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Chapter 8

The Home and Automobile Decision

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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 Sample Complaint Letter

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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 shopprice 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 holdback2 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:
Cheapestcash 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 Warrantydefine normal wear and tear Termination fee Depreciation factor Rent or finance charge

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Figure 8.2 Federal Consumer Leasing Act Lease Disclosure Form

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Smart Buying in Action: Buying a Vehicle


Step 4: Maintain Your Purchase Keep vehicle in best running condition. Dont 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 Worksheet for the Lease-Versus-Purchase Decision

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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 investmentbiggest 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:


Homeowners 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 Estimated Initial Costs of Buying a Home


The Down Payment, Points, and Closing Costs on the Purchase of a $150,000 House, Borrowing $120,000, with 20% Down at a Rate of 6% with 2 Points

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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 Monthly Mortgage Payments Required to Repay a $10,000 Loan with Different Interest Rates and Different Maturities

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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 Renting Versus Buying

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Figure 8.6 Worksheet for the Rent-Versus-Buy Decision

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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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Figure 8.7 Worksheet for calculating the maximum size mortgage loan you qualify for (cont.)

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Figure 8.7 Worksheet for calculating the maximum size mortgage loan you qualify for (cont.)

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Figure 8.7 Worksheet for calculating the maximum size mortgage loan you qualify for (cont.)

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Financing the PurchaseThe Mortgage


Sources of mortgages: S&Ls and commercial banks Credit unions, mutual savings banks Mortgage bankersoriginate mortgage loans, sell to banks, pension funds, insurance companies and collect payments Mortgage brokersmiddlemen 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 loansfrom a bank or S&L secured by the property. Government-backed loansloan from traditional lender but insured by governmentFHA 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 doesnt 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 Rateteaser ratelow for only a short time period then adjusted upward. Interest rate indexrates 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
Marginthe amount over the index rate that the ARM is set. Adjustment Intervalhow frequently the rate can be reset.

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Adjustable-Rate Mortgages
Payment Capsets 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 ARMto fixed-rate loan Reduction-option ARMone time opportunity to adjust interest rate. Two-step ARMcombined 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 Loansmall monthly payments for 5-7 years, then entire loan due. Graduated Payment Mortgagepayments set in advance, rising for 5-10 years, then level off. Growing Equity Mortgagedesigned to let homebuyer pay off mortgage early.

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Specialty Mortgage Loan Options


Shared Appreciation Mortgageborrower receives below-market interest rate, lender receives a portion of future appreciation. Interest Only Mortgageinterest 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 Mortgagescan 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 mortgagesmortgages taken out by borrowers with low credit scores. Predatory lenders take advantage of these lenders. Abusive loanshigh-cost loans with little chance of paying off

Avoid predatory loans with knowledge.

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Figure 8.9 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 8.10 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 Impact of the Loan Term on the Total Interest Paid and Monthly Payment for an $80,000 Fixed-Rate Mortgage at 8%

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Figure 8.11 Comparing a ShorterVersus Longer-Term 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 Prequalifyinghave maximum amount youll 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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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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Figure 8.8 Status of Nonprime Loans Originated from 2000 through 2007 as of December 31, 2009

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Checklist 8.6

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Figure 8.12 Worksheet for Refinancing Analysis

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Checklist 8.7

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Checklist 8.8

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