c. They would have only $800 ($39,000 – $34,000 - $4200) left in their savings and investments — Dave Diane Starr New Orleans Louisiana both whom are late 20s currently
Accounting & FinanceGeneralWorked Solution
Dave and Diane Starr of New Orleans, Louisiana, both of whom are in their late 20s, currently are renting an unfurnished two-bedroom apartment for $1,200 per month, plus $230 for utilities and $34 for insurance. They have found a condominium they can buy for $170,000 with a 20 percent down payment and a 30-year, 6.5 percent mortgage. Principal and interest payments are estimated at $860 per month, with property taxes amounting to $150 per month and a homeowner’s insurance premium of $900 per year. Closing costs are estimated at $4,200. The monthly homeowners association fee is $275, and utility costs are estimated at $240 per month. The Starrs have a combined income of $90,000 per year, with take-home pay of $5,800 per month. They are in the 25 percent tax bracket, pay $225 per month on an installment loan (ten payments left), and have $39,000 in savings and investments outside of their retirement accounts.
(a) Can the Starrs afford to buy the condo? Use the results from the Garman/Forgue companion website or the information on page 276 to support your answer. Also, consider the effect of the purchase on their savings and monthly budget.
(b) Dave and Diane think that their monthly housing costs would be lower the first year if they bought the condo. Do you agree? Support your answer. Assume that they currently have $10,000 in tax deductible expenses.
(c) If they buy, how much will Dave and Diane have left in savings to pay for moving expenses?
(d) Available financial information suggests that mortgage rates might increase over the next several months. If the Starrs wait until the rates increase ½ of 1 percent, how much more will they spend on their monthly mortgage payment? Use the information in Table 9-4 on page 285 or the Garman/Forgue companion website to calculate the payment.
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SOLUTION
a. Applying a 28 percent front-end ratio, the Starrs qualify for a mortgage requiring total annual expenditures of less than $25,200 (0.28 × $90,000). Their yearly housing costs would be $13,020 [12($860) + 12($150) + $900]. For a 36 percent backend ratio, their monthly gross income of $7500 ($90,000/12) would result in a maximum of $2700 for monthly debt and housing payments. Their monthly debt and housing payments would be $1585[$225 +$860 +$275 + $150 + ($900/12)]. This is true assuming the lender would require the $275 per month homeowner’s fee also be included in the calculations as a housing cost. Including all housing-related costs, the purchase of the condo would take $1360[$860+ $275 + $150 + ($900/12)] from their $5800 monthly take-home income compared to their current monthly housing expenditures of $1234 ($1200 + $34). Dave and Diane do have enough savings and investments ($39,000) to make a $34,000 down payment and pay $4200 closing costs. On the basis of the rules of thumb and their available savings, Dave and Diane can afford this house. However, their budget may seem tight, especially during the next 10 months until the $225 per month installment debt is paid off.
b. Dave and Diane’s monthly housing costs are lower as renters than they would be if they purchased this condo. As renters, they pay $1464 a month for rent, utilities, and insurance. Their monthly costs as condo owners would $1600 [$860 + $275 + $150 + ($900/12) + $240]. They would pay approximately $8840in deductible interest ($136,000 x 0.065)and $1800 in deductible real estate taxes. Assuming they currently have $10,000in itemized deductions but take the $12,600 standard deduction, the condo would save the Starrs approximately $2010in taxes [($8840+ $1800 + $10,000 – $12,600) × 0.25] or $167per month. This would decrease the monthly condo costs to $1433 ($1600 - $167), which is actually $31 ($1464 - $1433)less than the cost of renting.
c. They would have only $800 ($39,000 – $34,000 - $4200) left in their savings and investments.
d. Financing $136,000 for 30 years at 7percent interest requires a monthly mortgage payment (principal and interest) of $905($136 × $6.6530). The Starrs would pay an additional $45per month ($905 - $860)on principal and interest if they wait and rates go up.