Money and You: Course Notes

We’ve used the term “mortgage” many times so far, but we’ve never explored them. When you want to buy a house but do not have the full costs saved up, you need to take out a loan from a bank. The most common type of loan is a “mortgage.” A “mortgage” is simply a loan in which your house is used as collateral. So, if you are unable to keep up with your loan payments, the bank can take ownership of our house. If this happens, it is called “foreclosure.”

One thing about foreclosure is that it is costly for the banks. They generally cannot sell a foreclosed house for the full value of the home. So, banks generally will not loan out the entire value of a house. That is, if you want to buy a house that costs $200,000, a bank will generally not loan you $200,000; you’ll need to pay for some of the house immediately. The amount of cash that you pay for a house up front when you take out a mortgage is called the down payment. The amount of down payment needed depends on the bank and the type of housing/state of the housing. It can also depend on the loan “type.” There are some government-subsidy programs that will allow you to have down payments as low as 3.5%of the house’s value. Often, banks require down payments of at least 5%. Some may require more. If you put less than 20%down, your bank may charge you “property mortgage insurance” or PMI. This is essentially insurance the bank gets that will help them recover the full value of your house in case of foreclosure. Once you have 20%in equity, you no longer have to pay for PMI.

So far, we’ve described “conventional loans.” These are loans for houses that are in good condition with nothing tricky going on. However, there are a number of other kinds of loans. For example, some people may want a “rehab loan.” With a rehab loan, you borrow money to purchase and fix up a run-down property. With these loans, you generally do borrow more than the (current) value of the house. The idea is that your property value (and equity) will rapidly rise after the rehab. There are a number of other non-conventional loans out there with different terms and purposes.

One of the biggest determines of your monthly mortgage payments is the interest rate charged. As we explored in our work with credit, interest rates are, in part, determined by your credit. Interest rates are also determined by geographic location, property condition, and rates set by the FED. It is important to pay attention to interest rates. A single percent difference can mean the difference between being able to afford a house or not.

There are generally two kinds of interest program available. The most common is a fixed interest rate. With a fixed interest rate, your interest rate cannot change, no matter what, over the life of your mortgage. You can technically “change” your interest rate by re-financing. However, re-financing is technically a whole new loan. There are also variable-rate loans.

Pay attention.

Generally, variable-rate loans are dangerous. Most variable-rate loans have a very low “come-on” rate. That rate is then allowed to be changed (almost always increased) after a certain number of years. Many families have lost their homes because of variable interest rates when their monthly payments suddenly increased by hundreds of dollars once the new rate kicked in. There are some scenarios when a variable interest rate makes sense, but you should generally only consider fixed interest rates.

One of the biggest barriers to home ownership is not the monthly payment but the up-front costs to taking out a mortgage.

We have gone over down payments, which already require a hefty amount of cash. There are other costs as well.

Taking out a loan requires closing costs. When you actually sign the paperwork for a mortgage and assume ownership of a house, you engage in a process called “closing.” These days, closing requires a number of institutions involved. Lawyers are involved to handle the contract drafting and signing. Title companies are involved for changing ownership of the house deed and maintaining the deed. Banks are needed to actually give the cash to the seller and real estate agents. Accountants may be involved for tax purposes. All this needs to paid for. With the exception of real estate agent fees, all costs for closing, called closing costs, must be paid for by the buyer. (Technically, since real estate agent fees are incorporated in the house’s price, the buyer also kind of pays for those too.)

While, technically, closing costs must be paid for up front, like a down payment, practically, they can be “rolled into” the loan. That is, you borrow those closing costs from the bank on top of what you borrow for the house. For example, suppose you want to buy a house that costs $200,000. The bank requires a 10%down payment, and there are $10,000 in closing costs. How much do you need to actually pay up front? You have two options. One is to pay the down payment and closing costs in cash. 10%of the house loan is $20,000. So, you would need a total of $30,000 up front. The other option is to roll the costs into the loan. This effectively makes the implied total house cost $210,000. 10%of this is $21,000, which is what you’d need to have in cash. The benefit of rolling in the closing costs is needing less cash up front. The issue is that you’ll be paying interest on the extra borrowed money.

If you take out a mortgage, you will be required to have property insurance. Even if you don’t owe money on your house, you should have property insurance anyway. Insurance is another part of home ownership that is pricing people out of homes. The triple whammy of climate change, supply-chain disruptions from COVID, and the most recent tariffs put into place have made the cost of rebuilding a home much more expensive than it used to be. This has caused property insurance to sky rocket. This is worse in some areas. Areas with more hurricanes or wildfires are seeing astronomical insurance surges. Some insurance companies are dropping certain damage types from plans, which can drop the monthly costs, but it leaves your home in more danger. Also, some banks may not allow you to carry insurance without certain key damage types covered.

Property insurance can be hard to navigate. Many things influence your monthly rate. Also, the difference of one-tenth of a mile can drastically change the rate. Flood insurance is a main example. Some houses are in a “flood plane,” which often necessitates flood coverage in your property insurance. Other houses are often not required to have this coverage. Certain building structures may also influence your rate. Being surrounded by tall trees may increase the likelihood of damage from wind, which raises your rate. If you have a French drain installed, you are more protected from flooding, which may lower your rate.

While you have a mortgage on your house, your bank actually makes the insurance payments to the company. On top of your loan payment, you will also be charged the insurance premium in your monthly housing payment. Insurances costs vary wildly, but expect to pay hundreds each month for coverage. As the value of your house goes up and building material costs go up, your insurance payments will also go up.

As owner of your home, you will be responsible for any property taxes. Your taxes are usually paid every six months. Much like insurance, your bank actually pays them while you have the mortgage out. The cost is spread out over months and are included in your total monthly payments to the bank. How much your tax payments are are determined by your home’s “assessed” value and the tax rate set by your city. Different cities have different rates. Generally, cities with more amenities and more publicly-funded things like parks and what not have higher tax rates. You should expect to pay a few to several hundred in taxes each month. Usually, your house’s value, which determines your monthly tax cost, is done every two years.

It you own your home, you are responsible for utilities. While there are some programs in Massachusetts to help low-income families with utilities, most are responsible for the full amount. Water, heat, electricity, internet, etc. are all monthly costs. Utilities are usually more costly in the coldest and warmest months of the year. Depending on your house’s size and family size as well as location and utility companies, your average monthly cost can vary greatly. Expect at least a few hundred dollar each month.

Decay is a thing. Your house will get dirty. Things will break. Accidents happen. If you own your house, you need to pay for all upkeep. Mowing a lawn, cleaning a bathroom, tending a garden, replacing a broken stove. You have to pay for all of this. Generally, it’s recommended to expect to pay about 2%of your house’s value each year in repairs. General cleaning costs are not part of that.

There are a lot of costs to owning a home beyond what you owe your bank. Let’s take an example and break it down.

Suppose you want to buy a home in Westfield that is valued at $250,000. Closing costs are $10,000. The bank requires that 12%be put down. You take out a 30-year loan. The interest rate is 6.8%. The assessed value is $240,000, and the tax rate is 1.7%. Insurance costs are $2,000 per year. Utilities average $320 per month. You expect to pay $50 per month on cleaning supplies. How much would you expect to pay for housing on average?

Keep in mind that housing costs go up each year. Taxes and insurance go up with your home’s value. Utilities and other costs go up with inflation. So, always keep this in mind. Of course, there will be a point at which you pay off your house, which will means the loan part of your housing expenses goes away forever.