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. As a result, 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 finance a home, and when to rent rather than to purchase a home. It also discusses the best
way to go about buying a new or a used car and how to decide between leasing and purchasing a
car. Given the large costs of such assets, the frameworks provided in this chapter can
significantly improve your short- and long-term financial well-being. After reading this chapter
you should be able to make more informed decisions in purchasing and financing your home and
car.
This chapter along with Part 5 on Investment Planning will be of the most interest to the
students. Getting their attention should be easy and you want to build on their primary interests:
Should I lease or purchase a car
Should I rent or purchase a home
Given these are the major interests of students and in fact are the major topics in the chapter, I
suggest that you build on them and use a case for each. The critical thinking case 5.1 uses
worksheet 5.1 to examines the lease v purchase of a car. The critical thinking case 5.3 uses
worksheet 5.2 to examine the question whether to rent or purchase a home [a condo in this case].
In addition, financial planning exercises 2 and 9 examine these same questions. I suggest you
discuss in class the critical thinking questions and assign as homework problems 2 and 9.
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:
Car 1 is purchased new and sold at the end of four years versus
Car 2 is purchased as a two-year old used car and sold two years later
Of course car 2 requires more buying and selling with the sell price not certain. But the result
will be interesting.
LG2 Decide whether to buy or lease a car.
In 2013, 30 percent of registered cars were leased. The percentage is most likely greater today.
The Worksheet 5.1 gives a format for comparing the lease v purchase decision. In addition,
several web sites give information about the decision. The Consumers Report site is:
http://www.consumerreports.org/cro/2012/12/buying-vs-leasing-basics/index.htm [accessed
August 13, 2015]
As noted above, this decision is very relevant to students and generally of great interest. It
deserves some class time—at least about half of one class. After discussion, work through the
critical thinking problem 5.1 to give an example of the decision.
As noted above, homework problem 2 uses Worksheet 5.1.
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 rental their entire
life—they did not want the maintenance issues and wanted to invest in the stock market. For
them it was the right decision. For younger people, the decision may turn on the length of time
they plan to be in one place. Over three years, the appreciation in value will normally cover the
cost of selling a home, so if you plan to stay in one place more than three years, purchase is
frequently the better.
If you Google “rent buy house calculator” you will see a variety of calculators to analysis the
rent v buy decisions. I doubt they are any better than the one in the book, but they are there.
I suggest you spend half a class discussing this decision, and then work through criterial thinking
problem 5.3 to give an example of the decision.
As noted above, homework problem 9 uses Worksheet 5.2.
LG4 Evaluate the benefits and costs of homeownership and estimate how much you can afford
to pay for a home.
Worksheet 5.3 examines how much you can afford and is used in Financial Planning Exercise 4.
Discussing this problem will cover the topic.
LG5 Describe the home-buying process.
Exhibit 5.11 discusses strategies to improve the home-buying process. The chapter covers this
process and gives the terminology needed to understand the process. Small class time is all that
is required.
LG6 Choose mortgage financing that meets your needs.
The Test Yourself Questions 5-20, 5-21, and 5-22 cover the options to consider. The Financial
Planning Exercise 10 gives some examples of comparing mortgage types and payments.
Depending upon the prior knowledge of your students on using financial calculators or present
value tables, the coverage in the textbook may be sufficient. Thus, little time will be required. If
prior knowledge is less, this material may prove difficult and will require additional class time.
It is important that the students understand how to compute mortgage payments and various
mortgage terms.
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.
For most people, an automobile will be their second largest purchase.
Fact: A car ranks second only to housing with respect to the amount of money spent.
The most popular form of single-family housing is the condominium.
Fantasy: The most popular form of single-family housing is the single-family home – a detached
residence that sits on its own legally defined lot. Condos, in contrast, are built typically in large,
multi-unit developments on grounds that are common to all residents.
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.
The amount of money you earn has a lot to do with the amount of money you can borrow.
Fact: Your monthly income is a key determinate of how large a mortgage loan you can afford.
Also important are your credit record and the level of your total monthly installment loan
payment.
Mortgage insurance guarantees the lender that the loan will be paid off in the event of the
borrower’s death.
Fantasy: Mortgage insurance protects the lender from loss in the event the borrower defaults on
the loan.
In an adjustable-rate mortgage, payment will change periodically, along with prevailing interest
rates.
Fact: In this popular form of home mortgage loan, the term of the loan is fixed (usually at 15 or
30 years), but the rate of interest, and therefore the size of the monthly mortgage payment, is
adjusted up and down in line with movements in interest rates.
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?
If you have a car, it’s good to know what it is worth from time-to-time. That
way you’ll have a better sense of your net worth and you’ll know how much
your car is depreciating over time. Just go to the Kelley Blue book site at
http://www.kbb.com” www.kbb.com and go the “Price New/Used Cars” –
you can do it now.
YOU CAN DO IT NOW
Rent vs. Buy a Home?
Thinking about buying a home rather than continuing to rent? Or would you
just like to know the relative attractiveness of renting vs. buying a home? You
can use the “Rent vs. Buy Calculator” available at
http://www.trulia.com/rent_vs_buy/ to evaluate this for your area of the
country. It’s easy and informative – you can do it now.
YOU CAN DO IT NOW
Current Mortgage Rates
If you’re considering buying a home, you need to know current mortgage
rates to determine prospective monthly payments and what price you can
pay for the home. Up-to-date market rates for di.erent maturities of /xed
and adjustable rate mortgages are available at http://www.bankrate.com.
And you can also obtain re/nancing rates there when you already have a
mortgage and are considering re/nancing it. It’s so accessible – you can do
it now.
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.
Vivian Wants to Buy a House but Doesn’t Want a Roommate Now
Vivian has saved $10,000 toward a $20,000 down payment on buying a
home. She puts aside $300 a month in her house fund and is currently
renting a one-bedroom apartment on her own for $1,300 a month. If she
rented a two-bedroom apartment with a roommate, she could reduce her
rent to $900 a month. While having a roommate is not Vivian’s favorite
solution, she’d be able to build up her down payment for buying a house a
lot faster if she were able to save an extra $400 a month. If Vivian stays on
her own and her finance remain the same, it will take her about 2 ¾ years
to put aside the needed additional $10,000. In contrast, if she set aside the
rent saved by getting a roommate, she would have the needed $10,000 in
about only 14 months. Doing without a roommate at this stage in Vivian’s life
is costly.
Additional comments:
The case demonstrates the kind of tradeo.s that are necessary to maintain
and achieve a financial plan. There are others issues that could be raised.
For example, how would Vivian feel if she did not get along with the
roommate? Or if she does get along well, how will she feel moving out on
the roommate when she has her down payment saved? Personal choices
almost always have a financial impact.
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
readily available source of information: the local newspaper. Almost anything you want to know
about the local housing scene can be found in the real estate section of the paper. For this project,
you’ll gather information concerning your local housing market.
Review recent issues of your local newspaper and describe the market for both purchased homes
and rental units. Look for useful information such as location, size of property, price or rent,
lease requirements, and so forth. You should observe that the housing market is very fragmented,
which makes good purchase and rent decisions more difficult. See if you can answer questions
such as: What is the average size of a house or apartment in your community? What is the typical
sales price or monthly rent per square foot? Is the purchase market competitive? How about the
rental market? How great a difference exists in prices and rents between the most and least
desirable areas of the community? Also check online for other sources of information, such as
the county tax office, and try to find out how much property taxes and homeowner’s insurance
premiums average in your area. From your study of the local market, summarize its conditions
and be prepared to participate in a class discussion of the local housing market.
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
allows searches by type and size of housing, price of housing, and location. This will make a
good team project; it will take some time depending upon how adept the student is with
computers and web pages, and the resources available in the school’s or community’s library.
One last resource is the census bureau data that may be accessed via www.census.gov.
Test Yourself
5-1 Briefly discuss how each of these purchase considerations would affect your choice of a
car:
a. Affordability
This is your first step. You’ll need to calculate two numbers unless you can pay cash for the
• Amount of down payment: This money will come from savings, so be sure not to deplete
• Size of the monthly loan payment you can afford: Analyze your available resources—after
considering your other expenses, including housing—and then your transportation requirements.
b. Operating costs
The out-of-pocket cost of operating an automobile includes not only car payments but also
insurance, license, fuel, oil, tires, and other operating and maintenance outlays. Also, consider
c. Gas, diesel, hybrid, or electric?
Each of these options will impact the annual operating costs and the initial purchase cost. If you
want to go “green” regardless of the cost, you may select a hybrid [gas and electric] or an electric
car. With gas prices around $3 per gallon, the miles per gallon of gas number is important. Each
d. New, used, or “nearly new”?
Exhibit 5.2 offers pros and cons of buying a used car. You may be able to afford a “luxury” car
by buying a used car. The cost may be about 25% less by buying a used car than a new car. If
e. Size, body style, and features
Your personal choices and family status will control these features. The options that add to the
f. Reliability and warranty protection
Assess the reliability of a car by talking with friends who own similar cars and reading objective
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 5.3 lists some steps to take. The key
is to compare cars and dealers. In addition to assessing reliability, talking with friends who own
Negotiating price can always be done. Before making an offer, prepare a worksheet with the cost
versus the list price for the exact car you want. The more information you have, the better you
Closing the deal involves executing a sales contract. Whether you’re buying a new or used car,
to make a legally binding offer, you must sign a sales contract that specifies the offering price
5-3 What are the advantages and disadvantages of leasing a car?
Leasing is another way to pay for a car. You need to first look at the cost of leasing versus
buying. Note the Financial Road sign in the chapter, “When Does it make Sense to Lease a
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?
The factors referred to in 5-3 answer will apply here. Most students are concerned with down
5-5 In addition to single-family homes, what other forms of housing are available in the
United States? Briefly describe each of them.
Single-family homes: They can be stand-alone homes on their own legally defined lots or row
Condominiums: The term condominium, or condo, describes a form of ownership rather than a
type of building. Condominiums can be apartments, townhouses, or cluster housing. The
Cooperative apartments: In a cooperative apartment, or co-op, building, each tenant owns a
Rental units: Some individuals and families choose to rent or lease their place of residence
rather than own it. They may be just starting out and have limited funds for housing, or they may
5-6 What type of housing would you choose for yourself now, and why? Why might you
choose to rent instead of buy?
Worksheet 5.2 gives a format for analyzing the rent versus buy cost comparison. A major factor
in the decision is the availability of funds for down payment and the time you expect to stay in
5-7 Why is it important to have a written lease? What should a rental contract include?
Oral agreements may be binding as to the additional services that are offered by the lessor.
However, the written lease agreement will govern the use of the real estate. Most leases are
5-8 Briefly describe the various benefits of owning a home. Which one is most important to
you? Which is least important?
Major benefits of owning versus renting are:
Tax shelter, that is, property taxes and mortgage interest are deductible for federal and state
income tax, thus, these costs of ownership will reduce or “shelter” taxes on other income such as
5-9 What does the loan-to-value ratio on a home represent? Is the down payment on a home
related to its loan-to-value ratio? Explain.
The loan-to-value ratio specifies the maximum percentage of the value of a property that the
5-10 What are mortgage points? How much would a home buyer have to pay if the lender
wanted to charge 2.5 points on a $250,000 mortgage? When would this amount have to be
paid? What effect do points have on the mortgage’s rate of interest?
Mortgage points are fees charged by lenders at the time that they grant a mortgage loan. In
appearance, points are like interest in that they are a charge for borrowing money. In fact for
federal tax purposes, points are deductible as interest. 2.5 points on a $250,000 required the
5-11 What are closing costs, and what items do they include? Who pays these costs, and
when?
Closing costs are all other expenses besides the down payment that borrowers ordinarily pay at
the time a mortgage loan is closed and title to the purchased property is conveyed to them. The
buyer typically pays the majority of the closing costs, although the seller may, by custom or
Closing costs, including points, can total an amount equal to 50% or more of the down payment.
When the down payment is only 10%, closing costs can run as high as 70% or more of the down
5-12 What are the most common guidelines used to determine the monthly mortgage
payment one can afford?
The most common guidelines used to determine the amount of monthly mortgage payments one
can afford are the affordability ratios that stipulate:
Monthly mortgage payments should not exceed 25 to 30% of the borrower’s monthly
5-13 Why is it advisable for the prospective home buyer to investigate property taxes?
Because they’re local taxes levied to fund schools, law enforcement, and other local services, the
level of property taxes differs from one community to another. In addition, within a given
community, individual property taxes will vary according to the assessed value of the real estate
5-14 Describe some of the steps home buyers can take to improve the home-buying process
and increase their overall satisfaction with their purchases.
Gather all the information available about the location of the home. The standing joke: What are
the three most important factors in buying a home? Answer, location, location, and location.