► identify the various types of housing choices available to home buyers.

► describe the issues involved in making a home ownership decision.

► explain the tax benefits of home ownership and the provisions of recent changes to the Tax Code.

► distinguish the various types of homeowner's insurance policy coverage.

► define the following key terms: coinsurance clause, homeowner's insurance, liability coverage

equity,  policy, replacement cost .

REAL ESTATE PRACTICE & PRINCIPLES KEY WORD MATCH QUIZ  --- CLICK HERE ---

I would encourage you to take this “Match quiz” now as a pre-chapter challenge to see how many of these key words or phrases you are familiar with. At the end of each chapter I recommend that you take the quiz again to reinforce these important keywords. Each page contains four words or phrases and you need to drag and drop the correct definition into the puzzle key. Each page is considered as a question, but there is no scoring and you can return to each chapter quiz as many times as needed to reinforce your memory. 

 

In the past, most homes were single-family dwellings bought by married couples with small children. Today, social, demographic, and economic changes have altered the residential real estate market considerably. Many real estate buyers today are single men and women, childless professional couples, unmarried couples, and domestic partners. An aging Baby Boom generation has given rise to empty nesters—couples whose children have moved away from home. Still other buyers may be friends or relatives who plan to co-own a home together in the same way they might share an apartment lease. Today's homebuyers come from all economic classes, from all ethnic backgrounds, and from all over the world.

There are nearly as many different kinds of home ownership as there are people who own homes. As the real estate market changes and evolves over time, the successful real estate agent will understand the various (and sometimes conflicting) motivations that move people to buy property and the options and opportunities that are broadening their range of choices.

People buy their own homes for psychological as well as financial reasons. To many people, home ownership is a sign of financial stability. It is an investment that can appreciate in value and provide federal income tax deductions. Home ownership also offers benefits that may be less tangible but are no less valuable, such as pride, security, and a sense of belonging to the community.

As U.S. society evolves, the needs of its homebuyers become more specialized. The following paragraphs describe the types of housing currently available to meet these needs. Some housing types are not only innovative uses of real estate, but they also incorporate a variety of ownership concepts. These different forms of housing respond to the demands of a diverse marketplace.

Apartment complexes are groups of apartment buildings with any number of units in each building. The buildings may be lowrise or highrise, and may include parking, security, clubhouses, swimming pools, tennis courts, and even golf courses.

The condominium is a popular form of residential ownership, particularly for people who want the security of owning property without the care and maintenance that a house demands. It is also a popular ownership option in areas where property values make single-unit ownership inaccessible for many people. Condominium owners own their units individually and share ownership of common facilities (called common elements) such as halls, elevators, swimming pools, clubhouses, tennis courts, and surrounding grounds. Management and maintenance of building exteriors and common facilities are provided by the governing association and outside contractors, with expenses paid out of monthly assessments charged to owners. While condos are often apartment-style homes, this ownership form includes single-family and even commercial properties. The condominium form of ownership is discussed in detail in Chapter 8.

A cooperative also has units that share common walls and facilities within a larger building. The owners, however, do not actually own the units. Instead, a corporation holds title to the real estate itself. The unit owners actually purchase shares of stock in the corporation, not their individual units. Owners receive proprietary leases, not conventional deeds, that entitle them to occupy particular units. Like condominium unit owners, cooperative unit owners pay their share of the building's expenses. Cooperatives are discussed further in Chapter 8.

Planned unit development (PUDs), sometimes called master-planned communities, merge such diverse land uses as housing, recreation, and commercial units in one self-contained development. PUDs are planned under special zoning ordinances. These ordinances permit maximum use of open space by reducing lot sizes and street areas. Owners do not have direct ownership interest in the common areas. A community association is formed to maintain these areas, with fees collected from the owners. A PUD may be a small development of just a few homes or an entirely planned city.

Retirement communities, many of them in temperate climates, are often structured as PUDs. They may provide shopping, recreational opportunities, and health care facilities in addition to residential units. Security and convenience are major advantages offered by retirement communities to older homeowners.

Highrise developments, sometimes called mixed-use developments (MUDs) combine office space, stores, theaters, and apartment units in a single vertical community. MUDs usually are self-contained and offer laundry facilities, restaurants, food stores, valet shops, beauty parlors, barbershops, swimming pools, and other attractive and convenient features.

Converted-use properties are factories, warehouses, office buildings, hotels, schools, barns, churches, and other structures that have been converted to residential use. Developers often find renovation of such properties more aesthetically and economically appealing than demolishing a perfectly sound structure to build something new. An abandoned warehouse may be transformed into luxury loft condominium units; a closed hotel may reopen as an apartment building; and an old factory may be recycled into a profitable shopping mall.

Manufactured housing (also known as mobile homes) were once considered useful only as temporary residences. Now, however, they are more often permanent principal residences or stationary vacation homes. Relatively low cost, coupled with the increased living space available in the newer models, has made such -.homes an attractive option for many people. Increased sales have resulted in growing numbers of "housing parks" in some communities. These parks offer complete residential environments with permanent community facilities as well as semipermanent foundations and hookups for gas, water, and electricity.

 

Modular homes (also referred to as prefabricated homes) are also gaining popularity as the price of newly constructed "stick-built" homes rises. Each room is pre-assembled at a factory, driven to the building site on a truck, then lowered onto its foundation by a crane. Later, workers finish the structure and connect plumbing and wiring. Entire developments can be built at a fraction of the time and cost of conventional construction.

Through time-shares, multiple purchasers share ownership of a single property, usually a vacation home. Each owner is entitled to use the property for a certain period of time each year, usually a specific week or month. In addition to the purchase price, each owner pays an annual maintenance fee.

Congress, state legislatures, and local governments have been working to increase the affordability of housing for all people. As a result, according to the U.S. Bureau of the Census, by the end of year 2000, 67.5 percent of households were homeowners. However, real estate prices have risen, making it difficult for some buyers to save the down payment and closing costs needed for a conventional loan. Because more homeowners mean more business opportunities, real estate and related industry groups have a vital interest in ensuring affordable housing for all segments of the population.

Certainly, not everyone wants to own a home. Home ownership involves substantial commitment and responsibility. People whose work requires frequent moves or whose financial position is uncertain particularly benefit from renting. Renting also provides more leisure time by freeing tenants from management and maintenance.

Those who choose home ownership must evaluate many factors before they decide to purchase property. And the purchasing decision must be weighed care-fully in light of each individual's financial circumstances. Renters can probably make a higher mortgage payment than their current rent payment, without requiring a pay increase, because of the tax savings realized by home ownership.

The decision of buying or renting property involves considering

► how long a person wants to live in a particular area,

► a person's financial situation,

► housing affordability,

► current mortgage interest rates,

► tax consequences of owning versus renting property, and

► what may happen to home prices and tax laws in the future.

 

Liberalized mortgage terms and payment plans offer many people the option of purchasing a home. Low down-payment mortgage loans are available under pro-grams sponsored by the Federal Housing Administration (FHA) and the Department of Veterans Affairs (VA).

An increasing number of creative mortgage loan programs are being offered by various government agencies and private lenders. Adjustable-rate loans, whose lower initial interest rate makes it possible for many buyers to qualify for a mortgage loan, are now common. Specific programs may offer lower closing costs or deferred interest or principal payments for purchasers in targeted neighborhoods or for first-time buyers. Many innovative loans are tailored to suit the younger buyer, who may need a low interest rate to qualify but whose income is expected to increase in the coming years.

Home ownership involves many expenses, including utilities, such as electricity, natural gas, and water, trash removal, sewer charges, and maintenance and repairs. Owners also must pay real estate taxes and buy property insurance, and they must repay the mortgage loan with interest.

To determine whether a prospective buyer can afford a certain purchase, lenders traditionally have used a "rule of thumb" formula for homebuyers who are able to provide at least 10 percent of the purchase price as a down payment: The monthly cost of buying and maintaining a home—mortgage payments, both principal and interest, plus taxes and insurance impounds—should not exceed 28 percent of gross, i.e., pretax, monthly income. The payments on all debts—normally including long-term debt such as car payments, student loans, or other mortgages—should not exceed 36 percent of monthly income. Expenses such as insurance premiums, utilities, and routine medical care are not included in the 36 percent figure but are considered to be covered by the remaining 64 percent of the buyer's monthly income. These formulas may vary, however, depending on the type of loan program and the borrower's earnings, credit history, number of dependents, and other factors. (Note that these financial qualification ratios are true for most FNMA and FHLMC conforming mortgages, but there are many loans available with ratios more liberal than these.)

FOR EXAMPLE      A prospective homebuyer wants to know how much house he or she can afford to buy. The buyer has a gross monthly income of $3,000. The buyer's allowable housing expense may be calculated as follows:

$3,000 gross monthly income x 28% = $840 total housing expense allowed

$3,000 gross monthly income x 36% =  $1,080 total housing and other debt expense allowed

These formulas allow for other debts of 8 percent of gross monthly income—the difference between the 36 percent and 28 percent figures. If actual debts exceed the amount allowed and the borrower is unable to reduce them, the monthly payment would have to be lowered proportionately because the debts and housing payment combined cannot exceed 36 percent of gross monthly income. However, lower debts would not result in a higher allowable housing payment; rather, it would be considered a factor for approval.

Investment Considerations

Purchasing a home offers several financial advantages to a buyer. First, if the property's value increases, a sale could bring in more money than the owner paid—a long-term gain. Second, as the total mortgage debt is reduced through monthly payments, the owner's actual ownership interest in the property increases. This increasing ownership interest is called equity and represents the paid-off share of the property, held free of any mortgage. A tenant accumulates nothing except a good credit rating by paying the rent on time; a homeowner's mortgage payments build equity and so increase his or her net worth. Equity builds even further when the property's value rises. The third financial advantage of home ownership is the tax deduction available to homeowners but not to renters.

To encourage home ownership, the federal government allows homeowners certain income tax advantages. Homeowners may deduct from their income some or all of the mortgage interest paid, as well as real estate taxes and certain other expenses. Tax considerations may be an important part of any decision to purchase a home.

In the late 1990s, the federal government enacted several federal tax reforms that significantly changed the importance of tax considerations for most home-sellers. For instance, $500,000 is now excluded from capital gains tax for profits on the sale of a principal residence by married taxpayers who file jointly. Taxpayers who file singly are entitled to a $250,000 exclusion. The exemption may be used repeatedly, as long as the homeowners have occupied the property as their residence for two of the past five years. On investment real estate required period for a noncorporate taxpayer was changed from 18 months to 12 months for long-term capital gain.

First-time homebuyers may make penalty-free withdrawals from their tax deferred individual retirement funds (IRAs) for downpayments on their homes. However, these withdrawals are still subject to income tax. The limit on such withdrawals is $10,000 and must be spent entirely within 120 days on a down payment to avoid the 10 percent penalty.

In short, the changes in tax laws have generally benefitted home ownership, which is good news for homeowners and real estate professionals.

Tax deductions.

► mortgage interest payments on first and second homes (for mortgage balances below $1 million or $500,000 if married filing separately),

► real estate taxes (but not interest paid on overdue taxes),

► certain loan origination fees,

► loan discount points (whether paid by the buyer or the seller), and

► loan prepayment penalties.

IN PRACTICE      Note that appraisal fees, notary fees, preparation costs, mortgage insurance premiums, and VA funding fees are not interest but are part of the cost of acquiring a home. When it is sold at a later date, these charges can be figured into the cost basis. Points are deductible in the year of a house purchase if certain criteria are met. Points are deducted over the life of the loan for a refinance. Note that real estate licensees should not provide tax advice and that homeowners should consult with accountants or attorneys about home ownership tax deductions. The rules are complicated and constantly changing.

A home is frequently the biggest investment many people ever make. Most homeowners see the wisdom in protecting such an important investment by insuring it. Lenders usually require that a homeowner obtain insurance when the debt is secured by the property. While owners can purchase individual policies that insure against destruction of property by fire or windstorm, injury to others and theft of personal property, most buy a packaged homeowner's insurance policy to cover all these risks.

The most common homeowner's policy is called a basic form. It provides property coverage against

► fire and lightning,

► glass breakage,

► windstorm and hail,

► explosion,

► riot and civil commotion,

► damage by aircraft,

► damage from vehicles,

► damage from smoke,

► vandalism and malicious mischief,

► theft, and

► loss of property removed from the premises when it is endangered by fire or other perils.

A broad-form policy is also available. It covers

► falling objects;

► damage due to the weight of ice, snow, or sleet;

► collapse of all or part of the building;

► bursting, cracking, burning, or bulging of a steam or hot water heating system or of appliances used to heat water;

► accidental discharge, leakage, or overflow of water or steam from within a plumbing, a heating, or an air-conditioning system;

► freezing of plumbing, heating, and air-conditioning systems and domestic appliances; and

► injury to electrical appliances, devices, fixtures, and wiring from short circuits or other accidentally generated currents.

Further insurance is available from policies that cover almost all possible perils. Special apartment and condominium policies generally provide fire and wind-storm, theft, and public liability coverage for injuries or losses sustained within the unit. However, they do not usually cover losses or damages to the structure. The basic structure is insured by either the landlord or the condominium owners' association.

Most homeowner's insurance policies contain a coinsurance clause. This provision usually requires that the owner maintain insurance equal to at least 80 per-cent of the replacement cost of the dwelling (not including the price of the land). An owner who has this type of policy may make a claim for the full cost of the repair or replacement of the damaged property without deduction for ) depreciation or annual wear and tear.

If the homeowner carries less than 80 percent of the full replacement cost, how-ever, the claim will be handled in one of two ways. Either the loss will be settled for the actual cash value (replacement cost less depreciation) or it will be prorated by dividing the percentage of replacement cost actually covered by the policy by the minimum coverage requirement (usually 80 percent).

FOR EXAMPLE    Tom's insurance policy is for 80 percent of the replacement cost of his home, or $80,000. His home is valued at $100,000, and the land is valued at $40,000. Tom sustains $30,000 in fire damage to his house. Tom can make a claim for the full cost of the repair or replacement of the damaged property, without deduction for depreciation. However, if Tom had insurance of only $70,000, his claim would be handled in one of two ways. He would receive either actual cash value (replacement cost of $30,000 less depreciation cost of say $3,000, or $27,000), or his claim would be prorated by dividing the percentage of replacement cost actually covered (.70) by the policy minimum coverage requirement (.80). So, .70 divided by .80 equals .875, and $30,000 multiplied by .875 equals $26,250.

In the 1990s, problems with synthetic stucco exterior finishes on some residential properties began to emerge. This exterior insulating finishing system (EIFS) is a highly effective moisture barrier that also tends to "seal in" moisture—trapping water in the home's walls and resulting in massive wood rot. Frequently, the effects of the rotting cannot be seen until the damage is extensive and sometimes irreparable. If a homeowner suspects that EIFS was used on their home and is causing damage, the homeowner should have the property inspected. Some insurance companies refuse to cover homes with EIFS exteriors, and class action lawsuits have been brought against builders by distressed homeowners.

The National Flood Insurance Act of 1968 was enacted by Congress to help owners of property in flood-prone areas by subsidizing flood insurance and by taking land-use and land-control measures to improve future management for floodplain areas. The Federal Emergency Management Agency (FEMA) administers the flood program. The Army Corps of Engineers has prepared maps that identify specific flood-prone areas throughout the country. To finance property with federal or federally related mortgage loans, owners in flood-prone areas must obtain flood insurance. If they do not obtain the insurance, either they don't want it or they don't qualify because their communities have not properly entered the program, they are not eligible for this financial assistance.

In designated areas, flood insurance is required on all types of buildings—residential, commercial, industrial, and agricultural—for either the value of the property or the amount of the mortgage loan, subject to the maximum limits available. Policies are written annually and can be purchased from any licensed property insurance broker, the National Flood Insurance Program (NFIP), or the designated servicing companies in each state. However, if a borrower can produce a survey showing that the lowest part of the building is located above the 100-year flood mark, the borrower may be exempted from the flood insurance requirement, even if the property is in a flood-prone area.

Massive losses in the Federal Flood Insurance Program due to the Mississippi floods in 1993 caused Congress to pass laws that greatly increase the number of proper-ties that are required to be covered by the NFIP. This requirement not only results in higher expenses for the buyer but can also negatively affect property values. Agents should pay attention to what property is in a flood zone and communicate that to potential buyers.

Current trends in home ownership include single-family homes, apartment complexes, condominiums, cooperatives, planned unit developments, retirement communities, highrise developments, converted-use properties, modular homes, manufactured housing, and time-shares.

Prospective buyers should be aware of both the advantages and disadvantages of home ownership. While a homeowner gains financial security and pride of ownership, the costs of ownership—the initial price and the continuing expenses—must be considered.

One of the income tax benefits available to homeowners is the ability to deduct mortgage interest payments (with certain limitations) and property taxes from their federal income tax returns. Changes in income tax exemptions mean that most homeowners will never need to pay capital gains taxes on the properties in which they reside.

To protect their investment in real estate, most homeowners purchase insurance. A standard homeowner's insurance policy covers fire, theft, and liability and can be extended to cover many types of less common risks. Another type of insurance, which covers personal property only, is available to people who live in apartments and condominiums.

Many homeowner's policies contain a coinsurance clause that requires that the policyholder maintain insurance in an amount equal to 80 percent of the replacement cost of the home. If this percentage is not met, the policyholder may not be reimbursed for the full repair costs if a loss occurs.

In addition to homeowner's insurance, the federal government requires flood insurance for people living in flood-prone areas who wish to obtain federally regulated or federally insured mortgage loans.