,
payments and interest change with inflation.
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 Financing with
Adjustable-Rate Mortgages
 Adjustable-rate mortgage (ARM):
a mortgage where the interest owed changes in
response to movements in a specific market-
determined interest rate
 Advantage is that rates could go down;
disadvantage is that rates could increase
 Initial rate—usually relatively low
 Interest rate index—determines whether
mortgage rate goes up
 Frequency of rate adjustments—varies 4-59
 Other Mortgage Loan
Options
 Graduated payment mortgage: a mortgage
where the payments are low in the early
years and then rise to a higher level over
time
 Balloon payment mortgage: a mortgage
where the monthly payments are relatively
low, but one large payment is required after a
specified period to pay off the mortgage loan
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 Other Mortgage Loan
Options
 Balloon Payment 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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 Other Mortgage Loan
Options
 Shared Appreciation Mortgage – borrower
receives below-market interest rate and
lender receives a portion of future
appreciation.
 Interest Only Mortgage – combination of
interest only payment at beginning, then pay
both interest and principal for remainder of
loan.
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 Mortgage Refinancing

 Mortgage refinancing: paying off an existing

mortgage with a new mortgage that has a lower
interest rate
 Rate modification—may be available to some
fixed-rate mortgage holders
 Refinancing analysis—compare the monthly
savings to the cost of refinancing
 Must pay additional closing costs
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 How a Mortgage Fits
Within Your Financial Plan
 Key mortgage loan decisions for your
financial plan are:
 What mortgage amount can you afford?
 What maturity should you select?
 Should you consider a fixed-rate or an
adjustable-rate mortgage?

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 Adjustable-Rate Versus
Fixed-Rate Mortgages

Adjustable-Rate Fixed-Rate
 Primary benefit to  Usually a better choice
homeowner is low initial over adjustable.
interest rate.  Know your payments
 Rate gap between 1-2%. never change.
 Qualify for larger loan  Allows for control and
because PITI is lower. planning.

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 Selecting a Home

 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 (cont’d)
 Criteria used to select a home
 Price
 Freehold or Leasehold
 Convenient location
 Maintenance
 School system
 Insurance
 Taxes
 Resale value–consider real estate commission
 Personal preferences
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 Selling Your Home

 DETERMINING THE SELLING PRICE

 Appraiser estimates the current value
 Real estate agent markets your home
 If “FOR SALE BY OWNER,” use a lawyer or title
company to assist with contract and closing
 LISTING WITH A REAL ESTATE AGENT

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End of Lecture