An analytical view of home sale transaction, home maintenance, tax benefits, comparing different home types, etc.

1. © 2018 Karthik Ethirajan, all rights reserved
Economics of Home Buying
Karthik Ethirajan
May 2018

2. © 2018 Karthik Ethirajan, all rights reserved
2
Agenda
3. Housing Costs
4. Understanding Mortgage Interest
5. New Tax Law Changes
6. Loan Qualification
7. Loan Qualification Calculator
8. True Cost of Ownership
9. Comparing Different Types of Home Buys
10. Key Takeaways
EconomicsofHomeBuyingDisclaimer
This material does not constitute tax, legal or investment advice. Always,
consult with your licensed advisors regarding your personal circumstances.

3. © 2018 Karthik Ethirajan, all rights reserved
3
Housing Costs
For a home price of $1M with $750K loan amount
Buying Costs Monthly Costs Selling Costs
Closing Costs
Title $700
Escrow $700
Lender Fees $1700
Appraisal $700
$3,800
Basic Renovation $8,000
Relocation $2,000
$13,800
Title/Escrow fees are paid by sellers
in Santa Clara county, but paid by
buyers in San Mateo & Alameda
counties
PITI
Principal $987
Interest @4.5% $2,812
Property Tax @1.1% $917
Insurance $100
Home Warranty $50
Water, Sewer, Trash $100
Landscape $50
Single Family Home $5,016
Townhome / Condo $5,166
TH/CN adds another $400 in HoA but
may cover insurance, water, sewer,
trash, landscaping
Closing Costs
Title $2,500
Escrow $2,000
Recording @0.11% $1,100
Property
Inspections
$1,000
Buyer Realtor Fees
@2.5%
$25,000
Seller Realtor Fees
@2%
$20,000
$51,600
Basic Renovation $8,000
Relocation $2,000
$61,600
$5K monthly cash flow is required to maintain a
$1M property
About $75K can be spent in turning a home –
buying & selling process
Note: Some closing costs are representative
figures & some others are negotiable

4. © 2018 Karthik Ethirajan, all rights reserved
4
Understanding Mortgage Interest
30-year fixed loan at 4.5% for a loan amount of $750K
0 15 30 Years
$988
$2,813
Principal
Interest
P+I Monthly Payment
$3,800
Monthly Interest Calculation
 Interest is always calculated on the outstanding
loan balance
 1st interest payment = ($750K * 4.5%) / 12 months
= $2,813
Over the life of the loan
 Total interest paid is $618K
 A quarter point increase in interest rate will cost
+$40K
 Tax benefit @33% is $204k
Today’s Low Interest
Rate Environment
P&I for every $1000
borrowed
$4.84 @4.250%
$4.99 @4.375%
$5.07 @4.500%
$5.14 @4.625%
$5.21 @4.750%
P&I increases by ~$0.08 for
every 1/8th point increase in
interest rate

5. © 2018 Karthik Ethirajan, all rights reserved
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New Tax Law (TCJA 2017) Changes Affecting Real Estate
Changes will revert if Congress does not renew by 2025 (sunset provision)
Before After
Mortgage Interest Deductible <$1M of loan balance <$750K
Property Tax No limits
Deductible <$10K of Property Tax
& State Tax combined
Home Equity Loan
(HELOC) Interest
Deductible <$100K
Not deductible unless used for
home improvement
Maximum Tax Benefit
 Tax saving from deducting mortgage interest
= $750K loan * 4.5% interest * 33% tax
12 months
= $928 per month
No Tax Benefits from Property Tax
 State tax will contribute to most of the $10K max
allowed deduction
 An AGI income of $140K can generate $10K in
State income tax
Solve using State income tax calculation:
10K = 2376 + (AGI – 4236 – 53980) * 9.3%
Interest deductions amount to receiving ~$1K
rent check from Government for owning a home
Property tax will likely not provide home
owners with any additional tax benefits

6. © 2018 Karthik Ethirajan, all rights reserved
6
Loan Qualification
Back end ratio (liability to income ratio after purchase) is capped at 43%
Income
 W2 income is easier to qualify
 Bonus may be considered if there is a history
 Rental income is capped at 75% occupancy
rate
 Assume no liability besides mortgage, no HoA
Price * 0.005 = 43% * Monthly Income
Price = 86 * Monthly Income
= 7 * Annual Income
Liability
 Includes any HoA, car payment, student loan,
alimony, child support, etc.
 Property tax calculated at 1.25%
 Home insurance is included at $100 monthly
 Assumes at least 20% down payment
Max Loan
 20% down, 4.5% interest
PITI = Price * 80% * $5 P&I + Price * 1.25% Prop Tax
1000 12
= 0.004P + 0.001P
= 0.005P
(P is Price)
PITI is about 0.5% of property value in today’s
interest rate with 20% down payment
You can purchase a home up to 7x salary
with 20% down payment
Monthly Cash Layout

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Loan Qualification Calculator
Max loan amount with 20% down
Note: Blue cells are model inputs
Income
Annual Salary 150,000$
Monthly Salary 12,500$
Rental Income -$
Adjusted Rent -$
Total Income 12,500$
Adjusted Income 5,375$
Liability
Monthly Payments 500$
Property Sale Price 850,000$
Insurance 100$
HoA 400$
P&I 3,490$
Property Tax 885$
Loan Amount 688,281$ 81%
Down Payment 161,719$ 19%
Note: Blue cells are model inputs
Income
Annual Salary 200,000$
Monthly Salary 16,667$
Rental Income -$
Adjusted Rent -$
Total Income 16,667$
Adjusted Income 7,167$
Liability
Monthly Payments 500$
Property Sale Price 1,300,000$
Insurance 100$
HoA
P&I 5,213$
Property Tax 1,354$
Loan Amount 1,028,107$ 79%
Down Payment 271,893$ 21%
Note: Blue cells are model inputs
Income
Annual Salary 250,000$
Monthly Salary 20,833$
Rental Income 2,500$
Adjusted Rent 1,875$
Total Income 22,708$
Adjusted Income 9,765$
Liability
Monthly Payments 500$
Property Sale Price 1,800,000$
Insurance 100$
HoA
P&I 7,290$
Property Tax 1,875$
Loan Amount 1,437,788$ 80%
Down Payment 362,212$ 20%
Townhome Single Family Duplex
$150K salary qualifies one to
buy $850K townhome with HoA
$200K salary qualifies one to
buy $1.3M SF home
$250K salary qualifies one to
buy a duplex with rent potential
Note: Monthly Payments include all other
non-home related liabilities

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True Cost of Ownership (TCO)
Include opportunity cost of equity (down payment): if investing equity elsewhere
returned the same rate as interest rate, then the loan amount is irrelevant
Primary Residence Investment Property
Effective Interest Rate
= 4.5% * (1 – 33% tax rate)
= 3%
Monthly Cash Layout, PITI
= Price * 3% + Price * 1.2% Prop Tax
12 12
= 0.0025P + 0.001P
= 0.0035P
Rent Equivalency
Home Price = (1 / 0.0035) * Rent
~ 300 * Rent
Every $1 in monthly payment will buy about
$300 of additional home
Effective interest rate
Tax consideration is likely diminished as rental
income is netted against monthly expenses
Monthly Cash Layout, PITI
= Price * 4.5% + Price * 1.2% Prop Tax
12 12
= 0.004P + 0.001P
= 0.005P
Rent Equivalency
Home Price = (1 / 0.005) * Rent
~ 200 * Rent
Every $1 in rental income will offset about
$200 of additional home

9. © 2018 Karthik Ethirajan, all rights reserved
9
Comparing Different Types of Home Buys
Compute effective price using TCO conversion rates
Townhome
Single Family
Duplex
$1M Effective Price
$1,000 $400
$0.12M
TCO Monthly
x 300
$2,500
= $1.12M
= $3,900
Interest Property Tax HoA
$1.5M
$1,500 $250
$0.07M
$3,750
= $1.57M
= $5,500
Interest Property Tax Insurance, Landscape,
Water, Sewer, Trash
$2M
$2,000 $250
$0.07M
$5,000
= $1.57M
= $5,600
Interest Property Tax
Purchase Price
Purchase Price
Purchase Price
– $2,500 * 66%
– $0.5M
After-tax
Rental Income

10. © 2018 Karthik Ethirajan, all rights reserved
10
Key Takeaways
 HoA is deemed evil but it can include some benefits such as insurance,
landscaping, water, sewer, trash, club house, gym, pool, etc.
 Cost of borrowing $1000 is about $5 (P&I)
 A quarter point increase in interest rate costs $40K in additional interest over the
life of a $750K loan
 New tax law makes Property Tax more or less not tax deductible in CA
 Max tax benefit of owning a home equates to getting a $1,000 monthly check from
Government
 PITI is about 0.5% of property value with 20% down payment
 You can loan qualify to purchase a home up to 7x salary with 20% down payment
 Every $1 in monthly payment will buy about $300 of additional home for primary
residence. For e.g., paying $3,000 in rent is equivalent to owning a $900K home.
 An effective price calculated from TCO can be used to compare Townhomes with
HoA to Single Family homes with extra utility expenses to Duplex with rental
income
Many of the insights assume Bay Area market and low interest rate environment