Making Automobile
and Housing Decisions
Chapter 5
How Will This Affect Me?
A home is typically the largest single investment you’ll ever make, and a car is usually the
second largest. The decisions to buy and finance these assets are important, personal, and
complicated. This chapter presents frameworks for deciding when to buy a first home, how to
discuss in class the critical thinking questions and assign as homework problems 2 and 3.
Learning Goals
LG1 Design a plan to research and select a new or used automobile.
A useful exercise is to go to Carmax or other site and compare the cost of owning a car where:
LG2 Decide whether to buy or lease a car.
LG3 Identify housing alternatives, assess the rental option, and perform a rent-or-buy analysis.
The Worksheet 5.2 gives a format for making this decision. It is an important decision. I knew a
couple of school teachers in Milwaukee that never purchased a home. They rented their entire
LG4 Evaluate the benefits and costs of homeownership and estimate how much you can afford
to pay for a home.
LG5 Describe the home-buying process.
LG6 Choose mortgage financing that meets your needs.
Financial Facts or Fantasies?
These may be used as “teasers” to get the students on the right page with you. Also, they may be
used as quizzes after you covered the material or as “pre–test questions” to get their attention.
The closing costs on a home are rather insignificant and seldom amount to more than a few
hundred dollars.
Fantasy: Closing costs – most of which must be paid by the buyer – on home purchases can
amount to several thousand dollars and often total an amount equal to 50 percent or more of the
down payment.
In an adjustable-rate mortgage, payment will change periodically, along with prevailing interest
Financial Facts or Fantasies?
These may be used as a quiz or as a pre-test to get the students interested.
1. True False For most people, an automobile will be their second largest purchase.
2. True False The most popular form of single-family housing is the condominium.
3. True False The closing costs on a home are rather insignificant and seldom amount to
more than a few hundred dollars.
4. True False The amount of money you earn has a lot to do with the amount of money
you can borrow.
5. True False In an adjustable-rate mortgage, payment will change periodically, along
with prevailing interest rates.
6. True False Mortgage insurance guarantees the lender that the loan will be paid off in
the event of the borrower’s death.
YOU CAN DO IT NOW
The “You Can Do It Now” cases may be assigned to the students as short cases or problems.
They will help make the topic more real or relevant to the students. In most cases, it will only
take about ten minutes to do, that is, until the student starts looking around at the web site. But
they will learn by doing so.
What’s Your Car Worth?
YOU CAN DO IT NOW
Rent vs. Buy a Home?
YOU CAN DO IT NOW
Current Mortgage Rates
Financial Impact of Personal Choices
Read and think about the choices being made. Do you agree or not? Ask the students to discuss
the choices being made.
Clara Wants to Buy a House but Doesn’t Want a Roommate Now
Additional comments:
How’s Your Local Housing Market?
What’s the best source of information about available housing in your community? The answer
is a well-informed professional real estate agent whose business is helping buyers find and
negotiate the purchase of the most suitable property at the best price. However, there’s another
Teaching suggestions:
Perhaps you could help the student by identifying neighborhoods or areas of the city based upon
your knowledge of the locality. In addition, most large real estate agency have web pages that
Financial Planning Exercises
1. Planning a new car purchase: Anna Davis has just graduated from college and needs to
buy a car to commute to work. She estimates that she can afford to pay about $450 per
month for a loan or lease and has about $2,000 in savings to use for a down payment.
Develop a plan to guide her through her first car-buying experience, including researching
car type, deciding whether to buy a new or used car, negotiating the price and terms, and
financing the transaction.
Exhibit 5.1 lists the steps in buying a new car.
• Research which car best meets your needs and determine how much you can afford to
spend on it. Choose the best way to pay for your new car—cash, financing, or lease. Ask
2. Lease vs purchase car decision: Use Worksheet 5.1. Ben Halls is trying to decide whether
to lease or purchase a new car costing $18,000. If he leases, he’ll have to pay a $600 security
deposit and monthly payments of $450 over the 36-month term of the closed-end lease. Ben
could earn 1% on the amount of any down payment or security deposit. On the other
hand, if he buys the car then he’ll have to make a $2,400 down payment and will finance
the balance with a 36-month loan with a 4% interest rate; he’ll also have to pay a 6 percent
sales tax ($1,080) on the purchase price, and he expects the car to have a residual value of
$6,500 at the end of 3 years. Ben can earn 4 percent interest on his savings.
Use the automobile lease versus purchase analysis form in Worksheet 5.1 to find the total
cost of both the lease and the purchase and then recommend the best strategy for Ben.
Name Date
Item Amount
1
$
$
600.00
2 3
336
4 $ 450.00
5 $ 16,200.00
6 0.010
estimated end-of–term charges
Purchase price
Down payment
Item 6)
Payment/refund for market value adjustment
at end of lease ($0 for closed-end leases) and/or
Opportunity cost of initial payment (Item 1 × Item 2 ×
13 $ 1,080.00
14 15600.00 $ 460.57
36 months, 4.00 %)
15 $ 16,580.67
16 $ 72.00
17 $ 6,500.00
If the value of Item 9 is less than the value of Item 18, leasing is preferred; otherwise the
purchase alternative is preferred.
Total payments over term of lease (Item 3 × Item 4)
AUTOMOBILE LEASE VERSUS PURCHASE ANALYSIS*
Description
Initial payment:
LEASE
Ben Halls
a. Down payment (capital
cost reduction):
b. Security deposit:
Term of lease and loan (years)*
Term of lease and loan (months) (Item 2 × 12)
Monthly lease payment
600.00
Estimated value of car at end of loan
Monthly loan payment (Terms:
Opportunity cost of down payment (Item 2 ×
Item 6 × Item 11)
Total payments over term of loan (Item 3 × Item 14)
November 15, 2018
Sales tax (Item 10 × Item 12)
Interest rate earned on savings (in decimal form)
3. Rent versus buy home. Use Worksheet 5.2. Emma Sanchez is currently renting an
apartment for $725 per month and paying $275 annually for renter’s insurance. She just
found a small townhouse she can buy for $185,000. She has enough cash for a $10,000 down
payment and $4,000 in closing costs. Her bank is offering 30-year mortgages at 5 percent
per year. Emma estimates the following costs as a percentage of the home’s price: property
taxes, 2.5 percent; homeowner’s insurance, 0.5 percent; and maintenance, 0.7 percent. She
is in the 22 percent tax bracket and does not plan to itemize deductions on her taxes.
Emma estimates that the value of the home will appreciate 2 percent per year. Using
Worksheet 5.2, calculate the cost of each alternative and recommend the least costly
option—rent or buy—for Emma.
Note since Emma will not itemize, there are no tax advantages to mortgage interest or property
taxes. Given the increase in the standard deduction enacted by the 2017 tax act, 90% of
taxpayers are expected to elect the standard deduction and not itemize deductions.
Problem 5.3
A.
1.
(12 $ 725.00 ) 8,700.00$
2. 275.00
3. × after-tax savings rate (1-t) –
Total cost of renting (line A.1 + line A.2 + line A.3) 8,975.00
$
B. 0. Purchase price of house $185,000
1. 175,000.00 , 360 months, 5 %) 11,273.25$
(12 $939.44 )
2. 4,625.00
( 2.5
3. 925.00
( 0.5
4. 1,295.00
( 0.7
Total costs (sum of lines B.1 through B.5)
% after-tax rate of return)
Less:
8. 3,700.00$
( 2
9. 12,004.20$
% of price of home)
Homeowner’s insurance
RENT-OR-BUY ANALYSIS
× monthly rental rate of
COST OF RENTING
Annual rental costs
Renter’s insurance
Property taxes
Opportunity cost of security deposit:
COST OF BUYING
Annual mortgage payments (Terms:
× monthly mortgage payment of
% of price of home)
Maintenance
% of price of home)
% of price of home)
Total cost of buying (line B.6 – line B.7 line -B.8)
Estimated annual appreciation in value of home
4. Maximum affordable mortgage payment. Using the maximum ratios for a conventional
mortgage, how big a monthly payment could the Ross family afford if their gross (before-
tax) monthly income amounted to $3,500?
Would it make any difference if they were already making monthly installment loan
payments totaling $750 on two car loans?
5. Changes in mortgage principal and interest over time. Explain how the composition of the
principal and interest components of a fixed-rate mortgage change over the life of the
mortgage. What are the implications of this change?
6. Calculating required down payment on home purchase. How much would you have to put
down on a house with an appraised value of $105,000 and the lender required an 80
percent loan-to-value ratio?
7. Calculating monthly mortgage payments. Find the monthly mortgage payments on the
following mortgage loans using either your calculator or the table in Exhibit 5.6:
a. $90,000 at 6.5 percent for 30 years
b. $125,000 at 5.5 percent for 20 years
c. $97,500 at 5 percent for 15 years
8. Estimating closing costs on home purchase. How much might a home buyer expect to pay
in closing costs on a $220,000 house with a 10 percent down payment? How much would
the home buyer have to pay at the time of closing, taking into account closing costs, down
payment, and a loan fee of 3 points?
9. Using a real estate broker. Describe the ways in which a real estate broker represents
buyers versus sellers. What’s a typical real estate commission?
10. Adding to monthly mortgage payments. What are the pros and cons of adding $100 a
month to your fixed-rate mortgage payment?
11. Refinancing a mortgage.
Use Worksheet 5.4. Daisy Tran purchased a condominium ten
years ago for $300,000, paying $1,439 per month on her $240,000, 6 percent, 30-year
mortgage. The current loan balance is $200,857. Recently, Daisy has been considering
refinancing her condo. She expects to remain in the condo for at least four more years and
has found a lender that will make a 4 percent, 20-year, $200,857 loan, requiring monthly
payments of $1,217. Although there is no prepayment penalty on her current mortgage,
Daisy will have to pay $1,500 in closing costs on the new mortgage. She is in the 22 percent
tax bracket. Based on this information, use the mortgage refinancing analysis form in
Worksheet 5.4 to determine whether Daisy should refinance her mortgage under the
specified terms.
From the worksheet below, it will take 8.7 months to breakeven on the refinancing. Since she
plans to stay in the home for another 4 years, it will be to her advantage to refinance the
mortgage
Name Date September 6, 2018
Item Amount
1 240,000.00 , 6.00
%,
30 years) 1,439.00$
2 200,857.00 , 4.00
%,
20 years) 1,217.00$
3222.00$
422 %) 49.00$
5173.00$
6
$
1,500
1,500.00$
7 8.7
b. Total closing costs (after-tax)
Current monthly payment (Terms:
c. Total refinancing costs (Item 6a + Item 6b)
Months to break even (Item 6c ÷ Item 5)
New monthly payment (Terms:
Monthly savings, pretax (Item 1 – Item 2)
Tax on monthly savings [Item 3 × tax
Monthly savings, after-tax (Item 3 – Item 4)
Costs to refinance:
a. Prepayment penalty
Description
MORTGAGE REFINANCING ANALYSIS
Daisy Tran
Test Yourself – Legacy questions for your use
5-1 Briefly discuss how each of these purchase considerations would affect your choice of a
car:
a. Affordability
b. Operating costs
c. Gas, diesel, hybrid, or electric?
d. New, used, or “nearly new”?
e. Size, body style, and features
f. Reliability and warranty protection
5-2 Describe the purchase transaction process, including shopping, negotiating price, and
closing the deal on a car.
Shopping is all about finding the best car for you. Exhibit 5.2 lists some steps to take. The key
5-3 What are the advantages and disadvantages of leasing a car?
5-4 Given your personal financial circumstances, if you were buying a car today, would you
probably pay cash, lease, or finance it, and why? Which factors are most important to you
in making this decision?