Financing Options for a Home Loan
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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
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Solution Summary
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.
Solution Preview
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 ...
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