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

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=)

To estimate the affordable mortgage and purchase price for the Bergholts, we need to consider their monthly expenses, debts, income, and savings.

1. Monthly Expenses:
- Utilities: $220
- Maintenance: $100
- Property taxes: $380
- Home insurance: $50

Total Monthly Expenses = $220 + $100 + $380 + $50 = $750

2. Monthly Debt:
- Car loans: $350

Total Monthly Debt = $350

3. Gross Income:
- Kim's income: $55,000/year
- Dan's income: $38,000/year

Total Gross Income = $55,000 + $38,000 = $93,000/year

To estimate the affordable mortgage, we can use the rule of thumb that the monthly housing costs, including mortgage, should not exceed 28% of the borrowers' gross monthly income. Let's calculate:

Monthly Housing Costs = Total Monthly Expenses + Total Monthly Debt
= $750 + $350 = $1,100

Affordable Mortgage = Monthly Housing Costs / 0.28
= $1,100 / 0.28 = $3,928.57 (approximately)

Now, to estimate the affordable purchase price, we can use the affordable mortgage and assume a 30-year loan term with an initial interest rate of 8%.

Down Payment = 20% of Purchase Price
Closing Costs = $1,000 + 3% of Purchase Price

Let's calculate:

Down Payment = 20% of Purchase Price = 0.2 * Purchase Price
Closing Costs = $1,000 + (0.03 * Purchase Price)
Loan Amount = Purchase Price - Down Payment - Closing Costs

Using these values, we can calculate the monthly mortgage payment:

Monthly Mortgage Payment = Loan Amount * Monthly Interest Rate
= Loan Amount * (8% / 12)

Now, we can solve for the affordable purchase price by substituting the affordable mortgage into the equation:

Affordable Purchase Price = Loan Amount + Down Payment + Closing Costs

Note: Additional factors such as credit score, debt-to-income ratio, and other qualifying criteria may also impact the qualification process.

After estimating the affordable mortgage and purchase price, there are other factors the Bergholts need to consider before purchasing and taking out a home mortgage:

1. Future Changes: They should consider potential changes in their income, job stability, and lifestyle. They need to assess whether they will be able to continue making mortgage payments in case of income changes or unexpected expenses.

2. Affordability: They should ensure that the total costs of owning a home, including mortgage payments, utilities, property taxes, insurance, and maintenance, fit within their budget and do not strain their financial situation.

3. Long-Term Goals: They should align their decision with their long-term goals. If they plan to move in the near future or have uncertain plans, renting might be more suitable as it provides more flexibility.

Potential future changes that might present problems for the Bergholts include:

1. Increase in Interest Rates: If interest rates rise in the future, it could result in higher monthly mortgage payments, affecting their affordability.

2. Job Changes or Loss: Unplanned changes in employment, such as job loss or reduced income, can impact their ability to make mortgage payments.

3. Unexpected Expenses: Any unexpected expenses related to property maintenance or repairs can strain their finances and make it difficult to meet mortgage obligations.

Now, let's estimate whether it is financially more attractive for the Bergholts to rent or purchase the home over a five-year holding period.

Renting Option:
- Monthly Rent: $1,400
- Utilities: $220
- Renter's insurance: $25

Total Monthly Renting Costs = $1,400 + $220 + $25 = $1,645

Buying Option:
- Contract Interest Rate: 8%
- Monthly Interest Payments over five years: $87,574
- Expected Housing Price and Rent Increase: 3% annually
- Expected Money Market Fund Interest Rate: 5%
- After-tax retention rate: 55%

To compare the two options, we need to calculate the net cash flows for both options over the five-year period:

Net Cash Flow for Renting = (Total Monthly Renting Costs - After-tax Retention * (Interest Earned on Money Market Fund)) * 12 months * 5 years

Net Cash Flow for Buying = (Total Monthly Mortgage Payment - After-tax Retention * (Interest Paid on Mortgage)) * 12 months * 5 years

If the Net Cash Flow for Renting is positive, renting is more financially attractive. If the Net Cash Flow for Buying is positive, buying is more financially attractive.

To determine the preferred alternative after one year, we can calculate the interest payments over the first year:

Interest Payments for the first year = Monthly Interest Rate * (Loan Amount - Down Payment) * 12 months

If the interest payments for the first year exceed the net cash flow for renting, renting would be the preferred alternative. Otherwise, buying would be the preferred alternative.

Remember to account for the impact of taxes, interest rates, and any other financial factors specific to the situation while calculating the net cash flows and comparing the options.