Buying House

					       FIN 101 BUSINESS FINANCE

               Fall 2011

 Buying a House
An Analysis of Choices Involved
            RacQuelle Subia

       Our group decided to conduct this project by assuming the role of a married couple looking for their first

house. For simplicities sake we have chosen to go by the name “Smith.”

       The Smiths had many factors to consider when it came to obtaining a loan to purchase their house, from

the type of financial institution to the loan type and whether or not to go with points. In the end, they chose to

go with a 30-year fixed rate mortgage from SAFE Credit Union because of the lower down payment and the

lower monthly payments.

       The Smiths have many types of investments they may choose from to save money on a short-term basis.

The investment opportunities the Smiths considered were savings accounts, certificate of deposits, tax lien

certificates and mutual funds. With today’s market and the Smiths short-term investment goal, we selected the

Share Savings account in combination with a certificate of deposit; this would give us the best return on

investment for the least amount of risk.


Background Information
       The Smiths are a young couple in their late 20s, early 30s who have recently gotten married. They have

graduated college and received their respective Bachelor’s Degrees in Business. They are five years settled into

their careers with a combined, gross annual income of $100,000 and credit scores estimating around 700 each.

They plan to buy a house within the next five years and have their first child soon afterwards.

       Elk Grove is the neighborhood the Smiths chose to buy a house in. They chose this neighborhood

because it is well maintained, has a school district that ranks in the 60th percentile, in the state (Elk, n.d.), has

an average of one violent crime per 1,000 people (Elk, n.d.), and has a high level of ethnic diversity (Elk, n.d.).

       The house is located at 8536 Cord Way and costs $169,000 without closing costs (Coudright, n.d.) and

between $172,798 and $175,127 with closing costs (Investments, n.d.; SAFE, n.d.). It is 2,060 square feet with
four bedrooms, three bathrooms, a roomy kitchen with an attached dining nook, a living room, a family room

and a spacious backyard that is easily maintained (Coudright, n.d.). The house is perfect for the Smiths because

there is room for their family to expand. The house is a good size for entertaining company or having family

come to visit. It is also conveniently located to shopping, schools, recreation and emergency services (8536

Cord, n.d.). It is about a 20-30 minute drive to downtown Sacramento with traffic, making it an easy commute

to work or school (8536 Cord, n.d.).

Buying a House

       When planning to buy a house, there are some factors that need to be considered. The biggest two being

the type of financial institution to go through and the type of loan to get mortgage loan. The financial

institution and loan type decide affect the interest rates and the closing costs that have to be paid.

Banks vs. Credit Unions

       Two main types of financial institutions are: Banks and Credit Unions. The main differences include

capacity and size, interest rates on borrowing, fees and availability of coverage.

       Credit Unions are institutions that are owned by a group of people who put their money in to provide

bank services and loans to other members (Cite). They usually provide services to a small population and tend

to be located in one or two particular cities and towns. Overdraft fees, late fees and other fees are low to

nonexistent with a credit union (Cite), and the interest rates on borrowed money are low.

       The most well-known banks are the national banks that spread from coast to coast and are large

corporations, but there are also small local banks that can be found. Banks offer services to the general public,

can have multiple branches in the same city and provide more ATM machines. They also offer more availability

in the hours of their customer support services.

       The Smiths looked at SAFE Credit Union and Bank of America. SAFE Credit Union serves the

Sacramento area and surrounding counties (SAFE, n.d.).
Fixed Loans vs. Adjustable Rate Mortgage Loans

       Two main types of loans for purchasing and refinancing a home are: fixed rate loans and adjustable rate

mortgage (ARM) loans.

       Fixed rate loans are long term loans (Cite), the most common being 15 or 30 years, and have a single

fixed interest rate. With a fixed rate loan the interest rate will stay the same no matter the market conditions.

With a fixed rate loan the borrower knows how much has to be paid every month to cover the interest and the


       Adjustable rate mortgage loans have a short term, usually 3 or 5-years and a low interest rate and

monthly payments that are fixed only for the term (Cite). After the term is up the interest rate goes from fixed to

variable and changes with the market (Cite). ARM loans are usually chosen by people who have low credit

scores and don’t qualify for a fixed rate loan (Cite). People with low credit scores tend to use ARM loans to

raise their score during the term of the loan and then apply for a fixed rate loan when term is up and the score is

increased (Cite).

       The Smiths have a credit score of 700 so they would most likely qualify for a 30-year fixed rate loan and

is the option they plan on choosing.

Interest Rates and Annual Percentage Rates

       Interest rates are rates the lender charges the borrower (Interest, n.d.). Interest is charged as

compensation for the lender losing the ability to use the asset for some other purpose (Interest, n.d.). The

Federal Reserve sets the interest rates by raising or lowering them depending on the state of the economy

(Bruce, n.d.). When the economy is growing, the Federal Reserve raises the rates to keep the economy from

growing too fast and keep inflation under control (Bruce, n.d.). When the economy is shrinking, the Federal

Reserve will lower the rates to entice consumers to borrow and help the economy grow (Bruce, n.d.). Whether
or not a bank considers a borrower to be a risky investment also determines how high the interest rate will be. If

the borrower is considered to be risky, the lender will charge a higher interest rate to borrow the asset.

         An annual percentage rate (APR) is a rate charged by a lender for borrowing an asset (Annual, n.d.),

such as cash. This rate represents the total yearly costs of the asset over the term of the loan; it includes any fees

and miscellaneous costs associated with the loan, which is why it can differ from the interest rate (Annual, n.d.).

The APR provides a rate that a borrower can use to compare different financial institutions (Annual,n.d.).


         Borrowers can pay some the interest on the loan upfront and earn points (Cite). Each point is the

equivalent of 1% of the interest rate on the loan and reduces the rate and interest payments throughout the life of

the loan (Cite). The points can also be a tax deduction if they meet certain IRS requirements (Cite).

         The Smiths have decided to opt out of the points system in order to avoid a large down payment.

Closing Costs

         Closing costs are miscellaneous fees that come with buying a house. They tend to range from 1% to 6%

of the loan cost (Cite). The borrower usually pays the closing cost upfront (Cite), so they should be considered

when saving for the down payment; sometimes the closing cost can be rolled into the mortgage (Cite). The

buyer has the option of requesting that the seller cover part or all of the closing costs associated with the


         Many different fees make up closing costs and those fees vary from state to state. Jeanne M. Hogarth

stated in her article “H.O.M.E. Closing Costs” (Cite), that closing costs consists of statutory fees, third-party

fees and lender fees. Statutory fees are government fees that would have to be paid even if the house was paid

for in cash (Cite); they include transfer taxes, recording fees for deeds, state and local fees and pro-rated taxes.

Third-party fees are expenses paid to others, excluding the government or the lender; the fees include attorney

fees, title search costs, homeowner’s insurance, and real estate agent’s sales commission. Lender fees are costs
that come from obtaining a loan; they include application fees, credit reports, points, lender’s mortgage

insurance, lender’s title insurance, release fees, inspections require by the lender, prepaid interest and escrow


       Table 1 shows two different 30-year fixed rate loans, one from SAFE Credit Union and one from Bank

of America, that have been offered to the Smith’s. As the table shows, total closing costs from SAFE Credit

Union are $2329 less than what is offered by Bank of America. Going with SAFE makes the down payment

cheaper, which makes the entire cost of the house cheaper. SAFE also offers a lower interest rate and APR,

making the monthly payments cheaper. The obvious choice for the Smith’s is SAFE Credit Union.

                                                      Table 1
                       LOAN DETAILS: 8536 CORD WAY SACRAMENTO, CA 95828
PURCHASE PRICE                   $169,000.00                          LOAN AMOUNT                      $135,200.00
DOWN PAYMENT                      $33,800.00                          TERM                               30 YEARS
      Option #1 – SAFE CREDIT UNION                                         Option #2 – BANK OF AMERICA
RATE                                  4.000%                          RATE                                  4.375%
APR                                   4.306%                          APR                                   4.453%
DISCOUNT POINTS                       0.000%                          DISCOUNT POINTS                       0.000%
P&I PAYMENT                          $655.25                          P&I PAYMENT                           $679.00
TAX AND INSURANCE                    $226.04                          TAX AND INSURANCE                     $227.00
TOTAL MONTHLY PAYMENT                                                     $881.29                      TOTAL
MONTHLY PAYMENT                      $905.00
                                         CLOSING COST ESTIMATES
UNDERWRITING FEE                     $325.00                          UNDERWRITING FEE                          N/A
DOC PREP FEE                         $325.00                          DOC PREP FEE                              N/A
POINTS                                      0                         POINTS                                        0
LENDERS FEE                               N/A                         LENDERS FEE                            $1,075
TOTAL SAFE CU FEES                   $650.00                          TOTAL BOFA FEES                        $1,075
                                                THIRD PARTY FEES
APPRAISAL                            $425.00                          APPRAISAL                             $435.00
CREDIT REPORT                         $9.83                        CREDIT REPORT                         $35.00
TAX SERVICE FEE                      $61.00                        TAX SERVICE FEE                       $84.00
FLOOD CERT FEE                       $15.50                        FLOOD CERT FEE                        $26.00
CLOSING FEE                         $600.00                        CLOSING FEE                        $1,350.00
TITLE ENDORSEMENTS                   $50.00                        TITLE ENDORSEMENTS                   $125.00
NOTARY FEE                          $125.00                        NOTARY FEE                               N/A
TITLE INSURANCE                     $600.00                        TITLE INSURANCE                      $750.00
LENDERS TITLE INSURANCE                                                     N/A                    LENDERS
TITLE INSURANCE                     $345.00
CITY TAX/STAMP FEE                      N/A                        CITY TAX/STAMP FEE                   $467.50
WIRE/FAX FEE                            N/A                        WIRE/FAX FEE                             N/A
COURIER FEE                             N/A                        COURIER FEE                              N/A
EMAIL DOC FEE                           N/A                        EMAIL DOC FEE                            N/A
RECORDING FEE                       $125.00                        RECORDING FEE                           $150
TOTAL THIRD PARTY FEES                                                $2,011.33                    TOTAL
THIRD PARTY FEES                   $3955.00
                                               PRE-PAID ITEMS
DAYS OF INTEREST               15 - $232.33                        DAYS OF INTEREST                   3 - $48.88
MONTHS OF INSURANCE              4 - $200.00                       MONTHS OF INSURANCE                  $693.76
MONTHS OF TAXES                  4 - $704.17                       MONTHS OF TAXES                   2 - $353.95
TOTAL PRE-PAIDS                   $1,136.54                        TOTAL PRE-PAIDS                    $1096.59

TOTAL CLOSING COSTS               $3,797.87                        TOTAL CLOSING COSTS                $6,126.59

TOTAL COST AT CLOSING            $37,597.87                        TOTAL COST AT CLOSING             $39,926.59

Saving to Buy a House in Five Years

       Because of the amount of cash that has to be paid up front, buying a house can be a difficult experience.

The down payment that the Smiths have to pay is $37,598 and they have no money in savings so they have to

find some way to save up the entire $37,598 within the next five years.
Deposit Account Types

       Two common deposit account types are savings accounts and certificate of deposits (CD). Savings

accounts offer a variable rate and the ability to add and remove money at will, while CDs offer a fixed rate for a

specific term and the money is untouchable for the entire term of the CD.

       The Smiths decided to go with a SAFE Credit Union savings account to start.

                                                      Table 2
                                                  Saving Deposits

                    Investment Vehicles         APY          Variable Rate         Fixed Rate

                       Share Savings               0.10%            √

                         3 YR CD                   1.11%                                √

                         4 YR CD                   1.41%                                √

Other Investment Types

       There are many other types of investments, mutual funds and tax lien certificates are just the two that the

Smiths decided to look at.

       When the owners of a property have not paid their taxes, the government puts a tax on the property (Tax

Lien Certificates Directory, n.d.). The owners of a property with a tax lien may have the lien removed by paying

their taxes and back taxes on time, but if they are unable to pay on time the county government will allow

investors to pay the taxes for the owner (Tax Lien Certificates Directory, n.d.).. The county holds a public

auction and the winning bidder obtains a certificate as proof of purchase. The owner of the property is then in

debt to the investor for the amount the investor paid and all of the interest. The certificate terms in California

are usually 2 to 3 years (Tax Lien Certificates, n.d.). These certificates have two possible outcomes. In the first

outcome, the certificate owner will receive an annual return of up to 50% per year for the term of the certificate

(Tax Lien Certificates Directory, n.d.)., the annual return in California is 18% (Tax Lien Certificates, n.d.). In

the second outcome, through foreclosure, the certificate owner can become the owner of the real estate and the
property will be free of any other liens or mortgages, this only happens if the original property owners do not

pay all of the money and interest due.

       Mutual funds are an investment of large sums of money collected from many different investors to

invest in securities, such as stocks and bonds (Mutual, n.d.). A third party who takes the money and invests it

for the investors (Mutual, n.d) operates the funds. Because the money is going into the stock and bond securities

market, this investment is very risky and no poses unnecessary risk without a guaranteed of an actual return

on investment. at the end of the investment’s term.

       In short, the Smiths decided that both mutual funds and tax lien certificates are not ideal investments.

Mutual funds do not provide a guaranteed return with minimal risk. In regards to tax liens, the property owner

could default on payments whereby enacting a transfer of real property to the investor versus interest due on

mortgage payments. The Smith’s goal of pursuing an investment yielding interest would potentially be at risk

with the tax lien model.

       Table 3 shows the Share Savings goals, the monthly payments required to meet those goals and the total

interest accrued after depositing the money in a savings account. At first, the rates appear to be too low to be

useful produce anything of significant value, but it can be seen by looking closer ; however, after closer

inspection, we can see from the table 3 that plans two and three offer high savings compared much higher

savings in comparison to plan one. Based on their combined income, the Smiths can easily meet the monthly

payment requirements for plan three by creating a spending budget and sticking to it that they stick to.

                                                           Table 3
                                                      Savings’ Scenarios
                                                                                         Total Interest
                   Starting            Transfer             Share Savings                 Accrued on
  Inv. Plan                                                                 Payment
                 Investment₁         Investment₂                Goal₃                     Investment
                Share Savings
      1          @5yr, .10%              ----------            $37,597.87      $625.38           $92.34
      2         Share Savings         3 YR CD                  $36,373.15    $1,514.79          $894.84
                        @2yr, .10%                @1.11% APY
                       Share Savings
                                                   4 YR CD
         3              @1yr, .10%                                               $35,550.04               $2,962.50                $2,064.12
                                                  @1.41% APY
¹ Original source of investment beginning with zero funds. ² New investment vehicle upon meeting Share Savings Goal. ³ Amount required or due for Savings/CD to

meet savings goal of $37,597.87.00 upon maturity. ⁴ Amount required monthly to meet Share Savings Goal.


          To help us understand what goes into buying a house, our group created a fictional couple called the

Smiths. The Smiths looked through a variety of options for every step of buying their house. They compared

Bank of America and SAFE Credit Unions to find the best interest rates on loans, and then compared fixed rate

loans and to ARM loans. They eventually decided to go with a 30-year, fixed rate mortgage with a 4% interest

rate. Because the Smiths do not have any savings to buy the house, they have to save for five years. Then As a

result, the Smiths compared four different types of investment opportunities to place deposit their money in;

the investment types are were a savings account, a certificate of deposit, tax lien certificates and mutual funds.

They decided to go with a combination of a certificate of deposit in combination with and a savings account

from SAFE Credit Union because of the guaranteed returns and amount of savings they will would earn.
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