9.2: Identify the Product and the Market

Learning Objectives

1. Describe the different building structures for residential dwellings.
2. Describe the different ownership structures for residential dwellings.
3. Identify the factors lenders use to evaluate borrowers for mortgage credit.
4. Identify the components of the mortgage affordability calculation and calculate estimated mortgage affordability.
5. Identify the components of a buyer's inspection checklist.
6. Explain the potential effects of business cycles, unemployment, and inflation on the housing market.
7. Analyze the effects of the demand for housing financing on the housing market.

Renting a Home

If you have already decided on a goal of home ownership, you have probably already compared the costs and benefits of the alternative: renting. Renting requires relatively few initial legal or financial commitments. The renter signs a lease that outlines the terms of the rental agreement, including the term, rent, payment terms and fees, restrictions (such as pets or smoking), and charges for damages. A renter is usually required to provide the landlord with a security deposit to cover the landlord's costs for repairs or cleaning, as necessary, when the tenant moves out. If the deposit is unused, it is returned to the departing tenant (although typically without any interest earned).

Some general advantages and disadvantages of renting and owning are shown in Table 9.2.1 (Renting) and Table 9.2.2 (Owning).

Table 9.2.1 : Advantages and Disadvantages of Renting

Advantage	Disadvantage
Limited financial obligation	No equity growth or store of value
Limited maintenance expenses	Lifestyle limitations (e.g., pets, smoking)
More liquidity	Decorating/renovating limitations
More mobility	Less predictable housing expense

Table 9.2.2 : Advantages and Disadvantages of Home Ownership

Advantage	Disadvantage
Store of value and possible equity growth	Substantial financial obligation
Lifestyle choices	Significant annual expenses
Decorating/renovating choices	Less liquidity
Pride of ownership	Less mobility
Tax deduction for mortgage interest
More predictable housing expenses

The decision of whether to rent or own typically follows the pattern of life stages. People often rent early in their adult lives because they typically have fewer financial resources and place a higher value on mobility, which allows for greater career flexibility. When adults first begin their careers, their incomes are generally lower, and the tax advantages of homeownership don't provide much benefit.

As family size grows, the quality of life for dependents typically takes precedence, and a family seeks the added space and comfort of a home, as well as its benefits as an investment. This is the mid-adult stage of accumulating assets and building wealth. As income rises, the tax benefit may become increasingly valuable as well.

With both income and family size smaller in retirement, older adults will often downsize to an apartment, reducing responsibilities and financial commitments.

Homeownership decisions vary: Some people do not want the responsibilities of ownership, while others want a place of their own.

Finding an apartment is much like finding a home in terms of assessing its attributes, comparing choices, and making a choice. Property owners, property managers, and agents all rent properties and use various media to advertise available space. Since the rent for an apartment is a regular expense, financed from current income (not long-term debt), you only need to find an apartment, not the financing, which simplifies the process considerably.

Assessing Attributes

Once you decide to own your home, you must choose the one that is right for you, considering the different types of homes and forms of home ownership.

There are single- and multiple-unit dwellings, for example. A multiple-unit dwelling can be used to create rental income or to house extended family members. Still, this choice imposes the responsibilities of being a property owner and also limits privacy.

There are previously owned, new, and custom-built homes. Previously owned homes may require some renovation to make them comfortably modern and convenient. New and custom-built homes typically have more modern features and conveniences and require less maintenance and repair expense. Custom-built homes are built to the homeowners' specifications.

Sales of existing single-family homes far outnumber sales of new and custom homes. In September 2023, for example, 3.96 million existing homes^[1] were sold compared to 759,000 sales of new homes^[2]. The average price of a new house in the United States in June 2023 was $416,000. [3]

Mobile homes can be fitted with utility connections, installed with trailers on permanent sites, and used as residences. A mobile home may also be situated in a trailer park or mobile home community where the owner rents a lot. Mobile homes are often referred to as manufactured homes. Other examples of manufactured homes include prefabricated or modular homes, which are transported to a foundation site by trailer and then assembled.

In a condominium (condo), the homeowner owns a unit in a multiple-unit dwelling, but the common areas of the building are owned and managed by the condominium owners' association. Condo owners pay a monthly fee to cover the costs of overall building maintenance and operating expenses for common areas.

Cooperative housing refers to a unit in a building or complex that is owned by a nonprofit association or corporation for the exclusive use of its residents. Residents do not own the units; instead, they own shares in the cooperative association, which entitles them to the right to reside in its housing units.

Personal factors such as your age, family size, health, and career help you to answer some of the following key questions:

• How large should the house be? How many bedrooms and bathrooms?
• Which rooms are most important: the kitchen, the family room, or the home office?
• Do you need a parking space or a garage?
• Do you need storage space?
• Do you need disability accommodation?
• Do you want outside space, such as a yard, patio, or deck?
• How important is privacy?
• How important are energy efficiency and other "green" features?
• How important are design features and appearance?
• How important are the location and environmental factors?
• What is the proximity to work? Schools? Shopping? Family and friends?

After ranking the importance of such attributes, you can use an attribute-scoring matrix to score your choices. Once you understand exactly what you are looking for in a home, you should also consider how much house you can afford.

Assessing Affordability

Before looking for a house that offers what you want, you need to identify a price range that you can afford. Most people use financing to purchase a home, so your ability to access financing or get a loan will determine the price range of the house you can buy.

For example, Eva and Mateo are both twenty-five years old, newly married, and hoping to buy their first home. Both work and earn good incomes. The real estate market is strong, especially with mortgage rates relatively low. They buy a two-bedroom condo in a new development as a starter home.

Fast-forward five years. Eva is expecting their second child. While the couple is happy about the new baby, neither Eva nor Mateo can imagine how they will all fit in their already cramped space. They would love to sell the condo and purchase a larger home with a yard for the kids, but the real estate market has slowed, mortgage rates have risen, and a plant closing last year has driven up unemployment in their area. Eva hasn't worked outside the home since their first child was born two years ago. They are barely getting by on one salary, and a new baby will increase their expenses, making it even more challenging to consider financing a larger home.

A lender will look at your income, your current debts, and your credit history to assess your ability to assume a mortgage. As discussed in Chapter 7, your credit score is a crucial tool for lenders, who may also request verification of employment and income from your employer.

Lenders do their calculations of how much debt you can afford, based on a reasonable percentage - usually about 33 percent - of your monthly gross income that should go toward your monthly housing costs, or principal, interest, taxes, and insurance (PITI). If you have other debts, your PITI plus your other debt repayments should be no more than about 38 percent of your gross income. Those percentages will be adjusted for income level, credit score, and the amount of the down payment.

Say the lender assumes that 38 percent of your monthly gross income (annual gross income divided by twelve) should cover your PITI, plus any other debt payments. Subtracting your other debt payments and estimated cost of taxes and insurance leaves you with a figure for affordable monthly mortgage payments. Dividing that figure by the mortgage factor for your mortgage's maturity and mortgage rate shows the mortgage that is affordable overall. Once you know what percentage your mortgage will be of the home's purchase price, you can calculate the maximum purchase price of the home you can afford. That affordable home purchase price is based on your gross income, other debts, taxes, insurance, mortgage rate, mortgage maturity, and down payment.

Table 9.2.3 shows an example of this calculation for a thirty-year, 6.5 percent mortgage.

Table 9.2.3 : Mortgage Affordability Calculation

1. Gross Annual Income	$ 60,000
3. PITI + Other Debt Payments	$ 1,900 = 38% of $ 5,000
4. Other Debt Payments	$ 200 = your estimate
5. Affordable Monthly PITI	$ 1,700 = (3) - (4)
6. Monthly Taxes + Insurance	$ 700 = your estimate
7. Affordable Monthly Mortgage Payment	$ 1,000 = (5) - (6)
8. Mortgage Factor	6.32 = mortgage factor
9. Affordable Mortgage	$ 158,228 = (7) / (8) x 1000
10. Down Payment as % of Purchase Price	20% = your estimate
11. Mortgage as % of Purchase Price	80% = 1 - (10)
12. Affordable Purchase Price	$ 197,785 = (9) / (11)

You and your lender will have a clearer idea of how much house you can afford once you make these calculations. You may want to sit down and discuss this with a potential lender before you do any serious house hunting. That way, you have a price range in mind before you shop. Mortgage affordability calculators are also available online.

Searching for a Home

Once you understand exactly what you are looking for in a home and what you can afford, you can organize your efforts and begin your search.

Typically, buyers use a real estate agent and real estate listings to identify homes for sale. A real estate broker can add value to your search by providing information about the house and property, the neighborhood and its schools, recreational and cultural opportunities, and the cost of living.

However, remember that although the broker or their agent may be helping you gather information and assess your choices, they are working for the sellers and will be compensated by the seller when a sale is made. Consider hiring a buyer's agent, a fee-based real estate broker who works on behalf of the buyer to help identify their best options. The industry is regulated by state and federal laws, as well as self-regulatory bodies, and real estate agents are required to be licensed to operate.

Increasingly, sellers are marketing their homes directly to save the cost of using a broker. Buyers and sellers of real estate negotiate with real estate agents on the amount of the commission they will pay on the sale/purchase of a home. For-sale-by-owner (FSBO) sites online can make the exchange of housing information easier and more convenient for both buyers and sellers. However, keep in mind that sellers acting as their own brokers and agents are not licensed or regulated, and may not be knowledgeable about federal and state laws governing real estate transactions. This will potentially increase financial and legal risks.

After you narrow your search and choose a prospective home within your price range, you will have the home inspected to assess its condition and estimate the cost of any necessary repairs or renovations. Many states require a home inspection before signing a purchase agreement or as a condition of the agreement. A standard home inspection checklist, based on information from the National Association of Certified Home Inspectors, is shown in Table 9.2.4 .

Table 9.2.4 : Standard Home Inspection Checklist

Structural Elements	Foundation, floors, walls, ceilings, roofs
Exterior Elements	Sliding, fascia, trim, windows, doors, elevation, drainage, landscaping, pool, driveways, sidewalks
Roof and Attic	Framing, ventilation, flashing, gutters
Plumbing	Pipes: potable, drain, waste, vent, toilets, showers, sinks, faucets, traps
Electrical	Main panel, circuit breakers, wiring, fixtures
Systems	Furnace, water heater, air conditioner, ducts, chimney, sprinklers
Outdoor Buildings	Garage, tool shed, pool house

When purchasing a car, it's a good idea to have a trusted mechanic inspect the vehicle. When buying a house, buyers or their agents must ask a professional (structural engineer, contractor, or licensed home inspector) to perform a thorough home inspection. See the American Association of Home Inspectors (www.homeinspector.org) for detailed information. Not only will a professional be able to spot potential problems, but they will also identify evidence of past issues that may have been improperly addressed or that may recur, such as water in the basement or leaks in the roof. If there are problems, you will need an estimate of repair costs. If an inspection finds any significant need for repairs or renovations, especially those requiring immediate attention, a buyer or their agent can try to reduce the purchase price by those costs. You don't want any surprises after you buy a house, especially costly ones.

Your lender will require a title search to verify that no liens or claims are outstanding against the property. For example, the previous owners may have had a dispute with a contractor and never paid his bill. The contractor may have filed a mechanics lien or a claim against the property, which must be resolved before the property can be transferred. There are several other kinds of liens; for example, a tax lien is imposed to secure payment of overdue taxes, such as property taxes or federal income tax.

A lawyer or a title search company can do the search, which involves checking the county or city records where a lien would be filed. A title search will also reveal if previous owners have deeded any rights, such as development rights, water rights, or mineral rights. Grants of right-of-way across the property may diminish its value, so be aware of these as well.

Identifying the Market

Housing costs are determined by the price of the house and the interest rate or other costs associated with financing the house. House prices are determined by forces of supply and demand, which, in turn, are determined by macroeconomic circumstances.

When the economy is contracting and incomes are decreasing, especially if unemployment rises and incomes become uncertain, buyers are hesitant to take on the significant financial responsibility of new debt. They tend to continue with their present arrangements or may try to move into cheaper housing, such as downsizing to a smaller house, an apartment, or a condo, to decrease operating expenses. On the other hand, when the economy is expanding, expectations of rising incomes may encourage buyers to be more confident in their purchasing decisions.

Housing markets are local, however. If the local economy is dominated by a single industry or a large employer, the housing market will be susceptible to the fate of that industry or employer. If a location has value independent of the local economy, such as being a preferred vacation or retirement location, that value can offset local concerns. In that case, housing prices may be less sensitive to local economic conditions.

Acquiring a home relies on a buyer's ability to finance the purchase, provide a down payment, and secure a loan to cover the balance. That ability is determined by the buyer's personal situation (e.g., stability of employment or income, credit history) and by macroeconomic events such as interest rate levels, expected inflation, and liquidity in the credit markets. If interest rates and inflation are low and there is liquidity in the credit markets, it will be easier for buyers to borrow. If inflation and interest rates are high and the credit market is illiquid, it becomes harder for buyers to borrow. Demand for housing thus relies on the availability of credit for the housing market.

Summary

• Different building structures are
  • single-unit or multiple-unit dwellings or mobile homes
  • previously owned, new, or custom-built
• Different ownership structures include
  • conventional ownership
  • condominium
  • cooperative housing
• Lenders assess income, current debts, and credit history to determine the creditworthiness of borrowers
• A mortgage affordability estimate uses an estimate of PITI and other debt payments as a percentage of gross monthly income and of the down payment as a percentage of the purchase price
• The buyer's inspection checklist includes
  • structural elements
  • exterior elements
  • systems for plumbing, electrical, heating/cooling
  • outdoor buildings and features
• Housing prices may be affected by business cycles, as they affect
  • unemployment and income levels
  • inflation, which affects not only the cost of houses, but also interest rates and the cost of home financing
• Housing prices are affected by the availability of home financing, which in turn depends on
  • interest rates and inflation
  • liquidity in the credit markets

Exercises

1. Perform an analysis of your projected wants and needs as a homeowner. Begin by prioritizing the following personal and microeconomic factors in terms of their importance to you in deciding when to buy a home.
   • How large should the house be? How many bedrooms and bathrooms?
   • Which rooms are most important: the kitchen, the family room, or the home office?
   • Do you need a parking space or a garage?
   • Do you need storage space?
   • Do you need disability accommodation?
   • Do you want outside space, such as a yard, patio, or deck?
   • How important is privacy?
   • How important is energy efficiency or other "green" features?
   • How important are design features and appearance?
   • How important are location and environmental factors?
   • Proximity to work? Schools? Shopping? Family and friends?
2. In your financial journal, describe the first or next home you would like to own, including its location and environment. Predict how much you think it might cost in your state. Then look through real estate sites to find the asking prices for homes or housing units similar to the one you described. How accurate is your prediction?
3. Are you a renter and likely to remain one for a few years? Read legal tips about renting (www.nolo.com/legal-encyclopedia/ten-tips-tenants-29446.html) housing. How does that advice compare with the information in this chapter about buying a house? What advice, if any, would you add? Discuss with classmates the advantages and disadvantages of being a tenant and being a landlord. Develop a comparison chart that outlines the benefits, drawbacks, and risks.
4. Do you live in a dorm or at home with parents or other relatives? What needs to happen for you to have a place of your own? Research websites that aid students in finding independent housing, such as this article (www.collegiateparent.com/housing-residential-life/housing-search-tips-to-share-with-your-student) from CollegiateParent. Develop a flexible plan and timetable for finding and financing your own place, and record it in your personal finance journal.
5. Investigate the local real estate market. How do local housing availability and pricing differ from those of other cities, towns, counties, and states? Use online resources to find this information. Housing Predictor (www.housingpredictor.com) provides independent real estate market forecasts for local housing markets for all fifty U.S. states; Realty Times (www.realtytimes.com) analyzes local real estate markets nationwide. How stable or volatile is the real estate market? Is it a buyer's or seller's market, and what does that mean? To what local factors do you attribute the differences you find?
6. Identify and analyze the macroeconomic factors affecting your local real estate market. In what ways or to what extent does your local economy reflect macroeconomic factors in the national economy? According to the National Association of Realtors (www.nar.realtor), what are the most important present trends in the real estate market? If you were shopping for a new or existing home today or were planning to build, how would each macroeconomic factor or trend affect your choices? Record your answers in your personal finance journal.
7. Watch House Hunting Tips for First-Time Home Buyers (www.youtube.com/watch?v=iwz3eJyiWlk) (2:24 minutes). How do you determine the best location to look for a home? How do you find a real estate agent? Consider watching the Bank of America First-Time Home Buying series (www.youtube.com/playlist?list=PL4yQRNEEv-VnK-39hw4GQn86zQj2tAEoj) with Kristy and Desmond. The five short videos, each three to four minutes long, take you through their home-buying experience.

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^[1] Mutikani, Lucia. “US Existing Home Sales Drop to 13-Year Low in September.” Reuters, October 19, 2023. https://www.reuters.com/markets/us/u...-2023-10-19. www.reuters.com/markets/us/us-existing-home-sales-drop-13-year-low-september-2023-10-19/.

^[2] Mutikani, Lucia. “US New Home Sales Scale 19-Month High as Median Price Drops.” Reuters, October 25, 2023. https://www.reuters.com/markets/us/u...-2023-10-25. www.reuters.com/markets/us/us-new-home-sales-accelerate-september-2023-10-25/.

^[3] Phillips, Matt. “Old Houses Now Cost as Much as New Houses.” Axios, July 23, 2023. https://www.axios.com/2023/07/21/new...-home-prices. www.axios.com/2023/07/21/new-existing-home-prices.