unit 6 renting vs. buying

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UNIT 6 RENTING VS. OWNING ORCUTT ACADEMY HIGH SCHOOL ACCOUNTING & FINANCE

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Page 1: Unit 6 Renting vs. Buying

UNIT 6

RENTING VS.

OWNING

ORCUTT ACADEMY HIGH SCHOOL

ACCOUNTING & FINANCE

Page 2: Unit 6 Renting vs. Buying

THE FIRST

STEPS TO

HOME

OWNERSHIP

UNIT 6, LESSON 1

Page 3: Unit 6 Renting vs. Buying

Renting vs. Owning

Are You Ready to Buy?

How Much Can You Borrow?

The Down Payment & Closing Costs

PREVIEW

Page 4: Unit 6 Renting vs. Buying

RENTING VS. OWNING

Page 5: Unit 6 Renting vs. Buying

ADVANTAGES OF

RENTING

• Possibly lower cost

• If you can save 10% or more of your earnings, you are on your way to meeting your financial goals.

• No maintenance costs or insurance

• Flexibility

• Financial freedom: spend without obligation

• Psychological freedom: move more easily

• Liquidity

• Wealth not tied up in home

Page 6: Unit 6 Renting vs. Buying

COSTS OF RENTING

• Monthly rent is subject to inflation

• Consider your costs in the long-term

Cost of owning versus renting over 30 years

Year Ownership cost per

month

Rental cost per month

1 $920 $800

5 $980 $940

10 $1,080 $1,140

20 $1,360 $1,690

30 $1,800 $2,500

Comparing the costs of owning a home that costs $160,000

to renting that same home for $800/month.

Page 7: Unit 6 Renting vs. Buying

COSTS OF RENTING

• Owning becomes less expensive in the long run

• As a homeowner, you build equity

Page 8: Unit 6 Renting vs. Buying

ARE YOU READY TO BUY

Page 9: Unit 6 Renting vs. Buying

ASSESSING YOUR

TIMELINE

Wait to buy a home until you plan on being there for at least 3 years (preferably five or more)

Page 10: Unit 6 Renting vs. Buying

PROPERTY MUST

APPRECIATE 15%

TO COVER EXPENSES

Page 11: Unit 6 Renting vs. Buying

BEFORE BUYING, ASK

YOURSELF…

Are you saving enough money monthly to reach your

retirement goals?

Page 12: Unit 6 Renting vs. Buying

BEFORE BUYING, ASK

YOURSELF…

How much do you spend (and want to continue spending) on

fun things such as travel and entertainment?

Page 13: Unit 6 Renting vs. Buying

BEFORE BUYING, ASK

YOURSELF…

How willing are you to budget your expenses in order to meet

your monthly mortgage payments and other housing

expenses?

Page 14: Unit 6 Renting vs. Buying

BEFORE BUYING, ASK

YOURSELF…

How much of your children’s expected college educational

expenses do you want to be able to pay for?

Page 15: Unit 6 Renting vs. Buying

HOW MUCH CAN YOU BORROW

Page 16: Unit 6 Renting vs. Buying

THE EFFECT OF DEBT

Existing debt will lower the amount you are eligible to borrow.

Monthly Debt Payments + Housing Expenses < 38%

of monthly gross income

Page 17: Unit 6 Renting vs. Buying

CALCULATING HOW

MUCH LENDERS WILL

ALLOW YOU TO BORROW

General Rule: You can borrow up to 2.5 - 5 times your annual

income when buying a home.

Page 18: Unit 6 Renting vs. Buying

BUT… HOW MUCH YOU

CAN BORROW DEPENDS

ON INTEREST RATES

Set by the secondary market

Page 19: Unit 6 Renting vs. Buying

EXPENSES

• Mortgage costs

• Inspection expenses

• Moving costs

• Commissions

• Title insurance

Page 20: Unit 6 Renting vs. Buying

WHAT’S THE APPROXIMATE

MAXIMUM YOU CAN BORROW?

When mortgage rates are Multiply your gross income

by this figure

4% 4.6

5% 4.2

6% 3.8

7% 3.5

8% 3.2

9% 2.9

10% 2.7

11% 2.5

Page 21: Unit 6 Renting vs. Buying

MULTIPLIER

The number you multiply by your gross income to determine

how much money you can borrow for a home mortgage;

determined by interest rates.

OR

The number you multiply by your mortgage expressed in

thousands of dollars (divided by 1000) to determine your

monthly mortgage payment

Page 22: Unit 6 Renting vs. Buying

As rates fall, the monthly mortgage payment drops

Lower interest rates make buying real estate more affordable

Page 23: Unit 6 Renting vs. Buying

CALCULATE

What is the maximum amount you can borrow?

1. Annual income $45,870

a) Interest rate 5%

b) Interest rate 11%

2. Annual income $68,900

a) Interest rate 4%

b) Interest rate 8%

3. Annual income $159,650

a) Interest rate 9%

b) Interest rate 6%

Page 24: Unit 6 Renting vs. Buying

DOWN PAYMENT & CLOSING COSTS

Page 25: Unit 6 Renting vs. Buying

THE DOWN PAYMENT

If you put down 20% of the purchase price of the home

• Most favorable terms, including interest rate and closing

costs

• Don’t have to pay mortgage insurance

For a $100,000 home, the down payment would be $20,000

• (100,000)(.2) = $20,000

Page 26: Unit 6 Renting vs. Buying

PMI: PRIVATE

MORTGAGE INSURANCE

• If you put less than 20% down

• Protects lenders if you default on your loan

• Several hundred $ per year

• Varies depending on the percent of the purchase price you

put down

• The higher the down payment, the lower the PMI

• Visit http://www.goodmortgage.com/Calculators/PMI.html

Page 27: Unit 6 Renting vs. Buying

PURCHASE PRICE

Purchase Price = Mortgage Loan + Down Payment

Page 28: Unit 6 Renting vs. Buying

CLOSING COSTS

• In addition to a down payment, you must have cash saved

for closing costs

• Includes escrow fees, inspection fees, title insurance, and

other miscellaneous fees

• On average from 2-3 percent of the price of the home

• Could be anywhere from 1-8% of the price of the home

• Your lender will give you a “Good Faith Estimate”

Page 29: Unit 6 Renting vs. Buying

HELP WITH CLOSING

COSTS

• You can request

• Your seller pay part of the closing costs

• Your lender add part of the closing costs to your mortgage

loan

• Interest rate will go up about .25%

Page 30: Unit 6 Renting vs. Buying

1. How can you determine if you are ready to buy a home?

2. How do lenders decide how much money you can borrow to

purchase a home?

3. What factors should you consider when determining how

much money to save to buy a home?

ESSENTIAL QUESTIONS

WHAT ARE YOU LEARNING? WHY ARE YOU LEARNING IT? HOW WILL YOU USE IT?

Page 31: Unit 6 Renting vs. Buying

TOTAL

HOUSING

COSTUNIT 6, LESSON 2

Page 32: Unit 6 Renting vs. Buying

Calculating Mortgage Payment

Taxes: The Cost and the Benefit

Insurance & Maintenance

Calculating Total Housing Cost

PREVIEW

Page 33: Unit 6 Renting vs. Buying

TOTAL HOUSING

COST

1. Mortgage Payment

2. Taxes

• The Cost and the Benefit

3. Insurance

4. Maintenance

Page 34: Unit 6 Renting vs. Buying

CALCULATING MORTGAGE PAYMENT

Page 35: Unit 6 Renting vs. Buying

CALCULATE MORTGAGE

USING MULTIPLIER

Interest Rate 15-year mortgage

Multipliers

30-year mortgage

4% 7.4 4.77

4.5% 7.65 5.07

5% 7.91 5.37

5.5% 8.17 5.68

6% 8.44 6.00

6.5% 8.71 6.32

7% 8.99 6.65

8% 9.56 7.34

9% 10.14 8.05

10% 10.75 8.78

Multiply the multiplier by your mortgage expressed in thousands of dollars (divided by 1000)

Page 36: Unit 6 Renting vs. Buying

EXAMPLE

Skye is taking out a $100,000 30-year mortgage at 6.5%. What

will be her monthly mortgage payment?

The multiplier is 6.32, so

Monthly mortgage payment = 6.32 x 100,000/1,000

= 6.32 x 100

= $632

Page 37: Unit 6 Renting vs. Buying

CALCULATE MORTGAGE

USING FORMULA

M = P [ i(1 + i)n ] / [ (1 + i)n - 1]

M = The monthly payment

P = The principal, or the amount of money being borrowed

i = The interest for each compounding period, or the interest

per month for a standard mortgage

n = The number of compounding periods, or the number of

months for a standard mortgage

Page 38: Unit 6 Renting vs. Buying

EXAMPLE

Go to Mortgage Math Workbook

Page 39: Unit 6 Renting vs. Buying

TAXES: THE COST AND THE BENEFIT

Page 40: Unit 6 Renting vs. Buying

TAXES: THE COST

• Homeowners pay property tax, which helps support local

governments.

• Based on the assessed value of your home

• Land + Improvements

• May be higher or lower than the purchase price of the

home

Page 41: Unit 6 Renting vs. Buying

TAX RATES

• Set by the county

• Usually about 1-2%

• Average property tax rates by state

• Ex: Santa Barbara County

Page 42: Unit 6 Renting vs. Buying

CALCULATING

TAX COSTS

The value of a home in Greenwood County is $285,000.

Property taxes in Greenwood are 1.25%. What is the monthly

property tax bill for the home?

Annual property tax bill: (285,000)(.0125) = $3562.50

Monthly property tax bill: (3562.50)/12 = $296.88

Page 43: Unit 6 Renting vs. Buying

TAXES: THE BENEFIT

• You can deduct

• Interest paid to buy, build, or improve your home

• Interest paid on a home equity loan

• Property taxes

• You can deduct a second home

• Learn more about Tax Deductions on Mortgage Interest

Page 44: Unit 6 Renting vs. Buying

CALCULATING THE TAX

BENEFIT OF OWNING

TAX BENEFIT =

(Mortgage Payment + Property Taxes) (Tax Bracket)

EXAMPLE

Tyler’s gross annual income is $83,000. His mortgage payment is $1,200/month and he pays $260/month in property taxes. What is his tax benefit from owning.

(1200+260)(.25) = $365

Tax Brackets 2012 (Estimated) Single (Est) Married Filing Jointly (Est) Head of Household

10% Bracket $0 – $8,700 $0 – $17,400 $0 – $12,400

15% Bracket $8,700 – $35,350 $17,400 – $70,700 $12,400 – $47,350

25% Bracket $35,350 – $85,650 $70,700 – $142,700 $47,350 – $122,300

28% Bracket $85,650 – $178,650 $142,700 – $217,450 $122,300 – $198,050

33% Bracket $178,650 – $388,350 $217,450 – $388,350 $198,050 – $388,350

35% Bracket $388,350+ $388,350+ $388,350+

Page 45: Unit 6 Renting vs. Buying

HOMEOWNER’S INSURANCE

Page 46: Unit 6 Renting vs. Buying

HOMEOWNER’S

INSURANCE

• On average, between $45 and $75/month

• Varies depending on

• Home’s value

• Location

• Homeowner’s demographics

• Type and amount of insurance

Page 47: Unit 6 Renting vs. Buying

LEARN MORE…

Tips on homeowner’s insurance

Page 48: Unit 6 Renting vs. Buying

MAINTENANCE

Page 49: Unit 6 Renting vs. Buying

MAINTENANCE

About 1% of the home’s value on average

Example:

A home with a value of $475,000

Annual maintenance = (475,000)(.01) = $4,750

Monthly maintenance = 4,750/12 = $395.83

Page 50: Unit 6 Renting vs. Buying

MAINTENANCE

CHECKLIST

National Healthy Homes Training Center Checklist

Page 51: Unit 6 Renting vs. Buying

TOTAL HOUSING COST

Page 52: Unit 6 Renting vs. Buying

TOTAL

HOUSING COST

PUTTING THE PIECES TOGETHER!

Total Housing Cost =

(Mortgage Payment + Property Tax + Insurance + Maintenance) – (Tax Benefit)

Page 53: Unit 6 Renting vs. Buying

EXAMPLE 1

Taylor is an actor living in Los Angeles, California where the property tax is 1.25%. Her gross annual income is $71,500 and the value of her property is $367,000. Her monthly mortgage payment is $1,200 and she pays $40/month for insurance. Estimate her total housing costs.

Total Housing Cost =

(Mortgage Payment + Property Taxes + Insurance + Maintenance) – (Tax Benefit)

Mortgage Payment = $1,200

Property Taxes = (367,000)(.0125)/12 = $382.29

Insurance = $40

Maintenance = (367,000)(.01)/12 = $305.83

Tax Benefit = (Mortgage Payment + Property Taxes)(Tax Bracket)

(1200 + 382.29)(.25) = 395. 57

Total Cost = 1200 + 382.29 + 40 + 305.83 - 395.57 = $1532.55

Page 54: Unit 6 Renting vs. Buying

1. To calculate the mortgage payment, what three pieces of

information do you need to know?

2. How do taxes affect the overall total cost?

3. What components make up the total monthly housing

cost?

ESSENTIAL QUESTIONS

WHAT ARE YOU LEARNING? WHY ARE YOU LEARNING IT? HOW WILL YOU USE IT?

Page 55: Unit 6 Renting vs. Buying

FINANCING

YOUR HOME

UNIT 6, LESSON 3

Page 56: Unit 6 Renting vs. Buying

Adjustable vs. Fixed-Rate

30-year vs. 15-year

Finding a Lender

Points & Interest Rates

PREVIEW

Page 57: Unit 6 Renting vs. Buying

ADJUSTABLE-RATE VS. FIXED-RATE

30-YEAR VS 15-YEAR

Page 58: Unit 6 Renting vs. Buying

FIXED-RATE MORTGAGES

Interest rates never change

Monthly mortgage payment does not change

No uncertainty

BUT… if interest rates fall (and you can’t refinance), you are

stuck with your higher-cost mortgage

Page 59: Unit 6 Renting vs. Buying

ADJUSTABLE RATE

MORTGAGES

• Interest rate varies over time

• Can change yearly, or even monthly

• Most often, every 6 or 12 months

• Monthly mortgage payment fluctuates

• Advantage: Potential interest savings

• Lower rates for the first few years

• After that, your rate depends on overall trends

Page 60: Unit 6 Renting vs. Buying

CHOOSING BETWEEN

FIXED AND ADJUSTABLE

• Consider your ability to take on financial risk

• Reliability of income

• Job security

• Emergency savings

• Future expenses

• Stress level

• If you can’t afford the highest allowed payment on an

adjustable-rate mortgage, don’t take it.

Page 61: Unit 6 Renting vs. Buying

15-YEAR VS. 30-YEAR

15-year 30-year

Pay off faster, Build equity faster Takes longer to pay off

Higher payments Lower payments

Lower interest rate (about ½

percent)

Higher interest rate

If you don’t plan on investing, it is

better to pay off your mortgage

faster

Alternative investing opportunities

Page 62: Unit 6 Renting vs. Buying

CHOOSING BETWEEN

FIXED AND ADJUSTABLE

• Consider how long you plan to keep the mortgage

• Adjustable rate mortgages have lower interest rates for the

first few years.

• Wise if you plan on keeping your mortgage less than 5-7

Page 63: Unit 6 Renting vs. Buying

FINDING A LENDER

Page 64: Unit 6 Renting vs. Buying

SHOPPING FOR A

LENDER ON YOUR OWN

• Large banks usually don’t offer the best rates

• Check out smaller lending institutions

• Using a local bank can sometimes be a plus. Their staff

generally understand the specifics of local properties

• Find mortgage companies in cities across the country

Page 65: Unit 6 Renting vs. Buying

HIRING A MORTGAGE

BROKER

• Brokers

• Submit the home buyer's application to one or more

lenders

• Work with the chosen lender until the loan closes

• Can often find a lender who will make loans that a bank

refuses

• May be necessary for problem credit

Page 66: Unit 6 Renting vs. Buying

MORTGAGE BROKERS

Get paid a percentage of the loan amount

• typically 0.5-1%

Ask your mortgage broker what his cut is

The broker should shop among lenders to get you a good deal

Help you fill out documents lenders demand before giving you a

loan

Page 67: Unit 6 Renting vs. Buying

BEWARE

• Some brokers place their business with the same lenders

all the time, those usually don’t offer the best rates

• You can shop on your own, so you can compare with what

your broker tells you

• Thoroughly check a broker’s references before you do

business with them

• Make sure you ask who the lender is—most brokers refuse

to reveal this info until you pay a certain amount to cover

the appraisal and credit report

Page 68: Unit 6 Renting vs. Buying

POINTS AND INTEREST RATES

Page 69: Unit 6 Renting vs. Buying

POINTS

• The initial fee charged by the lender, with each point being

equal to 1% of the amount of the loan.

Page 70: Unit 6 Renting vs. Buying

THE SEESAW EFFECT

• As points go up, the interest rate goes down. As points

go down, the interest rate goes up.

• It is important to consider both the points and the interest

rate when comparing two mortgage loans.

Page 71: Unit 6 Renting vs. Buying

COMPARING

MORTGAGES

EXAMPLE: Compare the two loans. Identify when the loans will have the same cost and which loan will have a lower cost after the identified time period.

Loan #1: 3% interest rate, 2 points

Loan #2: 4% interest rate, 1 point

𝑫𝒊𝒇𝒇𝒆𝒓𝒆𝒏𝒄𝒆 𝒊𝒏 𝒑𝒐𝒊𝒏𝒕𝒔

𝑫𝒊𝒇𝒇𝒆𝒓𝒆𝒏𝒄𝒆 𝒊𝒏 𝒓𝒂𝒕𝒆𝒔=

𝟐−𝟏

𝟒−𝟑=

𝟏

𝟏= 𝟏

This formula tells you when the loans will have the same cost. After the given time period, the loan with the lower interest rate will have a lower cost, so…

After one year, Loan #1 will have a lower cost.

Page 72: Unit 6 Renting vs. Buying

GETTING THE BEST RATE

Page 73: Unit 6 Renting vs. Buying

Unit 6 Renting versus Owning

TERMS & ESSENTIAL QUESTIONS

Page 74: Unit 6 Renting vs. Buying

6-1 TERMS

Lender Someone who makes funds available to another with the

expectation that the funds will be repaid, plus any interest

and/or fees.

Debt An amount of money borrowed by one party from another.

Many corporations/individuals use debt as a method for

making large purchases that they could not afford under

normal circumstances.

Interest rate The amount charged, expressed as a percentage of

principal, by a lender to a borrower for the use of assets.

Mortgage A debt instrument that is secured by the collateral of specified

real estate property and that the borrower is obliged to pay

back with a predetermined set of payments.

Page 75: Unit 6 Renting vs. Buying

6-1 TERMS

Multiplier The number you multiply by your gross income to determine

how much money you can borrow for a home mortgage;

determined by interest rates. OR The number you multiply by

your mortgage expressed in thousands of dollars (divided by

1000) to determine your monthly mortgage payment.

PMI (Private

Mortgage

Insurance)

collected by the lender each month when a buyer's down

payment is less than 20% of the purchase price

Closing

Costs

The expenses, over and above the price of the property that

buyers and sellers normally incur to complete a real estate

transaction. Costs incurred include loan origination fees,

discount points, appraisal fees, title searches, title insurance,

surveys, taxes, deed-recording fees and credit report charges.

Page 76: Unit 6 Renting vs. Buying

From a financial standpoint, why is it wise to wait to

buy a home until you plan on being there for at least

three years (preferably five or more)?

• It takes at least three years for your home to

appreciate enough to cover the initial expenses of

buying. Waiting five or more years makes it more

probable you will see a return on your investment.

6-1 #1

ESSENTIAL QUESTIONS

WHAT ARE YOU LEARNING? WHY ARE YOU LEARNING IT? HOW WILL YOU USE IT?

Page 77: Unit 6 Renting vs. Buying

What questions should you ask yourself in order to

determine if you can afford to buy a home?

• Does buying a home fit with all of my other financial

goals (retirement, college savings, budget,

entertainment and travel)?

• Am I in a financial position to get the best rates?

6-1 #2

ESSENTIAL QUESTIONS

WHAT ARE YOU LEARNING? WHY ARE YOU LEARNING IT? HOW WILL YOU USE IT?

Page 78: Unit 6 Renting vs. Buying

How do lenders determine how much money you can

borrow to purchase a home?

• How much you can borrow is based on your debt,

your gross annual income, and interest rates.

6-1 #3

ESSENTIAL QUESTIONS

WHAT ARE YOU LEARNING? WHY ARE YOU LEARNING IT? HOW WILL YOU USE IT?

Page 79: Unit 6 Renting vs. Buying

6-2 TERMS

Real estate

tax

Or

Property tax

A tax assessed on real estate by the local government. The

tax is usually based on the value of the property (including the

land) you own.

Insurance Home owner’s insurance: a form of property insurance

designed to protect an individual's home against damages to

the house itself, or to possessions in the home. Homeowners

insurance also provides liability coverage against accidents in

the home or on the property.

Maintenance Maintenance costs include home repairs and improvements

and usually total about 1% of the property’s value annually.

Inflation The rate at which the general level of prices for goods and

services is rising, and, subsequently, purchasing power is

falling. Causes renting to be more expensive in the long run.

Page 80: Unit 6 Renting vs. Buying

To calculate the mortgage payment, what three pieces

of information do you need to know?

• You need to know the purchase price of the home,

the interest rate, and whether it is a 15-year or 30-

year mortgage.

6-2 #1

ESSENTIAL QUESTIONS

WHAT ARE YOU LEARNING? WHY ARE YOU LEARNING IT? HOW WILL YOU USE IT?

Page 81: Unit 6 Renting vs. Buying

How do taxes affect the overall total cost?

• Cost- Property taxes increase the cost of owning

• Benefit- Owning a home qualifies as a tax write-off

for income tax purposes.

6-2 #2

ESSENTIAL QUESTIONS

WHAT ARE YOU LEARNING? WHY ARE YOU LEARNING IT? HOW WILL YOU USE IT?

Page 82: Unit 6 Renting vs. Buying

What components make up the total monthly housing cost?

• Mortgage payment, insurance, maintenance, and property

taxes minus the tax benefit of owning.

6-2 #3

ESSENTIAL QUESTIONS

WHAT ARE YOU LEARNING? WHY ARE YOU LEARNING IT? HOW WILL YOU USE IT?

Page 83: Unit 6 Renting vs. Buying

6-3 TERMS

Fixed-rate

mortgage

A mortgage that has a fixed interest rate for the

entire term of the loan.

Adjustable

rate

mortgage

A type of mortgage in which the interest rate paid

on the outstanding balance varies according to a

specific benchmark.

Points The initial fee charged by the lender, with each

point being equal to 1% of the amount of the loan.

Appraisal A valuation of property (ie. real estate, a business,

an antique) by the estimate of an authorized

person.

Page 84: Unit 6 Renting vs. Buying

6-3 TERMS

Title the recognition of ownership

Escrow A financial instrument held by a third party on behalf of the

other two parties in a transaction. The funds are held by the

escrow service until it receives the appropriate written or

oral instructions or until obligations have been fulfilled.

Balloon loans A type of loan which does not fully amortize over its term.

Since it is not fully amortized, a balloon payment is required

at the end of the term to repay the remaining principal

balance of the loan.

Prepayment

penalties

A clause in a mortgage contract that says if the mortgage is

prepaid within a certain time period, a penalty will be

assessed.

Rate cap Limits to the interest rate on an adjustable-rate loan

Page 85: Unit 6 Renting vs. Buying

6-3 #1

ESSENTIAL QUESTIONS

WHAT ARE YOU LEARNING? WHY ARE YOU LEARNING IT? HOW WILL YOU USE IT?

Why is it financially wise to make a down payment of

at least 20 percent of the purchase price of the

property?

• When you make a down payment of at 20%, you

avoid Private Mortgage Insurance (PMI), which

could amount to hundreds of dollars a year.

Page 86: Unit 6 Renting vs. Buying

6-3 #2

ESSENTIAL QUESTIONS

WHAT ARE YOU LEARNING? WHY ARE YOU LEARNING IT? HOW WILL YOU USE IT?

Why would you choose a fixed-rate loan? An

adjustable rate loan?

• You would choose a fixed-rate loan if you could not

afford the highest payment possible with an

adjustable rate mortgage. You would choose an

adjustable rate loan if you only planned on keeping

your home for 5-7 years while the interest rate

would be at its lowest.

Page 87: Unit 6 Renting vs. Buying

6-3 #3

ESSENTIAL QUESTIONS

WHAT ARE YOU LEARNING? WHY ARE YOU LEARNING IT? HOW WILL YOU USE IT?

Why should you consider both the interest rate and

the points of a loan when shopping for a loan?

• Both factors affect the overall cost of owning. While

points affect the initial cost and the interest rate

affects the long-term cost.