Home Finance. Slide 1

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1 Slide 1 Home Finance The information provided in this e-course is intended for educational purposes only and does not constitute specific advice for you as an individual. When evaluating your particular needs, please contact your own tax or financial advisors. A home is typically the largest purchase that you ll make in your lifetime. Home prices run from the hundreds of thousands of dollars to several million dollars, so the purchase process can be stressful. Buying a home can be a great investment, but it can be a great responsibility as well. In this module, we ll walk through what you can do to prepare for buying a home. Whether it s your first home purchase or your fifth, the loan process can be intimidating. We ll talk about what to expect from that process, as well as what happens after you ve made the offer. We ll also explore how you may be able to lower your payments once you own a home, or tap into your home s equity. Let s start by learning how to prepare for the home buying process.

2 Slide 2 Advantages The purchase of a home has several benefits. While there s an emotional benefit as you and your family turn a house into a home, the purchase can also serve as an investment. There are also tax benefits to owning a home. Federal tax law has allowed the interest for mortgages, as well as property taxes, to be deducted. If and when you sell your home, you may be eligible to take advantage of a tax exemption for any capital gains you may have.

3 Slide 3 Drawbacks But there are certainly drawbacks to home ownership as well. Your costs don t end when you purchase your home; they re just beginning. You re responsible for the maintenance and upkeep of your property. These costs can run from a few hundred dollars a year to several thousand dollars, depending on the repairs that need to be done. In a down market, homes may not be easy to sell, so your ability to move on a whim is much more limited. Finally, there s no guarantee that you ll be able to sell your home for more than you paid for it. Real estate markets don t just go up; they go down as well!

4 Slide 4 Preparing for the Search After you've weighed the pros and cons and made the decision to buy a home, your work begins. The search for a home is one that should start long before you begin to look at houses. More than likely, you won't have the money on-hand to purchase a house outright, so you'll need to get a mortgage. How much you pay in interest will be, in part, determined by your credit score and how you've handled credit in the past. Begin your home purchase process by getting a copy of your credit report to determine if you have any negative marks which might prevent you from qualifying for a mortgage. If you have outstanding credit card balances, you'll want to reduce the amount that you're borrowing. The more money you can save for a down payment, the better off you'll be.

5 Slide 5 Reviewing Your Finances 36% 28% Once you ve reviewed your credit report, you may have a better understanding of your financial picture. At this point, ask yourself if you can financially handle the purchase of a new home and its associated costs in addition to all of your other expenses. You don t want to be house rich and cash poor by overextending yourself financially. Lenders recommend that you don t spend more than 28% of your gross income on your mortgage, real estate taxes, and home insurance and no more than 36% of your income on debt, including a mortgage. But lenders don t take into consideration such issues as saving for retirement, paying for a child s education, or even utilities and food.

6 Slide 6 Affording Your New Home If you re buying your first home, you should strongly consider taking a class for new home buyers. Many banks and credit unions, as well as local housing authorities, provide opportunities for people to learn about the home buying process. As you plan your home search, you must be realistic about what you will be able to afford. It s nice to dream about a home with a large yard in the nicest neighborhood in town, but it may not be in your price range. Think about what s important to you in a home. What s a nice to have and what s a must have? Location is also a key consideration. If you have children, maybe being in the best possible school district is most important. Or the location may be dictated by your commute to work. Spend time in some targeted neighborhoods, getting a sense of what they re like during the week and on the weekends, in the morning and in the evening.

7 Slide 7 Real Estate Agents Do you need a real estate agent? No, I can do it myself and save money Yes, I need help Once you're ready to begin looking at homes, where do you go for help? Or do you even need help? Click on the box you think best answers whether you need a real estate agent or not.

8 Slide 8 Real Estate Agents Experience Objectivity While you can certainly perform your search on your own, you'll more than likely use a real estate agent in your search for a new home. The internet has made the search process much easier, but an agent can bring a lot to the process. One benefit of using an agent is experience. You may only purchase one house in your life; a real estate agent has assisted people in the process numerous times. An agent can help you to define your search based on your needs and desires. In addition, a real estate agent brings objectivity to the process. When you do find the property you want, the agent can play a valuable role in assisting with negotiations.

9 Slide 9 Agent Contracts But the services of a real estate agent do come at a price. Typically, real estate agents ask you to sign a contract that ensures you'll work with them exclusively for a certain period, often six months. If you're unhappy with their services, it may prove difficult to get released from this agreement. Agents are paid commission, typically 5-6% of the sales price of the home, which your agent splits with the seller's agent. The commission is usually paid by the seller, but may be shared with the buyer.

10 Slide 10 Finding the Right Agent So how do you find the right agent? Often getting a recommendation from friends or family can be a good place to start. But the search shouldn't stop there. Do your research! Consider working with an agent who is a realtor. Realtors belong to the National Association of Realtors, which has a strict code of ethics. This helps to ensure that your needs are foremost when the agent performs his or her duties. Look for an agent who handles homes in your price range. Agents may specialize in high-end properties or fixer-uppers, so you want work with someone who knows your market. In addition, agents should be able to work on your time schedule. If you can only look at houses on weekends, then you should work with an agent who can accommodate your schedule. Websites such as the National Association of Realtors can provide you with more guidance as to what to look for in your agent.

11 Slide 11 Loans You're ready to begin the actual home search, but there's more you need to do to prepare. For most people, buying a home isn't possible without a loan. Let's look at how you should get ready so that once you find the perfect house, you can make it yours.

12 Slide 12 Pre-qualification We've already talked about being realistic about what you can afford. But how do you know how much that is? It's important to speak to a lender who will look at your income, debt and assets and pre-qualify you for a loan. Pre-qualification is essentially an estimate of the amount the lender might loan you at current interest rates. It's typically done over the phone or the internet at no cost. The lender isn't obligated by this process to actually approve a loan, and you're not obligated to use that lender once you do find a home.

13 Slide 13 Pre-approval Pre-qualification will give you an idea of how much you can afford, but it's far better to be preapproved for a loan. While it still doesn't obligate the lender to make a loan to you, it does provide you with the confidence that you can secure a loan for the approved amount. Pre-approval requires you to complete a formal mortgage application, as well as pay a fee. The lender will do a more detailed check on your finances and your credit rating and then provide you with a specific mortgage approval amount. You'll also get a better idea of the interest that you'd be charged. Loan pre-approval allows you to zero in on properties that are in your price range and reassures sellers that you can make a serious offer.

14 Slide 14 PROPERTIES Allow user to leave interaction: Show Next Slide Button: Completion Button Label: Anytime Show always Next Slide Mortgages come in a variety of shapes and sizes. During the pre-approval process, you ll be asked about the type of mortgage you want. Click on each of the buttons to learn about a few of the main types of mortgages. FHA loans: The Federal Housing Administration helps low to moderate income earners get mortgages by providing federal insurance, which protects the lenders from losses. FHA loans typically require low down payments and are more accessible to borrowers with little or no credit history or minor credit issues. You can learn more about FHA loans on the U.S. Department of Housing and Urban Development s website. VA loans: The U.S. Department of Veterans Affairs guarantees the loans made to active duty service members and veterans by financial institutions that participate in the program. The program requires that applicants have a certificate of eligibility. You can learn more about the VA loan program on the Department of Veterans Affairs website. Conventional loans: A conventional loan is any mortgage that isn t guaranteed by the federal government. Because they have fewer guidelines, these loans can typically be acquired with less difficulty than federally guaranteed mortgages.

15 Slide 15 Length of Your Loan 30 year mortgage 15 year mortgage Let s take a closer look at conventional loans. Conventional loans have either a fixed or an adjustable rate. Fixed rate mortgages allow you to lock in an interest rate so your payment amount doesn t change. As the name suggests, adjustable rate mortgages can fluctuate, so your payment amount can change over time. Because the rate is locked in, fixed rate mortgages make the most sense if you plan to be in your home for many years. Conventional loans are typically 15 or 30 years in length, but may be as long as 40 years. Generally, the shorter your loan, the lower your interest rate will be. The main advantage that a 30 year mortgage has over a comparable 15 year loan is that the monthly payments will be lower. But you ll pay far less interest over the lifetime of the 15 year mortgage. Click on either of the pictures to look at an example.

16 Slide 16 Length of Your Loan Return 30 year mortgage 4.75% X 30 years A $300,000 mortgage at a 4.75% interest rate for 30 years comes to a monthly payment of $ You d have a lower payment, but you d pay $263, in interest over the 30 years. To compare these amounts to the 15 year mortgage, click Return. If you ve finished, click the next button at the bottom of the screen to advance.

17 Slide 17 Length of Your Loan 30 year mortgage 15 year mortgage Click on the picture with the 15 year mortgage to compare the payment and interest amounts.

18 Slide 18 Length of Your Loan Return 15 year mortgage 4.00% X 15 years A $300,000 mortgage at a 4.00% interest rate for 15 years comes to a monthly payment of $ Your payment would be higher, but you d only pay a total of $99, in interest. To compare these amounts to the 30 year mortgage, click Return. If you ve finished, click the next button at the bottom of the screen to advance.

19 Slide 19 Length of Your Loan 30 year mortgage 15 year mortgage Click on the picture with the 30 year mortgage to compare the payment and interest amounts.

20 Slide 20 ARMs Adjustable Rate Mortgages % % % % % Lifetime of Loan As you've already learned, adjustable rate mortgages, or ARMs, have interest rates and monthly payments that change during the lifetime of the loans. They typically start with a low interest rate, but reset after a pre-determined period of time. For example, you may see an ARM expressed as 5/1. This means that the initial interest rate stays constant for the first five years of the loan and then can change annually. If mortgage interest rates stay the same or decline, you pay the same or less each month. If interest rates increase, your mortgage payment will increase as well. Since the amount of your monthly payment can increase, make sure you'll be able to pay it in the event that the interest rate reaches it maximum each year. ARMs can be a good choice if you're planning on owning your home for a short period of time, so the potential adjustments may not be a significant factor.

21 Slide 21 Caps Caps are usually placed on any increase or reduction that may occur after one interest adjustment. There may be an annual cap which limits how much of a change can occur each year, or a cap on the total adjustment that may occur during the loan's lifetime. If the dollar amount of the loan repayment is capped but the interest rate isn't, you could experience negative amortization. This means that the monthly payments are outpaced by the increase in interest charges and the amount of the principal (original loan amount) is increasing instead of decreasing.

22 Slide 22 Interest Rates Economic index Credit score Discount points Whether you choose a fixed or adjustable rate loan, your mortgage interest rate will be based on a number of factors. Interest rates are typically tied to an economic index, often short-term Treasury bond rates. Another major factor will be your credit or FICO score. Individuals with higher scores or better credit worthiness will be offered a lower interest rate than those with lower FICO scores. You may be able to reduce your interest rate by paying discount points. Each point is equal to 1% of the loan amount. Buying points can save you money if you re in your home long enough to recoup this investment.

23 Slide 23 What to Expect Once you ve taken the first steps to find a realtor and research your mortgage options, it s time to find a house. After you find the one that s right for you, there are additional steps you ll need to take. Let s take a look.

24 Slide 24 Making the Offer If you ve found the property you want to buy, you ll need to present an offer to the owners. Before you do, you and your real estate agent should review recent sales of comparable homes in the area. These homes should be similar in age, size, and number of rooms to ensure that they re truly comparable. The condition of the area s real estate market may also be a factor in your offer. If homes haven t been selling, you may be able to present a lower bid than what the sellers are asking.

25 Slide 25 Negotiations In most instances, the amount a buyer offers is not the same as what the owner is seeking. The owner may present a counter offer, which changes the price or other conditions that you may have set forth in your offer. This process can continue until both parties reach a point of agreement or one party walks away. You don t have a contract until one side accepts the other s latest proposal without modifications.

26 Slide 26 Contingencies But you re not quite ready to move in yet! A standard contract has a number of conditions or contingencies that must be met before the deal is final. The contract will define the period of time that you and the seller have to meet all of the contingencies in the agreement. If all of the contingencies aren t met, the contract can be cancelled or modified.

27 Slide 27 Home Inspection A standard contingency is a home inspection. Home inspections are conducted by professionals to search for problems in home and property, typically at a cost of several hundred dollars. Home inspectors search for structural issues, problems with exterior and interior of the home, as well as electrical, plumbing, heating, and air conditioning concerns. In addition, many lenders require the home to be inspected for termites and other pests that could do significant damage to the property. Your real estate agent or professional association can recommend a home inspector to you. Based on the inspection, you can negotiate with the owner to fix outstanding issues.

28 Slide 28 Financing Another standard contingency is that you'll be able to secure the required financing within a specified time period. Remember, that even if you've been pre-approved for a mortgage, that doesn't mean it'll close. Your lender will want to verify that your financial picture hasn't changed since you were preapproved. If you've acquired new debt or had a change in your credit report, your application may be denied. If you haven't been pre-approved, you'll need to apply for a mortgage and provide a lengthy list of financial documents and have your credit verified. Of course, if you're paying cash for the home, this contingency won't apply to you.

29 Slide 29 Down Payments When you close on your home, you'll need to have more than just a check from your lender. In almost all cases, you'll make a down payment on the home, usually 3 to 20% of the contracted price. It's best that your payment is at least 20% so you can avoid paying Private Mortgage Insurance, or PMI. PMI is an additional fee which protects lenders from a default on the loan. PMI charges vary depending on the size of the down payment and the loan, but they typically amount to about one-half of 1% of the loan. No matter what the size of your down payment, it'll be in the form of a certified check, not a personal check.

30 Slide 30 PROPERTIES Allow user to leave interaction: Show Next Slide Button: Completion Button Label: Anytime Show always Next Slide There will be a number of other payments that will have to be made as well. Closing costs typically range from 3% to 5% of your total mortgage amount, but you can negotiate sharing them with the seller when you present your offer. Click on each of the numbered tabs below to learn about the costs. Loan origination fee: This fee covers expenses incurred by your lender. The amount can vary by lender, ranging from 0.5% to 2% of the purchase price. Take care to look for additional hidden charges called "junk fees," as they're considered to be unnecessary markups. Title insurance: Title insurance protects you and your lender against the risk that the seller doesn t own the property. Property tax: The seller may have paid the property tax in advance. You may need to reimburse the seller for this on a pro-rated basis. Attorney fees: Many states require that attorneys be involved in a real estate transaction, which could cost several hundred dollars. Prepaid loan interest: Your lender may charge you for the interest that accumulates between the day the loan is funded and the day you're actually scheduled to make your first loan payment. Escrow fees: The escrow company, usually selected by the real estate agent, serves as a neutral intermediary between all parties involved in the transaction. The escrow agent also handles the transfer of money between the parties. The escrow agent will receive money from the lender, pay off any existing mortgages and closing costs, collect any buyer deposit, and give the rest as

31 sales proceeds to the lender. This fee ranges from $500 to $1500, depending on the size of the loan. Appraisal fee: Lenders require that the property be independently appraised to estimate its value. This ensures they're not loaning you more than the value of the house. Appraisal fees vary based on the size and price of a property. A typical appraisal fee is around $300 to $500, which can either be paid at closing or prior to closing, depending on lender requirements. Survey fee: The lender may hire a surveyor to survey the property, which will cost around $350. The surveyor prepares an official diagram indicating such things as the property lines, sidewalks, and public utility easements on the property. You'll get a copy of the survey with the papers you receive at the closing. Home insurance: The lender will require you to have home insurance in place as soon as the property belongs to you. In addition, the lender often requires that a full year s premium is paid.

32 Slide 31 Home Insurance Home insurance protects you against the potential loss of your home. Your lender will most likely require you to maintain home insurance throughout the lifetime of your loan in order to protect its interests, as well as yours. Your home should be insured for at least as much as it would cost to rebuild. You should inform your insurance company if you make a substantial change to your property, which would change the coverage amount.

33 Slide 32 Premium Amounts Just like any insurance, you ll need to pay premiums in order to keep the insurance in force. There are a number of things that you can do reduce the premium amounts, such as raising your annual deductible. You can upgrade the plumbing or electrical systems or add home security devices, such as smoke detectors and burglar alarms. Having other policies with the same insurer, such as your car insurance, also reduces your premiums. Many insurance companies reward customers who have multiple types of policies with them.

34 Slide 33 Equity and Refinancing You ve made the leap into home ownership and now you ve been in your house for a while. What happens to all the money you pay each month? Let s learn how you may be able to access that money if you need it, or be able to refinance your home.

35 Slide 34 Equity For every month that you make a payment, you build the equity in your home. Equity is the difference between what you owe on your home and its fair market value. Your equity can change as you reduce the size of your mortgage and as the value of your home changes. As you gradually build equity in your home, you may be able to use your home as collateral for a loan, should you need funds.

36 Slide 35 PROPERTIES On passing, 'Finish' button: On failing, 'Finish' button: Allow user to leave quiz: User may view slides after quiz: User may attempt quiz: Goes to Next Slide Goes to Next Slide At any time At any time Unlimited times You can tap into this equity in one of two ways. A home loan is a one-time lump sum loan which has a fixed interest rate and is repaid in installments. Once you receive the funds, you can t borrow further from the loan. A home loan is best used when you know the cost of your purchase, and you ll need several years to repay the loan. A home equity line of credit, or HELOC, allows you to borrow up to a certain amount for the lifetime of the loan. You would able to withdraw money as needed, often by check, credit card, or by phone transfer. When you repay the principal, the money becomes available again for your use. HELOCs have variable interest rates, so payments vary depending on the interest rate and the amount you owe. HELOCs are best used for short-term borrowing or as an emergency fund. One note of caution: taking a home equity loan can be a wise decision, but your home is not an ATM machine. Failure to repay an equity loan could cause you to lose your home.

37 Slide 36 PROPERTIES Allow user to leave interaction: Show Next Slide Button: Completion Button Label: Anytime Show always Next Slide At some point, you might become interested in refinancing your mortgage. Click on the buttons to learn about the reasons why someone may choose to refinance. Lower your interest rate: Lowering your interest rate by 1% or 2% can prove to be worth the time and money. It will help you save money over the long run and will increase the equity in your home faster. Shorten the length of the loan: If interest rates fall, you may be able to pay approximately the same monthly amount under a 15 year mortgage as a 30 year mortgage. This would allow you save money that would otherwise be paid in interest. Convert between an adjustable rate mortgage and a fixed rate mortgage: Adjustable rate mortgages begin with a low interest rate but can escalate over time, often exceeding those of fixed rate mortgages. Converting to a fixed rate mortgage could result in a lower interest rate that would remain the same. Consolidate debt: Many homeowners consider refinancing and withdrawing equity to pay off higher interest consumer debt. While this strategy can be beneficial, the danger is returning to the same habits that left you in debt. If you choose to refinance for this reason, make sure you avoid future debt or you'll be in worse financial shape than before you refinanced!

38 Slide 37 Refinancing Cost vs. Benefit But is refinancing right for you? A mortgage refinance can cost between 3% and 6% of the loan amount, so it s important to consider how long you plan to live in your home. It ll take a number of months, even years, to recoup the money that you spent in closing costs. If you re only going to be in your home for just a few more years, it may not be worth the expense.

39 Slide 38 Home Finance On the Web Financial Literacy Congratulations! Even if you don t own a home now, you ve taken the first step by learning about the process of buying a home. You understand how to prepare for the purchase and what to expect from the process. You ve also learned how to tap into your home s equity or refinance, once you become a home owner. Keep learning! For more information on this topic, select On The Web to visit where you ll find other home finance resources and tools. To view our other Financial Literacy presentations, select the Financial Literacy link.