Personal finance course

When people say that the nation's debts are going to be a burden on our children, they sometimes forget that a lot of the money that is borrowed is going to pay for things that will benefit our children. If the nation just did away with taxes and never borrowed anything, as some people would probably like, the nation might not be here at all when it comes time for our children to take over. Or if it were still here, nobody would want to live in it.

That's kind of silly. Thumper

I would add the concept of depreciation which isn't well understood by many people.

-- Ron

perhaps a field trip to look at some winos and bums might do the trick.

I didn't see "home ownership" on the list. Under that, I would cover things like renting vs buying (better to buy if annual rent is > approx 1/10 of home price, but not if significantly less), the costs of home ownership (principal + interest + taxes + insurance + maintenance), how much home one can afford based on income -- rules of thumb such, etc.

Also, it might be worth saying a little about quality of life vs standard of living in the beginning.

Anoop

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excellent ideas... can you please cite a reference for the rental cost being 1/10 home price (never heard that ratio before).

quality of life vs standard of living should be added, agreed.

Ginnie Mae site's not much help - mostly covers buying process, not costs of ownership. Many rent v own calculators assume some appreciation, and just run the numbers inside a black box (no specifications of utilities, maintenance, and so forth). You might do well to warn your students about using these calculators.

NY Times article breaks out costs and I get about 9% of price as a cost of owning, from their numbers, using a 5% lost opportunity cost - but I'm not sure about the tax rate (1.35%) and the maintenance costs (0.5% ?!). The article does give an indication of how to run the numbers. As anoop and others have noted, there are many variables, many intangible.

Every set of numbers I have personally run seems to indicate that 10% of purchase price (adjusted for land value) is a reasonable benchmark with some wiggle room. I still think the FDA should require warning labels to be prominently displayed on houses: "WARNING: Home ownership can be hazardous to your financial and emotional health!"

That is a good point. For a great many people, the costs of home ownership and related expenses amount to one of the largest and most important financial transactions of their lives. And the matters of concern go far beyond just the decision as to whether to own or rent. What kind of mortgage to obtain, the interest rate paid, and how to best shop around for a mortgage all have major financial implications. A small difference in interest rate can turn into big differences over a long period of time. There are a lot of pitfalls that need to be avoided. Most people need to become more knowledgeable about what to expect from real estate agents, and to know more about how negotiations with sellers typically play out and who represents whom in these negotiations.

The decision as to whether to deal with bank, some other financial institution, or to employ the services of a mortgage broker, etc. also is very important. Once a mortgage is in place, the question of possibly paying it off or making extra payments at some time in the future should be considered. Even the question about whether or not a particular mortgage allows extra payments is a matter of concern. When it is desirable to refinance, as interest rates rise and fall, is another question with big financial implications. Watch out for pre- payment penalties! I would go so far to suggest that for many people these consideration are equally important and perhaps more important than decisions about investing in the stock market. All these things together certainly add up to large amounts of money and should be a significant part of financial planning.

Nice post .I really liked it.

I believe that the cost of refunding somehow has to enter into that equation:

If you pay a yearly rent R, the capital needed to buy the property is C and the interest rate is i, buying the property would be cheaper than renting if

C * i < R, or if you convert it, C/R < 1/i.

R is supposed to be the net rental fee, without cost of utilities attached. With an interest rate around 10% you would indeed arrive at C/R = 10, using the current rate it should be nearer 20.

You might also look at it from the other side. If you have the capital and do not need refunding, 'i' would be the interest rate you are able to get from a long term investment.

I need to put my head around the math.

On my word outline, I had mortgages as a subject item, I even had mortgages in a few of the problems, but no specific item to discuss the many issues related to this.

Here are some thoughts as I might present this (this is me thinking out loud)

Compare a rent payment to a mortgage payment. If both are $1000/mo that does not tell a person "everything", but does give you a starting point.

To calculate a mortgage payment you need to know

1) Price of house 2) down payment (usually 20% or more of price) 3) interest rate 4) Credit score 5) Closing costs

As all of above will drive to the "price" of $1000/mo (or whatever math comes out to be) which you are comparing to rent payment.

As the person purchasing a home, you have several options

1) Buy a new contruction house pro/cons 2) Use a realtor to buy a house pros/cons (this is most popular method) 3) For sale by owner pros/cons

And to obtain financing you have several options

1) thru builder 2) thru a bank 3) thru a mortgage broker 4) thru a credit union

(each of above has pros and cons)

if anyone has comments on the finer points above (pros/cons of ways to purchase and finance) please chime in. I have experience with new construction (financed thru builder both times) and refinancing with a broker (done this 5 times).

Keep in mind I have no "material" except what I have experience with, so any references to someone which has blogged about all these, for example, could be a HUGE help.

Benefits of mortgage If the annual cost of a rental lease ($1000/mo times 12 months$12,000) is directly compared to the annual cost of owning ($1000/mo times 12 months) the cost of owning wins out (the higher the cost, the more owning comes out ahead). This is because of mortgage interest deduction and saving money on federal and state taxes.

The anti thesis of this is do not buy MORE HOUSE because it appears a better value. Meaning if you paid $1000/mo in rent, then realize all these deductions exist and decide you can "afford" $1500/mo in a mortgage because $500/mo is coming back to you in taxes thru either less payroll deductions (higher take home) or a higher refund April

For mortgages, I would suggest the following guidelines:

If you are YOUNG (under 30) at a point in life where wages will increase significantly Mortgage payment should be no more than 30% of take home pay.

If you are mid life, mortgage should be no more than 25% of take home pay

**Our area is not HCOL, so all you CA, NYC, Boston and HCOL residents can take those ratios and laugh.

If you have two incomes, you need to make some decisions based on risk and reward, and what you need vs what you want.

If you use the 30%/25% of total household income, and one spouse stops working (gets injured, gets pregnant, gets divorced) decide if the purchase is worth that risk.

Mortgages come with many forms

15 year fixed 30 year fixed ARM (7/1, 5/1, 3/1)

all have similarities and differences. All things being equal, I suggest 15 year fixed as if you need a 30 year fixed to afford the house, you might as well re-read this whole section and downsize planning a little bit. Too much of life happens in 15 years to suggest paying something over 30 years is a good idea IMO.

OP started out for someone who may be teaching a personal finance course and part of it have now morphed into other areas. The post to which I'm dealing mentioned a citation for the rental of a house being roughly equivalent to

1/10 the cost of the house, a citation was asked for. It is THIS issue to which I'm responding.

I've heard various "rules of thumb" for determing the fair rental price. Everyone seems to have their own guidelines and almost every one I've ever seen has some rational basis for it. For a peek into the other side I thought I'd share with everyone how I advise my clients who own rentals on how to set the rent. Note that not all of them follow it, especially in this economy and most especially if they acquired the home at the height of the housing bubble. But it is the starting point I recommend -

FIRST - consider how much cash the buyer had to put up to buy the house. NOT THE COST, just the out of pocket cash. SECOND - what rate of return would you have been happy to get in the local market had you invested that money instead of buying the house. THIS gives you the annual return on your investment in the house.

THIRD - we have to accumulate some other information about the property - 1 - annual amount owner pays for utilities, anticipated repairs, and management fees; 2 - annual amount for mortgage payments (PITI);

FOURTH - total all three of these numbers, then divide by 12. This gives you the montly rent you need to charge to cover your outlay and provide a return on your investment.

Sometimes this actually works out to some mystical rule of thumb. But whether it does or not, what it does give you a way to cover your costs. Of course, as I mentioned, in this economy it may not be possible to actually GET this much. Some of my clients are renting at a negative cash flow because they can cover the spread and are holding on till the economy changes.

Hope this helps, Gene E. Utterback, EA, RFC, ABA

All these various calculations that people have suggested are fine as rules of thumb, but one important fact should be borne in mind. The calculations are based on what seems reasonable NOW and what will perhaps be the economic climate for the next two or three years. However, home ownership is a long term, possibly even a lifetime commitment. In the future the comparison of rental costs and home ownership costs could result in entirely different numbers. And inflation is relevant to both. What PROPORTION of the costs of home ownership are vulnerable to future inflation? And what proportion of the costs of renting are vulnerable? The answer in the case of renting is easy, but for home ownership it is a bit more difficult. At any rate, it certainly seems that home ownership affords a certain amount of inflation protection, while renting affords none.