Unit 3: Concepts and Responsibilities of Home Ownership

A house cost $100,000 five years ago, has depreciated by $5,000, and will cost $150,000 to rebuild today. If the homeowner has a full-replacement coverage policy that meets coinsurance requirements, what would the insurance company pay if the house burns completely to the ground?

$150,000. With full-replacement coverage, which meets coinsurance requirements, the insurance company pays for replacing the property with no reduction for depreciation. However, the total settlement cannot exceed the face value of the property unless an endorsement to the policy specifies otherwise.

home owners are entitled to what deductions from there gross incomes

-loan intrest (1st or 2nd) homes -real estate taxes -loan organization fees -some loan discount points -some morage insurace preminum -intrest on home improvment loans -intrest on home equity loan

Most policies cover losses caused by?

1. Fire and Lightning 2. Aircraft and Vehicles 3. Vandalism and Malicious Mischief 4. Theft 5. Explosion 6. Riot and Civil Commotion 7. Smoke 8. Windstorm, Hurricane, and Hail (Gulf Coast excluded) 9. Sudden and Accidental Water Damage

Most policies do not cover losses caused by?

1. Flooding 2. Earthquakes 3. Termites 4. Insects, Rats, Mice 5. Freezing pipes while your house is unoccupied (unless you turned off the water or heated the building) 6. Wind or Hail damage to trees, shrubs 7. Losses if your house is vacant for 60 days or more 8. Wear and Tear or Maintenance 9. Water Damage resulting from continuous and repeated seepage 10. Underground plumbing; or any surface water in the ground

The maximum penalty-free withdrawal from an IRA for a first-time homebuyer i

10,000

For homeowners in upper-income brackets whose gains exceed $500,000 ($250,000 for a single taxpayer), the capital gains tax rate is limited to what percentage?

20

Lenders may use a conservative rule-of-thumb formula that the monthly cost of buying a home (PITI payment) should NOT exceed what percentage of the borrower's gross monthly income?

28

If a loan applicant has a poor credit history, a residential loan originator would be more likely to use housing-expense and total-debt ratios of

28% and 36%.

Using conservative lending practices, a loan officer would MOST likely use a front-end ratio of

28%.

coinsurance clause

A provision that states that the insurer and the insured will share the losses covered by the policy in a proportion agreed upon in advance. requires that the property be insured for at least 80% of its replacement cost.

First-time homebuyers may use up to $10,000 of their IRA savings to make a down payment on a home. What are some of HUD's definitions of a "first-time buyer"?

A single parent who has only owned a home before with a former spouse Anyone whose dwelling was not attached to a foundation, such as living in a mobile home or RV Someone who has not owned a home for at least three years

homeowners insurance policy

A standardized package insurance policy that covers a residential real estate owner against financial loss from fire, theft, public liability, and other common risks. cover all these risks on owner-occupied property

deductible clauses

An agreement in an insurance policy that the company will not reimburse victims for relatively minor losses and expenses.

Estate Tax Exemption

An estate tax exemption is the amount an individual can leave to heirs tax free Up to $10 million per person (indexed for inflation) through 2025

What is an insurance endorsement?

An extension of coverage

Income Tax Deductions

Any item or expenditure subtracted from gross income to reduce the amount of income subject to tax.

Homeownership Tax Benefit

Capital Gains Income Tax Deductions First-Time Homebuyers Estate Tax Exemption

Schools, colleges, places of worship, libraries, theaters, museums, zoos, sports attractions, and parks all constitute a powerful sociological attraction to a given community. Which of the five major factors influencing the choice of property location does this statement describe?

Cultural advantages

Characteristics of Homeowners Packages

Dwelling—pays for damage to the house and any outbuildings, such as detached garages and storage sheds. Personal property—pays when household items, including furniture, clothing, and appliances, are damaged, stolen, or destroyed. Liability—provides $25,000 in coverage if homeowner is sued and found legally responsible for someone else's injury or property damage Medical payments—pays medical bills for people hurt on the homeowner's property; a basic homeowners policy pays $500 in medical bills. Loss of use—pays living expenses if a home is too damaged to live in during repairs (if the damage was due to a covered loss).

As the owner reduces the debt on a property, which of the following increases?

Equity it represents the current market value of the property minus any loans. Thus, the owner establishes financial security for the future by investing and building up equity in a residence that also should increase in value. In addition, homeowners enjoy substantial tax advantages not available to renters.

Before purchasing a home, buyers must determine whether annual debt is sufficient to meet all costs of home ownership

FALSE Buyers must determine whether annual income is sufficient to meet debts. Guidelines are available to help determine the amount of debt a prospective homeowner should incur. Lenders may use a conservative formula that the monthly cost of buying a home (the housing-expense or front-end ratio—mortgage payments plus taxes and insurance) should not exceed 28% of a borrower's gross monthly income. The payment on all debts (the total-debt or back-end ratio) should not exceed 36% of gross monthly income.

Flood insurance generally covers damage caused by a leaking water heater.

FALSE Damage caused by flooding from a water heater would generally be covered under a homeowners policy. Flood insurance policies cover such losses as an overflow of inland or tidal waters, an unusual and rapid accumulation or runoff of surface waters, mudslides or mudflows on the surface of normally dry land areas, and the collapse of land along the shore of a body of water (under certain circumstances). They also exclude money, lawns, livestock, motorized vehicles, fences, swimming pools, and underground structures and equipment.

As the owner reduces the debt on a property, equity in the property decreases.

FALSE Equity represents the current market value of the property minus any loans. Thus, the owner establishes financial security for the future by investing and building up equity in a residence that also should increase in value. In addition, homeowners enjoy substantial tax advantages not available to renters.

Texas HO-A policies provide replacement cost coverage in the event of a covered loss.

FALSE HO-A policies provide limited actual cash value coverage of the home and its contents. HO-B policies provide replacement cost coverage for most types of damage to real property and actual cash value coverage for personal property unless endorsed to provide replacement cost coverage.

Investors in both cooperative and town-house properties own the land under their homes.

FALSE Owners of a cooperative unit own not the unit itself but shares of stock in the cooperative and, in return, receive a proprietary lease. The owner of a town house owns the lot under the home—just the same as though it were a detached single-family home.

The National Flood Insurance Act of 1968 was enacted by Congress to provide money for repairs and replacement of property to homeowners in floodplain areas who do NOT have insurance.

FALSE The National Flood Insurance Act of 1968 does not provide aid to uninsured homeowners in floodplain areas. It is meant to help owners of at-risk property who purchase flood insurance. It requires community wide land management and flood control programs.

To be eligible for the capital gains exclusion implemented by the Taxpayer Relief Act of 1997, a homeowner must have owned the residence and occupied it as a principal residence for at LEAST three of the five years preceding the sale or exchange.

FALSE To be eligible for the capital gains exclusion implemented by the Taxpayer Relief Act of 1997, a homeowner must have owned the residence and occupied it as a principal residence for at least two of the five years preceding the sale or exchange.

Because of coinsurance clauses, homeowners should periodically review all policies to be certain that the coverage is equal to at LEAST 85% of the current replacement cost of their homes.

FALSE Coinsurance clauses require homeowners to carry enough insurance to cover 80% of the current replacement cost of the home. If the policy contains an "inflation clause," however, the amount of coverage will automatically adjust.

For MOST homeowners, the net result of the Taxpayer Relief Act of 1997 is that they will always pay capital gains tax on the sale of their homes.

FALSE Concerns about the capital gains consequences of a sale are effectively eliminated for the most homeowners because they do not have capital gains that exceed $250,000 (single taxpayer) or $500,000 (married, filing jointly taxpayer) when their homes are sold.

Factors influencing housing affordability include mortgage terms, ownership expenses, ability to pay, governmental structure, and investment considerations

FALSE Housing affordability is influenced by mortgage terms, ownership expenses, ability to pay, and investment considerations. Governmental structure is one of the five major factors influencing a buyer's choice of location; the others are employment opportunities, cultural advantages, social services, and transportation.

Police and fire protection, water, and the many public utilities (gas, power, and telephone service, for instance) add to an area's desirability, as do various quasi-municipal authorities, such as ports, public transportation, antipollution practices, and forest preserves. Which of the five major factors influencing the choice of property location does this statement describe?

Governmental structure Five major factors that influence the buyer's choice of location include (1) employment opportunities, (2) cultural advantages, (3) governmental structure, (4) social services, and (5) transportation.

The basic types of policies sold in Texas include the following

HO-A policies limited *cash value* coverage of the home and its contents. Only the types of damage specifically listed in the policy are covered. HO-A amended policies provide more extensive coverage than the base HO-A policy but less coverage than an HO-B. HO-A amended policies are not standardized HO-B policies, the most common homeowners policies, provide replacement cost coverage for most types of damage to the real property, except claims specifically excluded in the policy. They provide actual cash value coverage for personal property unless endorsed to provide replacement cost coverage. HO-C policies provide the most extensive coverage but are more expensive than other types of policies. Approved alternative policies offer varying levels of coverage, are different from one company to another, and are sold only with the approval of the Commissioner of Insurance.

Which housings are guaranteed to show a positive return on investment?

None All real estate investments are subject to changes in market conditions. No real estate investment is recession-proof, and licensees should never guarantee returns. However, over the long term, property values have gone up.

First-Time Homebuyers

Penalty-free withdrawals up to $10,000 from an IRA for first-time homebuyers

Insurance companies settle property insurance claims on the basis of which of the following?

Proration according to the coinsurance clause Full-replacement coverage Actual cash value

Federal flood insurance policies are available on which types of properties?

Residential, commercial, industrial, and agricultural

As a condition for making a loan, an individual lender may require flood insurance if any part of the property is in a flood zone.

TRUE Federal law requires that owners of properties on which a "structure" is located in a floodplain area obtain flood insurance if properties are financed by loans provided, regulated, or insured by the federal government or purchased by Fannie Mae or Freddie Mac secondary mortgage market agencies. As a condition for making a loan, an individual lender may require flood insurance if any part of the property is in a flood zone. All types of buildings—residential, commercial, industrial, and agricultural—are required to maintain this coverage for either the value of the improvement or the amount of the mortgage loan, subject to the maximum limits available.

The qualifying ratios a specific lender uses to determine a prospective homebuyer's ability to pay depend on such factors as amount of down payment, potential future earnings, number of dependents, credit history, and general economic conditions.

TRUE Guidelines are available to help determine the amount of debt a prospective homeowner should incur. On conventional loans, lenders may use a conservative formula that the monthly cost of buying a home (the housing-expense or front-end ratio—mortgage payments plus taxes and insurance) should not exceed 28% of a borrower's gross monthly income. The payment on all debts (the total-debt or back-end ratio) should not exceed 36% of gross monthly income.

For income tax purposes, homeowners are entitled to at LEAST four deductions from their gross income.

TRUE Homeowners are entitled to income tax deductions for mortgage interest payments on first and second homes, real estate taxes, certain loan origination fees, and loan discount points. Deductions for mortgage insurance premiums have been deductible for several years but are extended year to year on a temporary basis. Check for recent changes in the tax code at www.irs.gov/taxtopics and review the list of itemized deductions.

Certain loan origination fees may be deducted on a homeowner's income tax return.

TRUE Income tax deductions for homeowners include loan interest on first and second homes (subject to limitation), real estate taxes, certain loan origination fees, and some loan discount points.

Mortgaged property represents an investment because it is the purchase of an asset that has the potential for profit.

TRUE Purchasing a home has certain financial advantages. Profit may be in the form of present income received or a long-term gain from increased value when the asset is sold.

One of the ownership expenses that a homeowner faces is the loss of the investment return that could be realized if the money used to purchase a home was available for income-producing investments.

TRUE Real estate taxes, depreciation, insurance, maintenance and repairs, and utilities are all examples of ownership expenses. In addition, that portion of the loan payment applied to interest represents an expense to the homeowner, along with necessary services such as trash removal.

The National Flood Insurance Program will insure properties that are NOT in a floodplain area.

TRUE The NFIP offers a preferred risk policy for any one-to-four-unit dwelling not existing in a floodplain area and not having more than one previous flood loss in excess of $1,000.

A conservative rule-of-thumb formula for determining the affordability of a home indicates that the housing-expense ratio should NOT exceed 28% of a borrower's gross monthly income.

TRUE The housing-expense, or front-end, ratio should not exceed 28% of a borrower's gross income. The total-debt, or back-end ratio, should not exceed 36% of gross monthly income.

A homeowner who does NOT meet the occupancy requirements for exclusion of capital gains income due to unforeseen circumstances may exclude the fraction of the maximum allowance that is equal to the fraction of two years that the residency requirements were met.

TRUE To be eligible for an exclusion of capital gains income, a homeowner must have owned the residence and occupied it as a primary residence for at least two of the five years before the sale or exchange. A homeowner who fails to meet these requirements because of a change of place of employment, health, death, natural or man-made disasters, acts of war (including terrorist attacks), divorce or legal separation, or other unforeseen circumstance is able to exclude the fraction of the $500,000 ($250,000 if single) that is equal to the fraction of two years that these residency requirements are met.

Loan discount points are fully deductible in the year of purchase and only under certain circumstances.

TRUE Loan discount points are fully deductible in the year of the purchase if, among other things, the mortgage is secured by the taxpayer's principal residence, (2) if the points are paid in cash at closing, and (3) if they are a charge for the use of money (i.e., interest, not fees). Otherwise, they are prorated over the term of the loan.

Factors influencing home ownership include mortgage terms, ownership expenses, ability to pay, type of home, location, and which of the following?

Tax deductions C) Potential for profit D) Investment considerations

In addition to principal and interest, which additional expenses must be included when using the housing-expense ratio?

Taxes and insurance for a month

Texas homeowners insurance policies combine five different types of coverage

Texas homeowners insurance policies combine five different types of coverage: dwelling, personal property, liability, medical payments, and loss of use.

If a tree falls on a house with homeowners insurance, who gets paid?

The borrower/owner of the property

The National Flood Insurance Program (NFIP) is

a federally backed flood insurance program that enables homeowners, renters, and business owners in designated flood zones to purchase flood-damage coverage.

Manufactured homes (mobile homes)

are built in manufacturing plants and transported on permanent chassis to manufactured home dealerships and then to purchasers' homesites, where they are connected to gas, water, and electricity. The homes are generally permanently attached to a foundation on land owned or leased by the manufactured home purchaser or semipermanently attached to a foundation in a "housing park." Housing parks often offer complete residential environments with permanent community facilities. Newer models of manufactured homes couple relatively low cost with increased living space, making them an attractive alternative to the conventionally constructed residence.

Modular and prefab or kit homes

are constructed with large wall and roof components that are built in factories. The pieces are trucked from a factory to a building site and lifted into place with a crane. Then workers finish the structure and install plumbing, wiring, and amenities. Modular homes can generally be built at a fraction of the time and cost of conventional construction and often enable buyers to take part in designing their homes without having to start from scratch with an architect.

Converted-use properties

are existing structures, such as factories, office buildings, hotels, schools, and churches, that have been converted to residential use as either rental or condominium units. Rather than demolish old structures to make way for new ones, developers often find it aesthetically and economically appealing to renovate the existing buildings into affordable housing. In this manner, an abandoned factory may be transformed into luxury loft condominium units and old warehouses converted to restaurants and shopping areas.

Retirement communities

are widely accepted in Texas. They lend themselves particularly well to areas with mild weather conditions. In addition to residential units, retirement communities often provide shopping, exercise, recreational opportunities, restaurants, and in some cases, health care facilities.

To be eligible for an exclusion of capital gains income, a homeowner must have owned the residence and occupied it as a primary residence for how long before the sale or exchange?

at least two of five years. A homeowner who fails to meet these requirements because of a change of place of employment, health, death, natural or man-made disasters, acts of war (including terrorist attacks), divorce or legal separation, or other unforeseen circumstances, is able to exclude the fraction of the $500,000 ($250,000 if single) that is equal to the fraction of two years that these residency requirements are met.

planned unit development (PUD)

is a project or subdivision that consists of common property and improvements that are owned and maintained by an owners association for the benefit and use of the individual housing units within the project. For a project to qualify as a PUD, the owners association must require automatic, nonseverable membership for each unit owner and provide for mandatory assessments to maintain the common areas.

The insurance company will pay the actual cash value of the loss or a percentage of the replacement cost if a homeowner has a coinsurance clause and coverage on the property is

less than the coinsurance clause percentage. If coverage is less than 80% of the replacement cost, the insurance company will pay the larger of (1) the actual cash value of the loss (replacement cost less depreciation) or (2) a percentage of the replacement cost calculated as follows: percentage of coverage carried ÷ percentage of coverage required in the policy × amount of the loss.

Which type of property combines condominium or apartment living with shopping and recreation facilities, in either one building or a group of buildings, and are popular in metropolitan areas?

mixed-use developments. These complexes usually are self-contained and include—along with housing—office space, retail stores, restaurants, theaters and other entertainment facilities, gyms, swimming pools, parks, and concierge services.

Endorsements to the Homeowners Policy

modifying a homeowners policy; glass breakage; replacement cost on personal property; and increased limits on jewelry, fine arts, camera and computer equipment, and radio and television satellite dishes and antennas.

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 each year, but many time-share trade agreements exist among developers of this type of property, allowing owners to vacation at various sites. In addition to the purchase price, each owner pays an annual maintenance fee.

When the vast majority of homeowners sell their homes, do they end up paying large amounts of tax on their capital gains?

no, the vast majority of sellers to do not exceed the exclusion amount. The exclusion amount is $500,000 for couples and $250,000 for individuals. If the owner's profit on the home sale exceeds those amounts, there is an obligation to pay capital gains tax on the excess.

Loan discount points may be fully deducted from a homeowner's gross income if the points are

paid in cash at closing. All loan discount points can be fully deducted in the year of the purchase only if the following conditions are met: the mortgage is secured by the taxpayer's principal residence, the points are paid in cash at closing, and they are a charge for the use of money (interest, not fees). Otherwise, they are prorated over the term of the loan.

What Homeowners Policies Do and Do Not Cover

policies do not cover flood, earthquake, war, or nuclear attack.

condominium

residential ownership, particularly for people who want the security of owning property but do not want the responsibilities of caring for and maintaining a house. Ownership of a condominium—which shares party walls with other units—involves individual ownership of the airspace within the unit itself, plus shared ownership of common facilities such as halls, elevators, and the land as undivided interests.

Purchasing a national flood insurance policy would be optional for owners of

residential properties that have flooded only once, with a loss of no more than $1,000.

cooperative

similar to a condominium in that it involves units within a larger building with common walls and facilities. However, an owner of a cooperative unit owns not the unit itself but shares of stock in the cooperative (a type of corporation) that holds title to the building. In return for stock in the cooperative, owners receive a proprietary lease, which entitles them to occupancy of a particular unit in the building.

Town houses

similar to single-family houses, are constructed on lots owned by the individual homeowners—but the homes are joined to each other. They may be connected by a common wall (usually a firewall), or they may be freestanding homes separated by airspace and attached to each other by exterior shingles and brick or siding. The names of some condominium projects indicate that they are town houses, when in reality, if the land is not owned by the individual homeowners, they are condominiums. An examination of the legal description will reveal whether the property is a town house or a condominium.

A retired couple tells a real estate agent that they want to find a home close to medical facilities and a senior citizens center. On which of the five major factors influencing the choice of property location is the couple basing this request?

social services. The availability and quality of hospitals, clinics, community centers, and similar facilities attract buyers to a community. The five major factors that influence the choice of location include employment opportunities, cultural advantages, governmental structure, social services, and transportation.

Income tax deductions on loan interest on first and second homes are

subject to limitations. Income tax deductions for homeowners include loan interest on first and second homes, real estate taxes, certain loan origination fees, and some loan discount points.

Mixed-use developments

that combine condominium or apartment living with shopping and recreation facilities either in one building or in a group of buildings are popular, especially in metropolitan areas close to a central city. These complexes usually are self-contained and include—along with housing—office space, retail stores, restaurants, theaters and other entertainment facilities, gyms, swimming pools, parks, concierge services, and other attractive and convenient features.

The percentage used in the formula for calculating a buyer's payment on all debts, including the house payment, installment loans, and credit card debt, is called

the back-end ratio. The percentage used in the formula for calculating a buyer's payment on all debts is called the total-debt, or back-end, ratio. The percentage used to calculate the monthly house payment is the housing-expense, or front-end, ratio.

Capital Gains

the profits realized from the sale or exchange of an asset, including real property

investment

the property's value increases, a sale could bring in more money than the owner paid—resulting in a long-term gain

Market value of an investment is

totally independent of any outstanding loan balance; that is, it is possible that the loan balance may exceed the market value. This is a serious concern to lenders, mortgage loan insurers, and investors and should be considered by prospective owners. Furthermore, the prospective owner should consider the responsibilities occasioned by ownership, compared with the relative freedom of renting.

if trees, shrubs, and other landscaping is damaged by wind or hail, the homeowners insurance policy likely

would not cover it. Trees and shrubs are usually specifically excluded from homeowners policies.

Are Townhouses constructed on lots owned by the individual homeowners?

yes

The 28/36 rule states that a household should spend a maximum of 28% of its gross monthly income on total housing expenses; it should spend no more than 36% on total debt service, including housing and other debt such as car loans

yes

Which type of housing is delivered on a permanent chassis to a purchaser's homesite, where it is connected to gas, water, and electricity?

Manufactured homes

Which type of housing is existing structures that have been altered to become appropriate for residential use as either rental or condominium units?

converted-use properties. For economic, structural, and/or location reasons, such buildings have been abandoned by their original owners or tenants. Rather than demolish them to make way for new structures, developers often find it aesthetically or economically appealing to renovate the existing buildings into affordable housing.

MOST Texas homeowners insurance policies exclude losses caused by

earthquake.

Most Texas homeowners insurance policies cover losses caused by

fire and lightning; aircraft and vehicles; vandalism and malicious mischief; theft; explosion; riot and civil commotion; smoke; windstorm, hurricane, and hail; and sudden and accidental water damage.

Historically, the largest volume of flood insurance claims are the result of

hurricanes along the Gulf Coast.

Which criteria may an insurance company use when evaluating and issuing a homeowners policy?

insurance company can refuse to insure a home in poor condition. However, it cannot deny coverage solely because of a home's age or value. An insurance company may consider a homeowner's credit score when deciding whether to issue a policy and what to charge for it, but it cannot sell a policy or cancel or refuse to renew a policy solely on the basis of credit. An insurance company can charge more for a policy if claims have been filed in the past. Many companies use the Comprehensive Loss Underwriting Exchange (CLUE) to review an applicant's claims history.