Buying vs Leasing Flashcards
Financial Considerations:
A Comparison of the initial or down payment costs, recurring costs, maintenance costs, and the tax effects of renting and buying will show that renting is more suitable for people who are planning on a short stay. Buying is more advantageous if the individual plans to live in the home for several years.
Lifestyle Considerations:
The decision to buy or rent a home includes many non-financial considerations such as the geographic location, size and type of home, time frame for living in the home, and quality of community schools and services.
Housing Affordability:
The rule of thumb is to spend no more than 25% of your after-tax income on housing expenses. Freddie Mac recommends that monthly housing expenses should not exceed 28% of gross monthly income and that monthly debt repayment should not exceed 36% of gross monthly income. Using these figures, a person can estimate what they may be able to afford.
Tax Advantages:
The benefits of owning a home include the opportunity to itemize and take deductions for interest paid for mortgages and property taxes paid to state and local governments.
One time Costs include
Down Payment-
Closing or Settlement Costs-
Points-
Loan Origination Fee-
Loan Application Fee-
Appraisal Fee-
Title Search-
What costs are needed to consider when determining to buy vs lease?
one-time costs
recurring costs, and
maintenance costs.
When computing the net results, factor in the various psychological issues.
Blended Mortage Option
A blended or “piggyback” mortgage is an option the buyer can consider if they cannot afford the 20% down-payment for the home. Essentially, the mortgage is split into two loans. The first mortgage should not exceed 80% of the purchase price; the second mortgage can account for the remaining percent. A blended mortgage may avoid the need for private mortgage insurance (PMI) and a jumbo rate.
This option should be discussed with a mortgage broker and a comparison of a traditional loan with PMI to the blended mortgage option should be evaluated. The outcome can depend on current interest rates, the spread between Jumbo and Conforming Rates, the amount of the loan(s), and the loan-to-value ratio (LTV). For example, someone putting down 20% would have a LTV of 80%.
Down Payment-
The part of the purchase price that is not borrowed via a mortgage represents the Buyer’s down-payment. This becomes the homeowner’s initial equity of their home. A 20% down-payment is common, but not required. Down-payments can be as low as 3%, (and sometimes lower with special government programs). In the case of a less than 20% down-payment, the borrower/buyer will have to obtain either private mortgage insurance or use a combination of a first and a second mortgage to obtain the financing.
Closing or Settlement Costs-
Expenses associated with finalizing the transfer of ownership of the house. They can range from 3 – 7% of the price of the house.
Points-
Charges paid to “purchase” a lower interest rate, which results in a lower payment over time. Each point is equivalent to a one percent of the loan amount. Points can represent loan origination fees, or discount fees (fees paid to the lender in exchange for a lower rate).
Each point is one percent of the loan amount, but that for each point you are effectively buying a lower monthly payment.
Calculating a breakeven analysis would illustrate how long the savings would take to offset the point(s), due to the lower rate.
Loan Origination Fee-
Its purpose is to compensate the lender for the cost of originating, reviewing and finalizing the loan.
Loan Application Fee-
A fee, generally in the $200 to $500 range, that is collected to defer some of the processing costs associated with the loan, (such as an appraisal fee and a credit report). It may or may not be refundable.
Appraisal Fee-
A fee for an appraisal of the house, which is generally required before a mortgage loan is approved. An appraisal will assess and/or confirm the fair market value of the property based on the sales history of similar properties in the same area. Although the cost varies depending on the size and location of the house, it can easily run between $300 and $500.
Title Search-
An investigation of the public records to determine the legal ownership rights to a property or a home. The lender wants to ensure the home passes cleanly (without liens) from seller to buyer.
What are the 4 recurring costs of a mortgage?
Principal, Interest, Taxes, Insurance (homeowner and/or PMI)
PITI
PITI costs should not exceed ____ of your pre-tax ____ income.
28% monthly
PITI compares monthly housing expenses to the borrower’s gross monthly income, is called the ____
The second ratio that mortgage lenders use to determine whether to grant a home mortgage or home equity line of credit is the _____. This is a total debt ratio that compares the borrower’s PITI plus other monthly
Housing Cost Ratio (also referred to as the front-end or Primary Housing Ratio).
Total Cost Ratio (also referred to as the back-end or Total Obligation Ratio).
Maintenance costs and operation costs to be __% of the ___ of the home.
1%
fair market value
Cost of renting
Total monthly rent (12)(# of years)
Total renter’s insurance (x)(# of years)
Opportunity cost of the initial deposit (rentX2)(# of years)(rate%)
Cost of buying
Total mortgage payments
Property taxes
Home owner’s insurance
Maintenance costs
Opportunity cost of down payment
Closing cost, including point
Mortgage payments going to principal
Appreciation of home, less sales commission
Total Cost of Buying a home without itemizing
Tax deductions of interest (total amount of interest portion of mortgage
Tax deductions of property taxes
Tax savings from closing costs
Total Cost of Buying a home for home buyers who itemize
Comparison of buying vs leasing is calculated
Advantage of buying (non-itemizing buyer): Total cost of renting minus Total cost of buying without itemizing
Advantage of buying (itemizing buyer): Total cost of renting - Total cost of buying with itemizing
Remember: it is exponential growth of 3% per year so it is not as simple as multiplying the 1st year by 7
Calculating Buying vs Renting
calculating the cost of rent, cost of buying, and comparison of both for 1 year and year periods
How to Calculate how much house can a client afford:
Step 1 - Divide annual income by 12 to determine Gross Monthly Income (GMI)
Step 2 - Since lenders allow you to use 28% of your Gross Monthly Income on your primary residence we can multiply the GMI by 28%.
Step 3 - The number we derived in the previous step should represent the total payment or PITI (principal, interest, taxes and insurance). We now need to make our first assumption. If we assume the taxes and insurance represent 20% of the total then principal and interest represent 80%. Keystrokes: Step 2 amount Enter 20 % -
Step 4 - Now we must make our second set of assumptions based on current interest rates and the term of the loan the borrower will be looking for.
___ n ___ CHS PMT ___ g 12÷ PV
Tax Advantages
If you itemize deductions, both the state and local taxes on the property and the interest on the mortgage that you pay may be deductible from the adjusted gross income when you calculate your federal taxable income (up to applicable limits). If you are in the 24% marginal tax bracket, each dollar you pay in property taxes and interest saves you 24 cents in federal income taxes.
The higher your marginal tax rate, the ___ the income tax advantage.
greater
Mortgage interest
Mortgage interest is fully deductible on primary and secondary homes for all loans used to acquire or improve the real estate up to a $750,000 threshold (Acquisition or Improvement Indebtedness), provided the loans do not exceed the fair market value of the home.
Michael has an adjustable rate mortgage that is nearing its adjustment date. His current rate is 4%. The margin on the loan is 2.75%. The index to which the loan is pegged is currently at 4.25%. The adjustment caps are 2% (each adjustment) and 6% over the life of the loan. Assuming nothing changes between now and his adjustment date, what will be his new interest rate after the adjustment?
6% The new rate equals the current index plus margin, rounded to the nearest 1/8 percent and governed by the caps. Because the interest rate may only adjust up or down by a maximum 2% each period, the new rate is limited to 6%. The current index, 4.25%, plus the margin, 2.75% equals 7%, which exceeds the maximum increase.
What are the factors that relevant when deciding between a fixed-rate mortgage and an adjustable-rate mortgage?
Amount of time you intend to live in the home
Current interest rate levels (historically low or historically high)
Current spread between fixed and adjustable rate mortgages
Financial strength and stability of the borrower
Market rates do not change the monthly payment.
A Fixed-Rate Mortgage Loan
Allows the interest rate to fluctuate according to the level of current market interest rates within limits and at specific intervals.
An Adjustable-Rate Mortgage (ARM) Loan
