R.P. Brown Real Estate

Why Buy a Home?

Buying a home provides financial security, residential stability and most of all, a place to call your very own.

1. Tax benefits. You can deduct the interest you pay on your mortgage, which can be substantial tax savings! For instance, It could equal a savings of $100 to $500 per month.

2. Appreciation. Real estate is one of the few investments which have kept up with the pace of inflation over the past few decades. In California, real estate appreciation has averaged more than 5% per year over the last twenty years. Many families have realized a substantial equity build up just by purchasing a home.

3. Control. You don't have to worry about your landlord raising your rent or giving you a notice to move. You don't have to worry about getting permission from your landlord to put up wallpaper, paint the inside, or install new carpet!

4. Future. Real estate is an investment for your future, and for that of your family.

5. Missed Opportunity. It is so easy to say, "I'll do it later." But if you put your dreams off until later, you lose momentum and excitement. By then your dreams may be out of your reach!

Home Ownership Benefits

In addition to building up equity over time, owning a home offers significant tax breaks. The interest expense that you pay on up to $1 million in home mortgage debt ($500,000 if you are single) is tax-deductible.
Your tax savings from the mortgage interest tax deduction are greatest in the early years of a mortgage loan. For example, on a 7%, 30-year fixed rate mortgage loan of $100,000, you pay $6,968 in interest the first year of the loan. If you are in the 27% income tax bracket, your tax savingsare $5,086 [$6,968*(1-0.27)]. In Year 16 of the loan, you pay $5,090 in interest, far less than your tax savings in the first year when adjusted for inflation.

When you sell your home, you can exclude up to $500,000 in capital gains ($250,00, if you file a single return). You will need to pass IRS ownership and use tests to show that the home has been your primary residence for at least two of the past five years. In addition to mortgage interest, you can also deduct your local property taxes on your income tax return.
As a homeowner, you can tap the equity in your home in the future with a home equity loan or line of credit. Interest expense that you pay on up to $100,000 in home equity debt is tax-deductible ($50,000 if you are single).

Deciding to Buy

Buying a home is a rewarding experience. You derive a great deal of personal satisfaction from owning a home. Homeownership allows you to build up your personal net worth over time. And continued increases in housing prices nationwide makes homeownership a relatively attractive investment.
In addition to building up equity over time, owning a home offers significant tax breaks. The interest expense that you pay on up to $1 million in home mortgage debt ($500,000 if you are single) is tax-deductible.
Your tax savings from the mortgage interest deduction are greatest in the early years of a mortgage loan. For example, on a 7%, 30-year fixed rate mortgage loan of $100,000, you pay $6,968 in interest the first year of the loan. If you are in the 27% income tax bracket, your tax savings are $5,086 [$6,968*(1-0.27)]. In Year 16 of the loan, you pay $5,090 in interest, far less than your tax savings in the first year when adjusted for inflation.

As a homeowner, you can tap the equity in your home in the future with home equity loan or line of credit. Interest expense that you pay on up to $100,000 in home equity debt is tax-deductible ($50,000 if you are single).

The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a mortage lender or financial adviser.

Personal Net Worth

Your personal net worth is equal to your personal assets minus personal liabilities. Personal net worth is measured as of a given date (for example, "Your personal worth is worth this much as of Dec. 31, 2000."). For example, if you have $100,000 in personal assets and $75,000 in personal liabilities, you have $25,000 in personal net worth. Since the value of your assets fluctuates, your personal net worth will fluctuate.

For example, six months later on June 30, your personal assets may have risen in value to $110,000. In this case, your personal net worth has also increased by $10,000 to $35,000. If you are married, consider computing a combined personal net worth, or splitting the value of jointly owned assets in two. If you have more assets than liabilities, you have a positive personal net worth. Personal net worth is also called personal equity.

Home Affordability

To determine how much of a home you can afford, you need to calculate your expected monthly payment. Most of your payment will go toward loan principal and interest, or P & I. But your monthly payment is likely to include amounts for property taxes and homeowners insurance. As a result of these extra payments, your monthly payment is sometimes called your PITI.

If you plan on making a downpayment of less than 20% of the home purchase price, you will also have to add an additional amount for private mortgage insurance (PMI). Lenders require PMI to insure against the higher risk of default that occurs at loan-to-value (LTV) ratios greater than 80%. (an LTV of 80% is equal to a down payment of 20%).

Although your monthly payment is fixed, the amounts applied to Principal and interest change as you make your payments. Initially, your payment is applied almost entirely to the interest you owe. The longer you pay on the loan, the greater the amount that is applied toward the Principal; the amount that you have borrowed and must repay.

The following analyzers can help you to calculate your monthly payment and determine whether PMI will be necessary:

After you calculate your monthly payment, you should calculate your housing and debt ratios. These ratios help you to get an idea of home affordability. Lenders rely on these ratios to help in their decisions to approve mortgage loans.
Your housing ratio is your total monthly payment divided by your monthly gross income. As a general rule, the ratio should not be more than 28%. For example, if your monthly loan P+I+T+I payment is $1,400, your monthly gross income should be at least $5,000.
Your debt ratio is the sum of your P+I+T+I and any other credit card or loan payments, divided by monthly gross income. Debt ratio will obviously be a higher percentage, since most people have other loans or credit card debt. As a general rule, your debt ratio should not be more than 36%. If your monthly gross income is $5,000, your total loan payments (including the proposed mortgage loan payment) should not be more than $1,800.
Mortgage lenders regularly use these 28% and 36% ratios as guidelines. The ratios change over the course of the economic cycle. When the economy is strong, lenders tend to raise the ratios, making it easier obtain a loan. When the economy is weak, lenders tend to lower the ratios, making it harder to obtain a loan. A weaker economy leads to lower interest rates, which makes it somewhat easier to qualify.

You may wish to limit a home search to home prices that allows you to obtain a mortgage loan that is conforming. A conforming loan means that the loan amount is within the annual limits set by Fannie Mae and Freddie Mac, two government-sponsored enterprises that focus on investing in residential mortgages.
For 2002, the conforming loan limit for Fannie Mae- and Freddie Mac-sponsored loans is $300,700. For Alaska and Hawaii, the limit is $451,050. For example, if you make a 20% down payment on a $360,000 home in California in 2002, you would borrow $288,000, which is within the limit.

If your mortgage loan is comforming, you will likely have an easier time finding a lender than if the loan is non-comforming. (A non-conforming loan is called a "jumbo" loan.) As a general rule, the interest rate on a conforming-loan mortgage is cheaper than on a non-conforming mortgage.

Down Payment

How much of a home you can afford also depends on the amount of your down payment. If you don't have one saved, consider these options as a source of down payment:

Federal government mortgage-financing programs. The U.S. Dept. of Housing and Urban Development and Dept. of Veterans Affairs run loan programs for first-time homeowners and veterans of the armed forces. These programs require little or no down payment. Your lender can tell you more about these programs.
Obtain private mortgage insurance. Private mortgage insurance, discussed above, allows you to make a down payment of as little as 5% of the home purchase price.
Borrow against the value of your investments. Some financial institutions offer mortgages that are backed by the value of your investments. With these programs, portfolio serves as the collateral for your mortgage.
Borrow from your employer-sponsored retirement plan. Most employers allow you to borrow against the value of your 401(k) plan. (The IRS does not allow you to borrow from an IRA, however.) Remember that if you leave your job, you'll likely have to pay back the full amount of the loan immediately.
Withdraw funds from an individual retirement account. While the IRS does not allow you to borrow from an IRA, it does allow penalty-free withdrawals of up to $10,000 for first-time homebuyers. However, you will owe income taxes on the amount of the withdrawal.
State government housing programs. Most states have programs to help residents buy their first homes.

In addition to a down payment, you should expect to closing costs on your home loan. How much you pay in closing costs depends on how points you pay on your loan. One point is equal to 1% of the loan amount. As a general rule, closing costs range from 2 to 4 percent of the home purchase price. Besides points, other major categories of closing costs include:

Fees to process your loan application, review your loan documents, and fund the loan.
Payments to fund an escrow account. Escrow funds are used to pay your homeowner's insurance and property taxes. As a general rule, you replenish an escrow account once or twice a year.
Fees for legal and appraisal services, credit review, and title search and insurance.

You will also have moving expenses if you buy a home in a different city. If you move to another region of the country, you may also face a change in the cost of living. If you're moving to a new city to take a job, your new employer may reimburse you for these expenses. If not, you can deduct them from your taxes.

Obtaining a Lender's Pre-Approval

A lender's pre-approval is a commitment to fund your mortgage loan for a fixed period of time. A pre-approval may include an interest rate lock. To obtain a pre-approval, a lender evaluates your credit history, and calculates your housing and debt ratios. You should expect to verify your income, length of employment and source of down payment.

A pre-approval legitimizes you as a serious buyer. It also gives you additional negotiating leverage to negotiate a sale price, especially if the seller cannot find other pre-approved buyers.
When seeking a pre-approval, it's important to not misrepresent the facts on your application. If a lender learns later that you've misrepresented or omitted information on your application, your pre-approval may be rescinded.

As part of the pre-approval process, a lender obtains your credit report. You should be familiar with the contents of your credit reports from all three major credit bureaus:
If a lender denies you a pre-approval, you should investigate immediately. Without one, your chances of obtaining a mortgage loan are jeopardized. If a lender bases the decision, in part, on information in your credit report, you have the right to receive a free copy of the report.

Own vs. Rent Comparison Online Calculator from First American Title Company.

Disclaimer: The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a mortage lender or financial adviser.