Mortgages Mortgage: a long-term installment loan for the purpose of buying a home. If payments are not made on the loan, the lender may take possession of the property. Down Payment: A percentage of the sales price of the home that you pay the seller. For example, the lender may require you to pay 10% to the seller. Amount of Mortgage: difference between sale price and the down payment.
Mortgages Monthly payments depend on the amount of mortgage (principal), the interest rate, and the duration of the mortgage. 1) Fixed-rate Mortgage Two Types Same monthly principal and interest payment 2) Variable-rate Mortgage Payments and interest rate changes throughout loan
Mortgages Lending institutions require the buyer to pay one or more points at the time of closing. A point is a onetime charge that equals 1% of the loan amount. Two points would mean a charge of 2% of the loan amount. Note: Points are taken as a percentage of the loan amount which is the amount after we subtract the down payment from the total cost of the home.
Mortgages We will only deal with fixed-rate mortgages. To find the regular payment amount, we use the formula for fixed installment loans. This is the same formula we used for car loan payments.
Mortgages Ex. The price of a home is $195,000. The bank requires a 10% down payment and two points at the time of closing. The cost of the home is financed with a 30-year fixed-rate mortgage at 7.5%. a) Find the required down payment b) Find the amount of the mortgage c) How much must be paid for the two points at closing? d) Find the monthly payment e) Find the total interest paid over 30 years
Mortgages Ex. The price of a home is $195,000. The bank requires a 10% down payment and two points at the time of closing. The cost of the home is financed with a 30-year fixed-rate mortgage at 7.5%. a) Find the required down payment We need to find 10% of $195,000: Down Payment = 0.1 x $195,000 = $19,500
Mortgages Ex. The price of a home is $195,000. The bank requires a 10% down payment and two points at the time of closing. The cost of the home is financed with a 30-year fixed-rate mortgage at 7.5%. b) Find the amount of the mortgage Amount of Mortgage = Price of Home Down Payment = $195,000 $19,500 = $175,500
Mortgages Ex. The price of a home is $195,000. The bank requires a 10% down payment and two points at the time of closing. The cost of the home is financed with a 30-year fixed-rate mortgage at 7.5%. c) How much must be paid for the two points at closing? 2 points is 2% of the loan amount. So, we need to find 2% of $175,500: 2 points = 0.02 x $175,500 = $3510 Note: $19,500 down payment is paid to seller and the cost of two points $3510 is paid to the lending institution
Mortgages Ex. The price of a home is $195,000. The bank requires a 10% down payment and two points at the time of closing. The cost of the home is financed with a 30-year fixed-rate mortgage at 7.5%. d) Find the monthly payment P = $175,500 r = 0.075 /yr t = 30 yr n = 12 /yr
Mortgages Ex. The price of a home is $195,000. The bank requires a 10% down payment and two points at the time of closing. The cost of the home is financed with a 30-year fixed-rate mortgage at 7.5%. e) Find the total interest paid over 30 years We pay $1227.12 every month for 30 years. That is 12 x 30 = 360 times. So, we paid 360 x $1227.12 = $441,763.20 on the loan. The amount of the mortgage was $175,500. Therefore total interest = $441,763.20 $175,500 = $266,263.20
Loan Amortization Schedules When a mortgage loan is paid off through a series of regular payments, it is said to be amortized. Monthly payments are the same, however with each successive payment the interest portion decreases and the portion applied toward paying off the principal increases. Interest computer using simple interest: I = Prt, where P is the balance of the loan, r is the annual interest rate, and t is 1/12 (if payments are monthly) The loan amortization schedule is a document showing how the payment each month is split between interest and principal
Loan Amortization Schedules Ex. Prepare a loan amortization schedule for the two months of the mortgage loan shown below:
Loan Amortization Schedules Payment 1: Interest for the Month = Prt = $130,000 x 0.095 x (1/12) = $1029.17 Principal Payment = Monthly Payment Interest Payment = $1357.51 $1029.17 = $328.33 Balance of Loan = Principal Balance Principal Payment = $130,000 $328.33 = $129,671.67
Loan Amortization Schedules $1029.17 $328.33 $129,671.67 Payment 2: Interest for the Month = Prt = $ 129,671.67 x 0.095 x (1/12) = $1026.57 Principal Payment = Monthly Payment Interest Payment = $1357.51 $1026.57 = $330.93 Balance of Loan = Principal Balance Principal Payment = $ 129,671.67 $330.93 = $129,340.74
Loan Amortization Schedules
Loan Amortization Schedules Ex. Prepare a loan amortization schedule for the first two months of the mortgage shown below:
Loan Amortization Schedules Ex. Prepare a loan amortization schedule for the first two months of the mortgage shown below: $1166.67 $383.33 $199,616.67 $1164.43 $385.57 $199,231.10
Determining What You Can Afford Most financial advisers suggest: Spend no more than 28% of your gross monthly income for your mortgage payment Spend no more than 36% of your gross monthly income for your total monthly debt, including mortgage payments, car payments, credit card bills, student loans, and medical debt.
Determining What You Can Afford
Determining What You Can Afford Ex. Suppose that your gross annual income is $30,000. a) What is the maximum amount you should spend each month on a mortgage payment? b) What is the maximum amount you should spend each month for total credit obligations? c) If your monthly mortgage payment is 90% of the maximum amount you can afford, what is the maximum you should spend each month for all other debt?
Determining What You Can Afford Ex. Suppose that your gross annual income is $30,000. a) What is the maximum amount you should spend each month on a mortgage payment? You should spend no more than 28% of gross monthly income. Monthly Income = $30,000 x (1/12) = $2500 Max Amount = $2500 x 0.28 = $700
Determining What You Can Afford Ex. Suppose that your gross annual income is $30,000. b) What is the maximum amount you should spend each month for total credit obligations? You should spend no more than 36% of gross monthly income. Monthly Income = $2500 Max Amount = $2500 x 0.36 = $900
Determining What You Can Afford Ex. Suppose that your gross annual income is $30,000. c) If your monthly mortgage payment is 90% of the maximum amount you can afford, what is the maximum you should spend each month for all other debt? Max you can afford: $700 Monthly Payment = 0.9 x $700 = $630 Max on all other Debt = $900 $630 = $270
Renting Vs. Buying Should you rent or buy a home? Benefits of Renting: No down payment or points required Flexibility: you can easily relocate Saves up money that can be invested in other ways May have lower monthly expenses Avoids risks of falling housing prices Doesn t require home repair and maintenance No property taxes Less costly than buying a home if you stay in it for less than 3 years
Renting Vs. Buying Should you rent or buy a home? Benefits of Home Ownership: Peace of mind and stability Tax advantages: deduction of mortgage interest and property taxes No chance of rent increasing over time Freedom to remodel, landscape, and redecorate Can build up equity, the difference between the home s value and what you own the mortgage, as the mortgage is paid off. If you are looking at 7-year time frames, renting becomes much more expensive
Practice Problems Page 555 Cost of Home Ownership: #1-12