You're about to purchase a home and your mortgage broker offers you two options.
Based on the information provided below, which option should you choose? (annual compounding is acceptable)
Option 1 Option 2
Mortgage Amount $200,000 Mortgage Amount $200,000
Interest rate 7.0% Interest rate 7.5%
Closing Cost $4,500 Closing Cost None
Additional Information (applicable to both options)
- You can invest surplus cash at 6%
- You're planning to refinance the mortgage at the end of the 5th year
For the first solution, I've made the assumption that the loan is IO (interest only) for 5 years. The total cash out over the five years can be computed as:
Option 1: 200,000 x 7% x 5 years + $4500 = $74,500
Option 2: 200,000 x 7.5% x 5 years = $75,000
Earnings for investing the $4500: 4,500 x 6% x 5 ...
The solution compares to the two options given by calculating the total costs over the five year period. Beyond that, the solution discusses several more options that could be applicable.