Page 570 - Introduction to Business

544 PART 5 Finance

deaden.” The idea of amortizing a loan over a long time period is to deaden the pain
of the debt. Mortgage lenders have an important responsibility to ensure that bor-
rowers can afford their American dream. Not only does this benefit the borrower,
but it also ensures the lender a profitable repayment of the loan. Consequently, all
parties to a mortgage loan benefit.
Is a home a good investment? Home prices increased at a double-digit pace dur-
ing the 1970s. In later years, home prices fell in areas like Texas, Louisiana, California,
and Oklahoma. In recent years, home prices have increased in some areas and
decreased in others. Either way, homeowners can benefit in several ways from own-
ing a home.
Paying off a real estate loan, a mortgage, builds equity that can sometimes be
used as collateral for financing other purchases. Home mortgage interest and prop-
erty tax are two of the tax breaks remaining in U.S. tax laws. Homeowners can still
deduct mortgage interest and property tax from other taxable income.
In light of recent market conditions, you should consider a home as a living
expense and not as an investment. Financial instruments generally make better
investments than property during periods of low inflation. Financial planners rec-
ommend paying off mortgage debt as quickly as possible when the home-value
appreciation rate is low. Why? The only way to build equity when the home is not
appreciating is to reduce the debt on the house. Consequently, the 15-year mort-
gage is widely used because it builds equity about seven times faster than the tra-
ditional 30-year mortgage.
How much can you afford to pay for a home? Most lenders have general rules
regarding the maximum loan amount. The National Association of Realtors uses
the method shown below.
1. Calculate the borrower’s gross monthly income. To do this, divide the bor-
In April 2004, the median house rower’s yearly salary before any deductions by 12. If the borrower’s spouse
price in the United States rose to
$176,000. works, do the same for that salary.
2. Deduct monthly payments on long-term debts (e.g., car
loans) from gross monthly income.
3. Multiply that figure (gross monthly income minus long-
term debt payments) by 0.32. The resulting amount is
the monthly payment that the borrower can afford,
according to most lending guidelines, with a down pay-
ment of 10 percent or more.
4. Determine the average real estate tax in the area. Real
estate taxes on an average home can vary substantially,
from several hundred to several thousand dollars annu-
ally. Add 2 to 4 percent for annual insurance premiums,
which also may vary substantially. Divide the total by 12
to calculate monthly costs for taxes and insurance. The
average monthly cost for taxes and insurance on a
$100,000 home would be about $200.
5. Subtract the monthly cost of taxes and insurance from
the monthly payment computed in step 3. The resulting
figure is how much the borrower can afford to pay for a
mortgage each month.
Let’s consider the case of Lawrence and Doris McDonald,
who have a combined gross income of $48,000 per year, a
monthly car payment of $280, and savings of $20,000. The
McDonalds’ gross monthly income is $4000; subtracting the

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