Personal finance canadian 7th edition kapoor solutions manual

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CHAPTER 7 THE FINANCES OF HOUSING CHAPTER OVERVIEW This chapter provides a complete discussion of selecting housing based on life situation, needs, and personal values along with the related financial aspects of this major expenditure. First presented is material regarding factors related to renting a residence. This is followed by discussion of buying alternatives and the home buying process including determining housing needs, evaluating potential homes, and pricing the property. The financing section covers types of mortgages and closing costs of a real estate purchase. Finally, suggestions for selling a home are offered.

LEARNING OBJECTIVES

CHAPTER SUMMARY

After studying this chapter, students will be able to: Obj. 1

Evaluate available housing alternatives.

Your needs, life situation, and financial resources are the major factors that influence your selection of housing. Assess renting and buying alternatives in terms of their financial and opportunity costs.

Obj. 2

Analyze the costs and benefits associated with renting.

The main advantages of renting are mobility, fewer responsibilities, and lower initial costs. The main disadvantages of renting are few financial benefits, a restricted lifestyle, and legal concerns.

Obj. 3

Implement the homebuying process.

Home buying involves five major stages: (1) determining home ownership needs, (2) finding and evaluating a property to purchase, (3) pricing the property, (4) financing the purchase, and (5) closing the purchase transaction.

Obj. 4

Obtain mortgage financing.

Once you decide to purchase a specific home, you will probably apply for a loan. Financing a home purchase requires obtaining a mortgage, an awareness of types of mortgages, and settling the real estate transaction.

Obj. 5

Develop a strategy for selling a home.

When selling a home, you must decide whether to make certain repairs and improvements, determine a selling price, and choose between selling it yourself and using the services of a real estate agent.

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Instructor’s Manual for Kapoor et al. Personal Finance 7CE.

INTRODUCTORY ACTIVITIES •

Ask students to comment on the opening case for the chapter.

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Point out the learning objectives in an effort to highlight the key points in the chapter.

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Ask students to discuss the relationship between housing selection and other financial goals.

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Point out the opportunity costs associated with various housing decisions.

CHAPTER 7 OUTLINE I.

Evaluating Housing Alternatives A. Your Lifestyle and Your Choice of Housing B. Opportunity Costs of Housing Choices C. Renting versus Buying Housing

II.

D. Housing Information Sources Renting A. Selecting a Rental Unit B. Advantages of Renting C. Disadvantages of Renting D. Costs of Renting E. Renting Rights

III.

The Home Buying Process A. Step 1: Determine Homeownership Needs B. Step 2: Find and Evaluate a Property to Purchase C. Step 3: Price the Property

IV.

The Finances of Home Buying A. Step 4: Obtain Financing B. Step 5: Close the Purchase Transaction Home buying: A Final Word

V.

Selling Your Home A. Preparing Your Home for Selling B. Determining the Selling Price C. Sale by Owner D. Listing with a Real Estate Agent

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CHAPTER 7 LECTURE OUTLINE

Instructional Suggestions

EVALUATING HOUSING ALTERNATIVES •

•

Text Highlight: Exhibit 71 presents suggested housing alternatives for different life situations.

•

Text Highlight: Exhibit 72 evaluating housing alternatives

Your needs, lifestyle, and financial resources will determine whether you decide to rent, buy, or have a home built.

Your Lifestyle and Your Choice of Housing • •

Your lifestyle (how you spend your time and money) is reflected in almost all consumer purchases including housing.

While personal preferences and tastes are the foundation of your housing decisions, financial factors may modify your final choice.

Opportunity Costs of Housing Choices • •

Consider what you are giving up when you live in a certain area or in a certain type of residence.

Common housing trade-offs include:  interest earnings lost on the down payment for a house or apartment  time and cost of getting to work living in a distant area  loss of equity growth  time and money to repair and improve a lowerpriced home  time and effort to have a home built to your specifications

Renting versus Buying Housing • •

Choosing between renting and buying your residence is an essential decision related to housing.

Economic conditions can influence this decision as well as a personal desire for ease of mobility or pride of ownership.

•

Housing Information Sources •

As with other consumer purchases, much information is available on housing including books, newspaper articles, people with knowledge and experience in this area, the World Wide Web, and government agencies.

•

Concept Check 7-1

RENTING •

At some point in your life, you are likely to rent your place of residence. You may rent when you are first on your own and cannot afford to buy a home or later in life when you want to avoid the activities required to maintain your own home.

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CHAPTER 7 LECTURE OUTLINE

Instructional Suggestions

Selecting a Rental Unit • •

An apartment is the most common type of rented housing.

People who need more room should consider renting a house.

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Text Highlight: Exhibit 7-3: presents the activities involved in finding and living in a rental unit.

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Assignment: Have student’s survey people who rent to determine factors that influenced this housing decision over buying.

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Supplementary Resource: Talk to a lawyer about common problems associated with renting and leases.

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Concept Check 7-2

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Exercise: Create a list of factors that could encourage or discourage the purchase of a housing unit.

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Supplementary Resource: Obtain information from a condominium sales office about the purchasing and management of this type of housing.

Advantages of Renting •

  

The main advantages of renting are: mobility fewer responsibilities lower initial costs

Disadvantages of Renting •

•

The main drawbacks of renting are:  few financial benefits  restricted lifestyle, restrictions on decorating, having pets, and other activities  legal details A lease is the legal document that defines the conditions of a rental agreement. It is designed to protect the rights of both the landlord and tenant.

Costs of Renting •

A security deposit is usually required when you sign a lease. This money is held by the landlord to cover the cost of any damages that may be done to the rental unit during the lease period.

Renting Rights •

The Canadian Charter of Human Rights recognizes and protects your rights to rent any apartment without discrimination.

THE HOME BUYING PROCESS •

Owning a home is a goal of many people and involves various activities as well as personal and economic trade-offs.

Step 1: Determine Home Ownership Needs What Are the Benefits of Home Ownership?

•

The main advantages of home ownership are pride of ownership, financial benefits, and flexibility in using the property.

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CHAPTER 7 LECTURE OUTLINE

Instructional Suggestions

What Are the Drawbacks of Homeownership?

• • • •

Financial risks related to having down payment funds, obtaining a mortgage, and changing property values.

Limited mobility may result if a home is difficult to sell.

Higher living costs due to repairs and maintenance.

Higher property taxes affect homeowners more directly than renters, who pay them in the form of higher rent.

•

Assignment: Have students talk to people who have had their own house built, or to contractors who work with people having a house built.

Obtain information on the process and potential difficulties.

•

Text Highlight: Exhibit 7-5: goes through the home buying process.

Assess Types of Housing Available • • •

• •

Single-family dwellings are the most popular type of housing.

Multiunit dwellings include duplexes and townhouses.

Manufactured homes are housing that is fully or partially assembled in a factory before being moved to the living site. These include prefabricated homes and mobile homes.

Mobile homes are a second type of manufactures homes. These housing units are typically less than 100 square meters in size.

Some people want a home built according to their specifications. Before you begin such a project, be sure you possess the knowledge, the money, and the perseverance that are needed to complete it.

Forms of Ownership •

The most common form of home ownership is one in which an individual or a couple is the sole owner of an entire property. Two other legal forms of ownership are condominiums and co-operative housing.

•

A condominium (condo) consist of two parts: a collection of private housing called units, and the shared areas of the building such as lobbies, hallways, elevators, recreational facilities, garden, etc. Each unit is owned by the purchaser of that unit and the common areas are jointly owned by these individual unit owners.

•

Co-operatives (co-ops) are member-owned communities where residents make decisions on how the co-op operates. A co-op is governed by directors 7-5 Copyright © 2018 McGraw-Hill Education Ltd. All Rights Reserved.

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CHAPTER 7 LECTURE OUTLINE

Instructional Suggestions

and member of the co-op. Each member has a vote and say in its overall direction. There are two main types of housing co-operatives: non-profit and forprofit. Many provinces require that housing co-ops operate on a non-profit basis because the main purpose is to provide affordable housing. In a nonprofit co-op, members cannot sell their shares. In a for-profit co-op, members own a share of the co-op but not the individual unit they live in.

Determine Amount of Down Payment •

•

Before shopping for a home, you should assess your financial situation to determine how much you can afford to put as a down payment. The higher the down payment the lower the loan amount you will need to borrow.

Understand the benefits of CMHC as well as the costs associated with not having a 20% down payment. CMHC allows buyers to buy a home and insures the lenders of default but it comes at a cost that a lot of people don’t take into consideration right away. Exhibit 7-6 shows the cost of CHHC fees.

•

Text Highlight: Exhibit 7-6: looks at housing affordability and mortgage qualification amounts.

Calculate Your Affordable Home Purchase Price • •

Will you have enough money to make your mortgage payments?

A mortgage is a long-term loan on a specific piece of property, such as a home or other real estate.

Step 2: Find and Evaluate a Property to Purchase • • •

• •

In selecting a neighborhood, consider the character of the community.

Zoning laws are restrictions on how the property in an area can be used.

If you have or plan to have a family, you should assess the school system. Homeowners without children also benefit from strong schools since the educational advantages of a community affect property values.

A real estate agent can help you assess your housing needs and determine the amount you can afford to spend on a home.

A real estate agent can be helpful in presenting your offer to the seller, negotiating a settlement price, assisting you in obtaining financing, and representing

•

Discussion Question: Why is home location considered more important than any other factor when making a housing purchase?

•

Current Example: In addition to the location, be sure to:  consider the entire community  be aware of possible malls or highways  consider cost and time of commuting  remember that yards, home conditions, and other items in view are an indication of the lifestyles and values of people in the community.

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CHAPTER 7 LECTURE OUTLINE •

Instructional Suggestions

you at the closing Before reaching your decision about a specific home, conduct a complete evaluation of the property.

This evaluation can help minimize future problems.

Step 3: Price the Property •

•

The main factors you should consider in determining the home prices are recent sales prices in the area, the current demand for housing, the length of time the home has been on the market, the owner’s need to sell, the financing options, and the features and condition of the home.

Once a price has been agreed upon, the buyer must deposit earnest money—a portion of the purchase price that the buyer deposits as evidence of good faith to show that the purchase offer is serious.

THE FINANCES OF HOME BUYING •

•

Text Highlight: Exhibit 7-9: presents a detailed format for inspecting a home.

•

Supplementary Resource: Use local newspapers to obtain information on the price range of houses and other housing in your community.

•

Text Highlight: Exhibit 710: shows the components of a home purchase offer.

•

Concept Check 7-3

•

Assignment: Have students compare mortgage qualification requirements and procedures of several lenders in your area.

•

Text Reference: The “Financial Planning for Life’s Situations” feature provides information and warnings on paying off your mortgage early.

Financing a home purchase requires obtaining a mortgage, being aware of the types of mortgages, and settling the real estate transaction.

Step 4: Obtain Financing •

Personal savings, pension plan funds, sales of investments or other assets, and assistance from relatives are the most common sources of down payment money.

•

Federal law requires that you have mortgage insurance if your mortgage represents 75 percent or more of the total price you pay for your home. This coverage protects the lender from financial loss due to default.

It can be obtained through the Canada Mortgage and Housing Corporation (CMHC), a federal Crown corporation, or GE Capital Mortgage Insurance Company, a private company.

To qualify for a mortgage, you must meet criteria similar to those that must be met for other loans.

The major factors that affect the affordability of your mortgage are your income, other debts, the amount available for a down payment, the length of the loan, and current mortgage rates.

The mortgage loan for which a person can qualify is larger when interest rates are low than when they are high. As interest rates rise, fewer people are able to afford the cost of an average-priced home.

Obtaining a mortgage requires the potential

•

• •

•

•

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CHAPTER 7 LECTURE OUTLINE

•

•

• • •

• •

•

Instructional Suggestions

borrower to submit an application form containing personal and financial data.

The conventional mortgage has equal payments over 25 years based on a fixed interest rate. The mortgage payments are set at a level that allows amortization of the loan, that is, the balance is reduced with each payment.

The variable-rate mortgage (VRM), also referred to as a flexible rate mortgage, has an interest rate that increases or decreases during the life of the loan based on changes in market interest rates. A rate cap restricts the amount that the interest rate can increase during the loan term.

Split or multi-rate mortgages allow you to arrange part of your mortgage at one rate and term and another part at another rate and term.

Most mortgage lenders offer options to your payment plan that will allow you to speed up your payment schedule.

The vendor take back (VTB) mortgage is a loan extended to you as the buyer by the seller. This type of loan frequently has the advantage of a lower rate than most institutions offer.

A second mortgage, more commonly called a home equity loan, allows a homeowner to borrow on the paid-up value of the property.

Reverse mortgages provide an elderly homeowner with tax-free income in the form of a loan that is paid back (with interest) when the home is sold or the homeowner dies.

Refinancing refers to obtaining a new mortgage on your current home at a lower interest rate.

Step 5: Close the Purchase Transaction • • •

• •

The closing involves a meeting of the buyer, seller, and lender of funds, or representatives of each party, to complete the transaction.

Closing costs, also called settlement costs, are the fees and charges paid when a real estate transaction is completed.

Title insurance protects the owner or the lender against financial loss resulting from future defects in the title and from other unforeseen property claims not excluded by the policy.

A deed is a document that transfers ownership of property from one party to another.

An escrow account is money, usually deposited with a financial institution, for the payment of

•

Text Highlight: Exhibit 711: Common additional costs associated with purchasing a house are discussed.

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CHAPTER 7 LECTURE OUTLINE

Instructional Suggestions

property taxes and homeowner’s insurance Home Buying: A Final Word •

For most people, buying a home is the most expensive decision they will undertake. As a reminder, Exhibit 7-12 provides an overview of the major elements to consider when making this critical financial decision.

SELLING YOUR HOME

•

Concept Check 7-4

Preparing Your Home for Selling •

The effective presentation of your home can result in a fast, financially favorable sale. Real estate salespeople recommend that you make needed home repairs and paint the exterior and interior areas.

•

Current Example: Real estate professionals suggest that your home be made as appealing as possible so potential buyers can imagine themselves living there. The smell of fresh-baked bread or cookies can add to the appeal.

•

Discussion Question: What types of improvements would add to the sale value of homes in this area?

•

Assignment: Have students talk to people who have sold their houses on their own.

•

Supplementary Resource: Talk to a real estate agent and use newspaper housing ads to determine the factors that influence the selling price of homes.

Determining the Selling Price •

•

Putting a price on your home can be a difficult decision. You face the risk of not selling it immediately if the price is too high, and you may not get a fair settlement if the price is too low.

An appraisal, which is an estimate of the current value of the property, can provide a good indication of the price you should set for it.

Sale by Owner •

•

If you decide to sell your home without the use of a real estate professional, price the home and then advertise it through local newspapers and through a flier describing it in detail.

Use the services of a lawyer or title company to assist you with the contract, the closing, and other legal matters.

Listing with a Real Estate Agent • •

If you decide to sell your home with the assistance of a real estate agent, you can probably choose among real estate businesses in your area.

Your real estate agent will provide you with various services. These services include suggesting a selling price, making potential buyers and other agents aware of your home, providing advice on features to highlight, conducting showings of your home, and handling the financial aspects of the sale.

•

Concept Check 7-5

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CONCLUDING ACTIVITIES •

Point out the chapter summary and key terms in the text margin.

•

Discuss selected end-of-chapter Financial Planning Problems, Financial Planning Activities, and Life Situation Case.

•

Use Chapter Quiz in the Instructor’s Manual.

CHAPTER 7 QUIZ ANSWERS True-False 1. F 2. F 3. T 4. T 5. F 6. F 7. F 8. T

Multiple Choice 9. A 10. C 11. B 12. B 13. C 14. C 15. B 16. B

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Name ________________________________________

Date____________________________

CHAPTER 7 QUIZ TRUE-FALSE _____1.

Several financial benefits are associated with renting your place of residence.

_____2.

A lease is mainly designed to protect the rights of the landlord.

_____3.

Financial risks are associated with the purchase of a home.

_____4.

Cooperative housing and condominiums are forms of home ownership.

_____5.

Higher property values result in lower property taxes.

_____6.

Refinancing and a second mortgage are essentially one and the same.

_____7.

There is no ability to negotiate on the price of a home you are interested in purchasing.

A variable rate mortgage usually has a lower initial interest rate than a fixed rate mortgage.

_____8.

MULTIPLE CHOICE ______9

A common advantage associated with home ownership is a. financial benefits. b. ease of mobility. c. limited financial risks. d. low initial costs.

______10

Most real estate professionals believe that the most important factor in selecting a home is a. price. b. style. c. location. d. desired features.

______11

The major factor that affects a person’s qualification for a mortgage is a. current interest rates. b. the applicant’s credit rating. c. the value of the property being purchased. d. the source of the down payment funds.

______12

Most lending institutions believe that a person can afford a monthly payment of about __________ percent of gross income less any long-term debts. a. 20 b. 30 c. 40 d. 50

______13

A __________ mortgage allows a person to borrow on the paid-up value of a home. a. conventional 7-11 Copyright © 2018 McGraw-Hill Education Ltd. All Rights Reserved.

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______14

______15

______16

b. growing equity c. second d. share appreciation One of the advantages of owning your own home is: a. The easy ability to move b. Few or no responsibilities for maintenance c. The growth in equity while you own the home d. Lower initial costs A(n) ____________ is a form of home ownership that consists of individually owned units and shared common areas. a. Single family dwelling b. Condominium c. Cooperative d. Duplex The ____________ ratio is your monthly shelter costs as a percentage of your gross monthly income. a. TDS b. GDS c. Loan to value d. Gross debt service

SUPPLEMENTARY ACTIVITY

For each of the following types of mortgages, describe life situations and economic conditions that could make this type of home loan an appropriate choice.

Type of mortgage

Description of life situation

Description of economic conditions

Conventional, fixed-rate, fixed-payment

Variable Rate

Split or Multi rate

Vendor take back

Second mortgage

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Reverse mortgage

Refinancing

(Note: This activity may be done as a discussion in a large group, as a small group exercise, or as an outof-class assignment.)

ANSWERS TO CONCEPT QUESTIONS, OPENING CASE QUESTIONS, FINANCIAL PLANNING PROBLEMS, FINANCIAL PLANNING ACTIVITIES, AND LIFE SITUATION CASE

CONCEPT QUESTIONS Concept Check 7-1 1. How does a person’s employment and household situation influence the selection of housing?

A person who works at home would, for example, require home facilities different from a single person or a household with several small children.

2. What are some common opportunity costs associated with the selection of housing?

Opportunity costs include lost interest on a down payment or security deposit and travel time to work when living in the country.

Concept Check 7-2 1. What are the main benefits and drawbacks of renting a place of residence?

Advantages of renting are mobility, fewer responsibilities, and lower initial costs. Disadvantages are few financial benefits, restricted lifestyle, and legal concerns.

2. Which components of a lease are likely to be most negotiable?

Some people will tell you that just about everything in a lease is negotiable; however, certain things are likely to be more flexible than others. Most negotiable items include rent, amount of security deposit, starting date of lease, and decorating.

Concept Check 7-3 1. What are the drawbacks of owning a home?

Disadvantages are financial uncertainty, limited mobility, and higher living costs.

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2. What type of individual would prefer a condominium over a single-family dwelling?

Someone who likes having someone else deal with the maintenance of the building and common areas and who is willing to sacrifice owning land to have that. Maybe even someone who doesn’t need the extra space that a single-family dwelling provides. It all depends on a person’s lifestyle and preferences.

3. What are the main sources of funding for a down payment?

Personal savings, pension plan funds, sales of investments or other assets, and assistance from relatives are common sources.

4.

What is the TDS ratio?

The TDS ratio is your monthly mortgage payment, including any outstanding debt as a percentage of your gross monthly income.

5.

How do changing interest rates affect the amount of mortgage a person can afford?

The lower the rate the higher the amount of the mortgage loan you can qualify for.

6. How can the quality of a school system benefit even homeowners in a community who do not have school-age children?

The quality of a school system is an important factor affecting home prices in a community. By maintaining quality schools, all homeowners in an area benefit from stable and increasing property values.

7. What services are available to home buyers from real estate agents?

A real estate agent can help assess housing needs and determine the amount a person can afford to spend. Agents also have information on available homes and obtaining a mortgage.

8. How does a seller’s market differ from a buyer’s market?

In times of high demand for housing, negotiating may be minimized; this situation is referred to as a seller’s market, since the current owner is likely to have several offers for the property. On the other hand, when home sales are low, a buyer’s market exists and a lower price is likely.

Concept Check 7-4 1. Under what conditions might a variable rate mortgage be appropriate?

A variable rate mortgage may be appropriate when interest rates are relatively high and they are expected to decline. This situation would benefit the borrower as rates decline, or the homeowner may refinance when rates drop at a lower-rate, fixed-rate mortgage.

2. When might refinancing a mortgage be advisable?

Refinancing might be appropriate when interest rates decline and a homeowner plans to stay in the same house long enough for the savings from lower mortgage payments to recover the cost of refinancing.

3. How do closing costs affect a person’s ability to afford a home purchase?

Closing costs can add several thousand dollars to the expense of buying a home. These are funds that the homebuyer must have available to complete the real estate transaction.

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Concept Check 7-5 1. What actions are recommended when planning to sell your home?

When planning to sell your home, make needed repairs, consider new paint, clear out living and storage areas, and remove unnecessary furniture and other items.

2. What factors affect the selling price of your home?

Home prices are affected by location, size, condition, features, and current market demand.

3. What should you consider when deciding whether to sell your home on your own or to use the services of a real estate agent?

If you decide to sell by owner, you will need to price, advertise, and show the house. Some people would like to save money by taking on these tasks and not use a real estate agent. If you would like someone else to handle these and other duties, you may decide to use the services of a real estate agent.

OPENING CASE QUESTIONS 1. What factors affect a person’s ability to buy a house?

The amount a person can afford when buying a house is affected by income, amount of down payment money available, current interest rates, and other debts.

2. What are common sources of a down payment? Why should home buyers not use all their savings for the down payment on a home purchase?

Common down payment sources include personal savings and investments, gifts from relatives, loans, or use of retirement savings. If home buyers use all their savings for a down payment, they may have financial difficulties when funds are needed for closing costs, home repairs, or family emergencies.

3. What problems could arise in a co-ownership housing arrangement?

The problems encountered with a co-ownership housing arrangement may include differences of opinions between the individuals involved, financial difficulties faced by one of the people, or changes in the life situation of one of the individuals.

4. Locate Web sites that provide housing information that would be of value to Mike and Ike during their home buying activities.

Useful Web sites would include www.themortgage.com, www.canmortgage.com, and www.cmhc-schl.gc.ca.

5. What is one risk they need to consider with their financing decision and how to prepare for changes?

One very important risk that Mike & Ike should watch for is the rising interest rate environment on the variable rate mortgage that they are considering. Under new rules set out by the government they would have to qualify for the mortgage (GDS & TDA) ratios based on the 5yr rate but can still elect the variable rate. What happens when the rate goes up 0.5% or even more as this usually has a 3-month reset rate? One thing that I like to recommend to clients when they choose variable rates is to round up the payment (in this example to $1,800) and pay this amount as now you’re paying quicker and any variable rate adjustments will not impact the mortgage payment amount (although it pays less principle after adjustment) and can be a better budget number to use.

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FINANCIAL PLANNING PROBLEMS 1. What type of housing would you suggest for people in the following life situations? a. b. c. d.

A single parent with two school-age children A two-income couple without children A person with both dependent children and a dependent parent A couple near retirement with grown children

While answers may vary, suggested responses may be found in Exhibit 7-1 2. Based on the following data, would you recommend buying or renting?

Rental Costs Annual rent, $7,380 Insurance, $145 Security deposit, $650

Buying Costs Annual mortgage payments, $9,800 ($9,575 is interest) Property taxes, $1,780 Insurance/maintenance, $1,050 Down payment/closing costs, $4,500 Growth in equity, $225 Estimated annual appreciation, $1,700

Assume an after-tax savings interest rate of 6 percent and a tax rate of 28 percent.

Rental Costs $7,380 Rent 145 Insurance 39 Interest lost on security deposit $7,564 Total rental costs

Buying Costs $9,800 Mortgage payments 2,830 Property Taxes,insurance, maintenance 270 Interest lost on down payment closing costs Less: 225 Growth in equity 1,700 Annual appreciation

$10,975 Total buying costs Mortgage interest and property taxes potentially could be deductible for self-employed individuals but not taken into consideration here. In addition, in a real-life situation, they could qualify for a provincial tax credit for the rent and property taxes. These factors will change the bottom line.

3. Use the buy-versus rent analysis on page 202 to compare two residences that you might consider.

Compare house purchase to renting a house or an apartment.

This activity can help students understand renting vs. buying in a practical situation.

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4. Calculate the gross debt service (GDS) and the total debt service (TDS) ratios for the following data.

(Obj. 3) Monthly mortgage payment = $2100 Property taxes = $200 Heating costs = $115 Other housing costs = $70 Personal loan payment = $150 Car loan payment = $200 Credit card payment = $150 Gross monthly household income = $7800 GDS = ($2100 + $200 + $115 + $70) / $7800 GDS = 31.86 % TDS = ($2100 + $200 + $115 + $70 + $150 + $200 + $150) / $7800 TDS = 38.27 %

5. Estimate the affordable monthly mortgage payment, the affordable mortgage amount, and the affordable home purchase price for the following situation: Monthly gross income, $2,950 Down payment to be made, 15 percent of purchase price Other debt (monthly payment), $160 Monthly estimate for property taxes and insurance, $210 25-year loan at 6.5 percent.

Based on example A (with other debts), Exhibit 7-7 Affordable monthly mortgage payment, $810 (($2,950 x 0.40) - $160 - $210) Affordable mortgage amount, $120,896 (($810/6.70) x $1000) Affordable home purchase, $142,230($120,896/ (1-0.15)) 6. Based on Exhibit 7-7, what would be the monthly mortgage payments for each of the following situations? a. A $100,000, 15-year loan at 7.5% APR compounded semi-annually b. A $200,000, 25-year loan at 9% APR compounded semi-annually c. A $165,000, 20-year loan at 10% APR compounded semi-annually What relationship exists between the length of the loan and the monthly payment? How does the mortgage rate affect the monthly payment?

Solution a. $9.21  100 = $921 b. $8.28  200 = $1,656 c. $9.52  165 = $1,570.80 7-17 Copyright © 2018 McGraw-Hill Education Ltd. All Rights Reserved.

Instructor’s Manual for Kapoor et al. Personal Finance 7CE.

The longer the maturity of the loan, everything else constant, the smaller the payment. The size of the monthly payment is affected by the principal amount borrowed, the maturity of the loan and the mortgage rate (higher the rate, the higher the payment) 7. Which mortgage would result in higher total payments?

Mortgage A: $985 a month for 25 years, Mortgage B: $780 a month for 5 years, and $1,056 for 25 years A: $985  300 months = $295,500 B: ($780  60 months) + ($1,056  300 months) = $363,600 8. Kelly and Tim Johnson plan to refinance their mortgage to obtain a lower interest rate. They will reduce their mortgage payments by $56 a month. Their closing costs for refinancing will be $1,670.

How long will it take them to recover the cost of refinancing? $1,670  $56 = 29.82 (about 30 months; two and a half years) 9. You have bought a home that has a $750,000 mortgage and you have decided to use the variable closed rate of 2.65 percent that your bank has available. The rate can adjust on a quarterly basis based on market changes. What is the payment if you amortize the mortgage over 25 years? Assume 6 months later the variable rate goes up to 3.15 percent as inflation has picked up. What is your monthly payment now? What is the impact and risk associated with this market and variable rate interest rates?

As we are paying monthly we need to calculate an effective monthly rate for our formula. Remember under the Bank Act in Canada all mortgages are compounded on a semi-annual basis. Therefore EMR=(1+.0265/2)2/12 - 1 = 0.002196239 Therefore, the mortgage using a PV of annuity formula: $750,000 = Mortgage Payment x ((1-1/1.002196239300)/0/002196239) Mortgage payment = $3,416.03 a month When rates go up after 6 months there will be (300 months -6 months) 294 months left on the amortization schedule and the new EMR = (1+0.0315/2)2/12 - 1 = 0.002607937 or 0.2607937% After 6 months of payments the balance outstanding on the initial mortgage is: $3,416.03 x ((1-1/1.002196239294)/0.002196239) = $739,328.63 Therefore, the new mortgage amount will be: $739,328.62 = Mortgage payment x ((1-1/1.002607937^294)/0.002607937) = $3,603.91 As you can see the risk is the increased payment that can have an impact on your ability to continue to pay beyond your budget. If rates go up again in the short term you can sense of some issues here. Big mortgages caused by the rapid increase in housing prices tied with an increasing interest rate environment can be a cause for concern.

10. You estimate that you can save $3,800 by selling your own home yourself rather than using a real estate agent. What is the future value of that amount if invested for five years at seven percent? $3,800  1.4026 = $5,329.79 using table Or $3,800 x (1.07)5 = $5,329.70 11. You want to pay off your mortgage on something called an accelerated bi-weekly payment plan (your parents told you to do this). You have a mortgage of $500,000 amortized over 25 years at a rate of 3.5% 7-18 Copyright © 2018 McGraw-Hill Education Ltd. All Rights Reserved.

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APR compounded semi-annually. What would the regular bi-weekly payment be? What would the accelerated bi-weekly payment be? How much quicker would you pay off the mortgage and how much interest would you save by doing the accelerated bi-weekly payment?

Regular BW payments We need to use and effective bi-weekly rate and amortized over 25 x 26 = 650 payments. EBWR = (1+.035)2/26 - 1 = 0.001335401 Therefore, payment under the regular BW schedule is: $500,000 = Mortgage payment x ((1-1/1.001335401650)/0/001335401) for a bi-weekly mortgage payment of $1,151.27.

Under the accelerated bi-weekly plan, we need to calculate the monthly mortgage amount and then just divide the number in half to get the accelerated bi-weekly payment. Therefore, we need the effective monthly rate (EMR) = (1+,035/2)2/12 - 1 = 0.002895624 and number of payments is (25x12)=300 payments. $500,000 = Monthly mortgage x ((1-1/1.002895624300) / 0.002895624) Monthly mortgage = $2,496.35 and thus we get an accelerated bi-weekly payment of $2,496.35/2 = $1,248.18.

Now we need to determine how quickly we will pay off the mortgage under the accelerated bi-weekly payment plan. Using PV formula, the EBWR and solving for n: $500,000 = $1,248.18 x ((1 - 1/1.001335401n)/0.001335401) ($500,000/1,248.18) x 0.001335401 = 1 – 1/1.001335401n n = ln(1/0.465060728) / ln1.001335401

n = 573.6874110 payments or 22.065 years

Therefore, total interest saved by paying accelerated bi-weekly is: Regular bi-weekly total paid = $1,151.27 x 26 x 25 = $748,322.52 Accelerated bi-weekly total paid = $1,248.18 x 573.687411 = $716,062.39 As you can see you pay $248,322.52 in interest using regular bi-weekly compared to $216,062.39 under the accelerated bi-weekly schedule. Thus saving $248,322.52 - $216,062.39 = $32,260.14 in interest payments.

FINANCIAL PLANNING ACTIVITIES 1. Interview several people about the factors that influenced their current residence.

This assignment can provide students with expanded awareness of factors that motivate housing decisions. Encourage students to talk with people who live in various types of housing.

2. Compare the costs, facilities, and features of apartments and other rental housing in your area. You may obtain this information through newspaper advertisements, information from rental offices, or online searches of the World Wide Web. This activity will be especially useful to students who plan to live on their own for the first time in the near future, and those who may have recently moved to a new area.

3. Interview a tenant and a landlord to obtain their views about potential problems associated with renting. How do their views on tenant-landlord relations differ?

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This activity can help students appreciate another’s perspective with regard to renting housing.

4. Compare Renting vs Buying in your area. Look around your area and compare the cost of buying a house and renting. You can compare renting an apartment or a house as well. Assume the average annual maintenance costs on the purchase of your house would be 3% that you have to pay. Assume also that you're disciplined and you invest any difference in amounts from renting into a diversified portfolio of investments that averages you 8% over the 25 years comparable to a mortgage amortization period.

This activity can put into perspective the cost of renting but more so to understand the extra costs that are not necessarily thought about initially when buying a home. Most just think of mortgage vs the rent comparison.

5. Visit the sales offices of condominiums, new homes, and mobile homes. Based on the information obtained, prepare a written or oral presentation comparing the benefits and potential concerns of these housing alternatives.

This hands-on experience will give students the opportunity to see some of the advantages and disadvantages of each housing alternative. After a few students visit each type, a class discussion can bring out different points of view.

6. Interview a real estate agent about the process involving in selecting and buying a home. Ask about housing prices in your area and the services provided by the agent. Also, obtain information about the agent’s opinion as to what will happen to housing prices and interest over the next six months.

A debate continues as to whether real estate agents are worth the amount they charge for their services. Some people have had pleasant experiences buying or selling a house without the services of a real estate agent, but the opposite is also true for many who had a difficult time. This activity can assist students in deciding whether they will want to use a real estate agent when the situation arises.

The housing prices in a community are affected by many factors; a real estate agent as well as other information sources (newspaper articles, government officials, and insurance agents) can provide current and expected home prices.

7. Talk with people who have different types of mortgages. What suggestions do they offer about obtaining home financing? What were their experiences with closing costs when they purchased their homes?

One of the best sources of information related to any purchase or financial decision is the experience of others. Obtaining information about the types of mortgages most people have and the situation under which they were obtained can be most educational.

8. Visit bank websites, such as http://www.royalbank.ca to learn how fixed rate and variable rate mortgages differ. What are the advantages and disadvantages of each? Which would a first-time home buyer likely prefer and why?

This activity will help students in the future, to make sure they make informed decisions in their everyday life.

9. Contact several mortgage companies and other financial institutions to obtain information about current mortgage rates, application fees, other charges, and the process for obtaining a mortgage.

This activity will help students better understand the mortgage application process.

10. Using Web sites such as http:// www.canadamortgage.com, http://www.cannex.com, or http://money.canoe.ca, to obtain information on current mortgage rates available in different parts of the country.

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This assignment will help students to improve their Web research skills and will provide insight into the changing nature of mortgage rates.

11. Visit a couple of homes for sale. What features do you believe would appeal to potential buyers?

What efforts were made to attract potential buyers to the open houses?

This practical experience can be useful to students who plan to make a purchase in the near future.

The checklist for making a home inspection (Exhibit 7-9) can be helpful in this activity.

LIFE SITUATION CASE Housing Decisions 1. How could the St. Onges have benefited from buying a home that needed improvements?

Buying a home that needs improvement can make sense for two reasons. First, it may be the only affordable choice, and the buyer may be willing to fix up the residence. Second, the location or style may be exactly what is desired and improvements a tradeoff that must be made.

2. How might Brigitte Lavoie have found out when mortgage rates were at a level that would make refinancing her condominium more affordable?

By regularly reading the business section of the newspaper it is possible to keep up to date on changing home mortgage interest rates. Regularly talking to a real estate agent or a loan officer at a financial institution will also help in keeping informed on mortgage rates.

3. Although the Stewards had good reasons for continuing to rent, what factors might make it desirable for an individual or a family to buy a home?

Renting is desired by those who may need to move frequently or who do not want the responsibilities associated with the home ownership. But people who buy their place of residence wish to take advantage of the financial benefits of home ownership along with the stability of residence and flexibility in decorating their home.

LIFE SITUATION CASE 2 Mortgage Affordability 1. While on maternity leave, Maria will only receive 55 percent of her salary. Taking this and some of the additional baby costs (such as diapers and formula) into account, will the Dias’s be able to make ends meet? Will they be eligible for any tax credits and benefits that would increase their cash inflow? Are there any expenses they can reduce to help meet their obligations?

Solution While on maternity leave, Maria’s take home pay will be $1,196.25. So, the couple’s new combined take-home pay will be $5,221.25 .

Their current monthly expenses are as following: Mortgage payment

$1,997.07 7-21 Copyright © 2018 McGraw-Hill Education Ltd. All Rights Reserved.

Instructor’s Manual for Kapoor et al. Personal Finance 7CE.

Property taxes Home insurance Auto loan and RRSP repayment Auto insurance Utilities Transportation Food Total

400 60 700 200 450 ($250 of which is Hydro/heating) 350 700 $4,857.07

(Cash inflow of $5,221.25 – Cash outflow of $4,857.07) = $364.18 There are no tax credits that they will be eligible for. With Maria being on unemployment, she should be aware that they never take enough off as taxes at source (usually 10%) and this could create a tax liability when they file their taxes for the year end. They will be eligible for the Child Tax Benefit (non-taxable benefit) effective immediately, but the amount is dependent on the amount of income they ear. So, the amount would be determined when they apply. As she will be at home, they can cut their transportation cost and potentially save $100 per month.

This will give them an additional $100 in saving per month to help cover the baby expenses plus whatever they receive in CTB. Still funds will be tight and they may end up dipping into their savings or incurring some credit card debts during this time. Unknown factors such as baby clothes, car seats, diapers/formula etc. need to be considered too.

2. Calculate the maximum monthly mortgage payment, the maximum mortgage amount, and the maximum home purchase price - Maria and Jose could have afforded based on the GDS ratio and TDS ratio guidelines. Would this have been wise?

Maximum monthly mortgage payment, maximum mortgage amount, and maximum home purchase price based on TDS ratio and GDS ratio guidelines are as follows; Monthly gross income (annual income divided by 12) $104,000/12 = $8,666.67 TDS $8,666.67 x 0.40 = $3,466.67 GDS $8,666.67 x 0.32 = $2,773.33 Subtract: debt payments (700) property taxes, Heating (650) (650) Maximum monthly mortgage payment $2,116.67 $2,123.33 EMR = (1+.035/2)2/12 - 1 = 0.002895624 Solve for PV of annuity $2,116.67 x ((1 - 1/1.002895624300)/0.002895624) = $424,952.02 OR using the GDS # $2,123.33 x ((1 - 1/1.002895624300)/0.002895624) = $425,287.30 Maximum home purchase price would simply be max mortgage they would qualify for ($2,123.33) plus the down payment they have saved less any closing costs they need to pay for up front to avoid having any CMHC fees etc.

Their situation isn’t that bad but when interest rates go up or if things start to go wrong with the house it is nice to know that you don’t have to have the extra debt. Also remember that with everything there is always an opportunity cost. Bigger house and then maybe you can’t afford to save for the 7-22 Copyright © 2018 McGraw-Hill Education Ltd. All Rights Reserved.

Instructor’s Manual for Kapoor et al. Personal Finance 7CE.

children’s education or your own retirement. Base things on budgeting first and foremost, adding a margin of error to help reduce risks. Purchasing a house is a big financial commitment and it is important to leave yourself enough room to handle changes in your life such as a job loss or the starting of a family.

3. When her maternity leave ends, can Maria afford to go back to work? What are the tax benefits of child care costs?

Yes. With a combined take home pay of $6,200 and CTB of ?? per month, Maria and Jose will be able to meet their financial and living expenses and still be able to afford day care expenses of $600.

Remember also that Child Care Expenses are tax deductible (up to $8,000 till the age of 6) and will lower Maria’s taxes (person with lowest income).

CONTINUOUS CASE FOR JAMIE LEE AND ROSS Questions: 1. Using a spreadsheet, compare the advantages and the disadvantages of renting a home or apartment versus purchasing a home.

Solution: Student solutions may vary. The following are suggested responses.

Advantages Renting a Home/Apartment

Purchasing a Home

1.

Mobility- you can move easily (subject to lease agreement)

Permanence- your home is not subject to a lease renewal

2.

Fewer responsibilities for maintenance or repairs

The upgrades you make to the home may enhance its value in the long run

3.

Minimal financial commitment

4.

Small upfront payment for rent and security

The mortgage payments you make on the principle of the loan go towards equity in the home Mortgage interest may be tax deductible

5.

A wise choice if moving to an unfamiliar area –may want to be sure you want to move there

Pride of ownership

6.

You are only committed to rental for term of lease

Privacy

7.

Renter’s insurance is less expensive than homeowner’s insurance

Value of the home may increase over a number of years

8.

You may have more disposable income as rent is typically less expensive than a mortgage payment

Equity in the home may be used as collateral for other loans

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Instructor’s Manual for Kapoor et al. Personal Finance 7CE.

9.

No major upfront fees, such as closing costs associated with home purchases

Mortgage payments are the same month to month (on a fixed rate mortgage)

Disadvantages Renting a Home/Apartment

Purchasing a Home

1.

No tax advantages

Large financial responsibility

2.

Limitations on remodeling/ decorating

3.

Restrictions on pets, hobbies, other activities

Property taxes are an additional expense and may fluctuate Maintenance and upkeep is your responsibility

4.

Rent payments have no equity value

Large down payment required

5.

No ownership of dwelling

Must have good credit to secure a mortgage

6.

Landlord may decide not to renew the lease

You may not like the neighbors

7.

Landlord may decide to increase the rent when the lease is up for renewal

You may have difficulty selling the property

8.

Fellow tenants may be noisy

Property value may decline if the economy takes a turn for the worse

9.

Landlord rules must be followed or you risk losing your security deposit or being evicted

If you are unable to make the mortgage payment, you may lose your home to bank foreclosure

2. Jamie Lee and Ross are estimating that they will be putting $55,000 from their savings as a down payment on their home purchase. $25,000 coming from the RRSP using the 1st time home buyers plan (HBP) and the balance from the other savings. Calculate the maximum affordable monthly mortgage amount that would be suggested by a lending institution and based on Jamie Lee and Ross’ income. Use the following amounts for Jamie Lee and Ross’s calculations. Estimated Property taxes and Hydro of $500 per month total. Estimated 5-year closed mortgage rate of 2.89%.

Solution: Salaries combined: $45,000 (Jamie Lee) + $70,000 (Ross)

= $115,000

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GDS Ratio maximum 32% ≤ (monthly mortgage amount + $500) / ($115,000/12) TDS Ratio maximum 40% ≤ (monthly mortgage amount + $500 +389) / ($115,000/12) Therefore: using GDS ratio max monthly mortgage is $2,566.67 Using TDS ratio max monthly mortgage is $2,944.33 Assuming a 25-year amortization at the rate given and 25-year amortization this would equal a total mortgage of $548,879.41. This is attained by using the GDS ratio with the lower mortgage amount and the Effective monthly rate of (1+.0289/2)2/12 – 1 = 0.00239396 and the formula of: $2,566.67 x ( ( 1 – 1/1.00239396300 ) / 0.00239396 ) = $548,879.41

3. What are some potential closing costs that they will have to be concerned with when looking at buying a home and should take into consideration when budgeting for a purchase?

They need to consider closing costs such as those listed on Exhibit 7-11 of the textbook.

4. Jamie Lee and Ross have had the home inspection and it has come back clean on a house that they made an offer on and was accepted for $350,000 with no issues. At the bank, they have negotiated a 25-year amortization period mortgage but are looking at the options of a 5year fixed 2.89% mortgage or a 5-year closed variable 2.3% mortgage. What would be the monthly mortgage in both cases and the benefits and risks to each option?

First thing we need in both cases is the EMR (effective monthly rate) to calculate the mortgage amount.

EMR = ( 1 + 0.289/2 ) 2/12 - 1 = 0.00239396 EMR = ( 1+ 0.023/2 ) 2/12 – 1 = 0.001907547 Total mortgage amount = ($350,000 – $55000) = $295,000 (which is 295/350 = 84% loan to value). Thus, we have a CMHC fee as noted in exhibit 7-6 to be 1.8% or $5,310.

Therefore, the mortgage amount is ($295,000 + $5,310) = $300,310.

Using the Fixed Rate, the mortgage will be: $300,310 = Mortgage payment x ( ( 1 - 1/1.00239396300) / 0.00239396 ) Mortgage payment = $1404.31 Using the Variable Rate, the mortgage will be: $300,310 = Mortgage payment x ( ( 1-1/1.001907547300) / 0.001907547) Mortgage payment = $1,315.56 The benefit to the variable rate mortgage is simply a lower monthly mortgage amount due to the lower rate being charged. If they were smart they could use this method and pay as if they were paying on a 5-year plan and pay off the mortgage quicker. The biggest negative to the variable rate mortgage is the risk of rising interest rates (in which we are currently in) and increasing the cost of the mortgage to a point that is higher even than the current 5-year rate.

The benefit to the 5-year mortgage is locking in the rate and having a budget now for the next 5 years on the mortgage that they know is static. If rates don’t go up or if they go down the negative is that they would pay higher interest costs than the variable rate.

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Note both plans are closed mortgages and would encounter a penalty to pay it off prior to the 5year term of the mortgage.

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