The cost of Home Ownership

• The loan you buy a home with is called a mortgage.
• It is an installment loan.
• But it is big, and you pay on it for a long time (15- more years)
• Fixed rate mortgages
  • Have the same mortgage rate throughout the life of the mortgage
  • The payment stays the same.
• Variable rate mortgages
  • The rate is adjusted occasionally.
  • It is based on the prime interest rate, or T-Bills, or ...
  • There are sometimes limits on how much a rate can change in a year.
  • These just scare me.
• Balloon Payment Mortgage
  • Pay at a reduced rate for a period of time, then the entire loan is due.
  • 7 year loan, paid as a 30 year loan. At the end of 7 years the total amount is due.
  • This lets you buy a house you can't afford, but will be able to in 7 years.
  • These petrify me.
• Most banks don't want you to spend over 28% of your adjusted income on your house payment.
• When purchasing a home
  • Most banks require some form of a down payment.
  • They would like 20%
  • With government assistance (FHA loans) you can drip to 2% or less
  • Most banks require some form of a down payment.
  • They would like 20%
  • With government assistance (FHA loans) you can drip to 2% or less
• You can get mortgages from banks, or mortgage brokers.
• For the most part, banks and always mortgage brokers will sell your mortgage on the market.
  • This means you will be paying someone else (not the person who loaned you the money)
  • This can change over the life of the loan multiple times.
  • But the terms of the loan can not change.
• points are a percentage of the amount you borrow.
  • These are a fee the bank imposes.
  • For each point, you pay 1% of the amount borrowed.
  • Example: You want to finance $134,000 at 3 points.

    The cost of the points is
       .03 * 134,000 =  4,020
    	 

  • Sometimes you pay points to lower the interest rate.
• There are other fees associated with purchasing a house
  • inspection fees
  • Lawyer's fees
  • Filing Fees
  • Property insurance
  • Copying Fee
  • Fee Fee
  • ...
• Usually you have to pay the financed fees and points up front.
• Escrow of taxes and insurance
  • The bank requires you to maintain insurance for the price of the house
  • The bank requires you to pay your taxes.
  • If you don't have a minimum down, you must escrow this.
• To calculate the monthly payment for a loan

            P(r/n)
   PMT = -------------
         1 -(1+r/n)-nt
  
         P is the principle
         r is the interest rate
         t is the number of years
         n is the payments per year
       

• Finally to compute the cost of interest:
  • This is the same as finance costs
  • total of monthly payments - amount financed.
• Example:Problem 2, page 497

  Price 180,000
  Down : 5%
  Down Payment = 180,000 x .05 = 9,000
  Amount Financed = 180,000 - 9,000
                  = 171,000
  Points 1 point
      cost of points = 171,000 x 0.01 
                     = 1,710
  Monthly Payment
    
        P = 171,000
        r = 8%
        n = 12
        t = 30
  
         171,000(0.08/12)
   PMT = ----------------   =  1,254.74
         1 -(1+0.08/12)-12*30
  
  Find the total cost of interest
        12 * 30 *  1,254.74 - 171,000 =  280,706.40
       

• Amortized Loan Schedules
  • Compute the monthly interest as last section
  • Find the amount to principle, (monthly payment - monthly interest)
  • Compute the next month's interest.
  • Example:

    Continue the previous example:
    Payment #   Prin        Int Due                Prin
       1        171,000     171,000x.08/12    1,254.74-1,140
                                1,140             113.26
       2    171,000-113.76  170,886x.08/12    1,254.74-1139.24
                170,886         1,139.24          115.50 
    	 

Homework