Rent or to purchase the home
Complete the following exercise in your groups:
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 $55,000/year and Dan’s is
$38,000/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 8% 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.
Estimate the affordable mortgage and the affordable purchase
price for the Bergholts.
Suppose they do qualify; what other factors might they
consider before purchasing and taking out a home mortgage?
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 5% 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.
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.)
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.
ScholarMatic: Explanation & Answer
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