Housing Investment

The amount invested in a house, equal to the sale price less the loan amount. The House Investment Decision: Lenders impose the upper limit on how much a household can spend for a house. When borrowers push the limit, it becomes costly because such borrowers are viewed as more risky to the lender. Small down payments require a higher interest rate or mortgage insurance. The major component of wealth is the value of the house. This is affected by the assumed rate of price appreciation. Higher price appreciation benefits the aggressive buyer more than the cautious one. From this must be deducted the balance of the mortgage. Both the rapidity with which the loan balance is reduced and the size of the monthly mortgage payment are affected by the mortgage interest rate. Since the aggressive buyer borrows more than the cautious buyer, higher mortgage rates hurt the aggressive buyer more than the cautious buyer. We must also deduct the amount paid each month for interest, principal reduction, mortgage insurance, and the lost interest on this amount. This is affected by the assumed 'investment rate,' which is the rate the buyers could have earned if they invested this money elsewhere. Since the monthly payments are larger for the aggressive buyer, higher investment rates hurt the aggressive buyer more than the cautious buyer. On the other hand, interest is tax deductible so that higher tax rates work in the opposite direction. Buying the Next Home Before the Existing One Is Sold: Many home-buyers are dependent on the equity in their existing house to finance the new one, but the closing date on the new one comes first. The cash needed to close before the sale can be obtained through a swing loan from a bank, or a home equity loan on your current house. A home equity loan is likely to be more costly than a swing loan, although the cost will be influenced greatly by the amount of equity in the current property and on how astutely the borrower shops. Pay a higher interest rate if necessary to avoid points (an upfront charge expressed as a percent of the loan amount), other upfront fees, and prepayment penalties. On a three-month loan, a borrower can afford to pay an interest rate up to four percentage points higher to avoid paying a fee equal to 1% of the loan.