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    Bergholts Planning a home purchase

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    Kim and Dan Bergholt are both government workers. They are considering purchasing a home in the Washington D.C. area for about $280,000. They estimate monthly expenses for utilities at $220, maintenance at $100, property taxes at $380, and home insurance payments at $50. Their only debt consists of car loans requiring a monthly payment of $350.

    Kim's gross income is $50,000/year and Dan's is $35,000/year. They have saved about $60,000 in a money market fund on which they earned $5,840 last year. They plan to use most of this for a 20% down payment and closing costs. A lender is offering 30-year variable rate loans with an initial interest rate of 7% given a 20% down payment and closing costs equal to $1,000 plus 3 points.

    Before making a purchase offer and applying for this loan, they would like to have some idea whether they might qualify.

    1. Estimate the affordable mortgage and the affordable purchase price for the Bergholts.
    2. Suppose they do qualify; what other factors might they consider before purchasing and taking out a home mortgage?
    3. What future changes might present problems for the Bergholts?

    The real estate agent tells the Bergholts that if they don't care to purchase, they might consider renting. The rental option would cost $1,400/month plus utilities estimated at $220 and renter's insurance of $25/month. The Bergholts believe that neither of them is likely to be transferred to another location within the next five years. After that, Dan perceives that he might move out of government service into the private sector. Assuming they remain in the same place for the next five years, the Bergholts would like to know if it is better to buy or rent the home. They expect that the price of housing and rents will rise at an annual rate of 3% over the next five years. They expect to earn an annual rate of 4% on the money market fund. All other prices, including utilities, maintenance, and taxes are expected to increase at a 3% annual rate. After federal, state, and local taxes, they get to keep only 55% of a marginal dollar of earnings.

    4. Estimate whether it is financially more attractive for the Bergholts to rent or to purchase the home over a five-year holding period. (Assuming the contract interest rate of 8%, monthly interest payments over the five-year period would total $87,574.)

    5. Suppose it turns out that they have to relocate after one year. Which is the preferred alternative after one year? (Interest payments over the first year would equal $17,852.)

    Show all work for each assignment and explain each step carefully.

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    Solution Preview

    Long Term Financial Planning

    First, the total monthly expenses (excluding the mortgage payment) of Kim and Dan Bergholt assuming that they purchase the house are presented below:
    Expense Item Amount
    Utilities $ 220
    Maintenance 100
    Property taxes 380
    Home insurance 50
    Total home related expenses $ 750
    Car loan payment 350
    Interest 1,313
    Total $ 2,413

    The interest on the mortgage loan, given that the interest rate for the first year is at 7 per cent, is computed as follows:
    Contract price of the house $ 280,000
    Less: 20% down payment 56,000
    Add: closing costs
    Fixed $1,000
    3 points ($280,000 x 3/100 x 1%) 84 1,084
    Total mortgage loan $ 225,084

    Interest for the first month is $1,313 ($225,084 x 7% / 12 months).

    Now, given that Kim's annual gross income is $50,000 and Dan is $35,000, the family's total gross income for the year is $85,000. Assuming further that the net pay from this, less taxes, Medicare and other deductibles, is two-thirds, then the family has about $57,000 to spend a year and about $4,740 a month.

    Assuming further that Kim and Dan Bergholt spend another $1,500 on clothes, food and fuel a month, the couple's estimated monthly expenses, if they both the house and excluding mortgage payment, is $3,913 ($1,500 + $2,413) which means that about $800 is free for mortgage principal payment.

    Given the above, the affordable monthly mortgage payment for Kim and Dan Bergholt is about $2,100 which is comprised of $800 for ...

    Solution Summary

    The expert examines Bergholts planning a home purchase. Qualify, affordable mortgage and investment analysis is given.