Kim and Dan the Price

Kim and Dan

The price of the home is $280,000. The initial down payment to be made is 20% of the purchase price, or $56,000. Their monthly expenses on utilities, maintenance and property tax, home insurance are approximately $750 and they also have car credit servicing costs monthly of $350, thus, overall $1,100 monthly expenses besides future mortgage servicing costs. Kim's gross income of $55,000 a year and Dan's income of $38,000 make the total annual income of $93,000, and their tax rate on this income is 25% according to tax rates in 2006. Their savings in money market fund of $60,000 has earned them the last year interest of $5,840, thus overall savings of $65,840. They are planning to use the most of this money for the initial down payment of $56,000 and closing costs of $1,000 plus three points, or 3% of the loan amount and we assume it is prepaid interest on the loan which is after wards deducted from the overall loan payments over the term of the loan, thus the down payment of $56,000, plus $1,000, which amounts to total initial outlay of $57,000, after deducting this sum from the total savings, the family has $8,840 left. Thus, the family must borrow $280,000-$56,000=$224,000. Three initial 3% points of this loan amount to be also paid are $6,720 and the family can pay this out of remaining after the down payment and fees $8,840. After this initial outlay, the family would have remaining $2,120 in their savings from the market money fund.

The loan is offered at 8% variable interest rate for the term of 30 years. Annuity annual payments thus will equal

Loan Amount / (1/r - 1/(r*(1 + r)^n)), where r is the annual interest rate and n is the loan term in years. The monthly payments then have to be divided into their monthly equivalents, or $1,658 monthly payments. Besides these loan servicing costs, the family has other costs of $1,100. Total household monthly income is $93,000/12 = $7,750. Total loan plus maintenance costs of $2,758 of 35% of their monthly income and thus the family is eligible for the mortgage. Nevertheless, the mortgage of $2,325 which would amount to equal 30% of their monthly income would be more affordable for the family. But, the family must also consider that the interest rate is variable and is subject to inflation indexation in case of high market volatility and thus future monthly payments of the family may increase significantly if the risks of the lender increase. Presently the Federal Reserve discount rate is increasing constantly and there is overall tendency to growing cost of financial resources in international markets which can further push interest rates upwards and the family will have very high mortgage servicing costs.

The renting option would include $1,400 per month plus utilities of $220 and insurance of $25, thus overall monthly payments of $1,645, while mortgage servicing and utilities costs are $2,758. Presently they are purchasing a house for $280,000 and it is expected to increase in value by 3% annually, or up to $324,500 approximately by the end of the fifth year. This means that their rental payments will also grow by 3% annually and will amount to $1,622 rental payments in five years' time. If the family does not use the money it generated in the money market fund and keeps earning 5% annual interest on it, in some years the family gross income will exceed present 25% tax rate and they will keep only 55% of marginal income received. This income still will offset much of the rental expenses to be incurred by renting.