Kim and Dan Bergholt are both government workers considering purchasing a condo for 280,000. Kims gross incoem is 55,000 and Dans is 38,000 they have 60,000 in a money market fund which earned 5,840 last year. they plan to use most of it for a 20% downpayment and closing costs equal 1,000 plus 3 points. The reals estate agent tells them that if they don't care to purchase the rental option would cost 1,400 a month plus utilities estimated at 220. and insurance 25. assuming they stay for 5 years they would like to know if it owuld be better to buy or rent.they expect the housing and rents will rise annual at 3% over the next 5 years they expect ot earn an annual rate of 5% on the money market fund. Utilities taxes are expected to increase 3%annual all federal state and locales they get to keep 55% of marginal dollar of earnings. estimate wheather it is financially more attractive to rent or purchase the home over 5 years holding period assuming the contract interest rate of 8% monthly interest payments over the 5 years would total 87,574
To determine whether it is financially more attractive to rent or purchase the condo over a 5-year holding period, we need to calculate the costs and benefits associated with each option.
1. Renting Option:
a. Monthly Rent:
The monthly rent is estimated at $1,400, and the yearly total rent expense would be $1,400 x 12 = $16,800.
b. Annual Rent Increase:
The housing and rents are expected to rise annually at a rate of 3%, so the increased rent each year can be calculated as follows:
Year 1: $16,800 x 3% = $504
Year 2: ($16,800 + $504) x 3% = $526.32
Year 3: ($16,800 + $504 + $526.32) x 3% = $549.78
Year 4: ($16,800 + $504 + $526.32 + $549.78) x 3% = $574.38
Year 5: ($16,800 + $504 + $526.32 + $549.78 + $574.38) x 3% = $600.56
c. Annual Utilities Expense:
The estimated monthly utility cost is $220, so the yearly total utilities expense would be $220 x 12 = $2,640.
d. Annual Insurance Expense:
The annual insurance expense is estimated at $25.
e. Total Annual Rent Expense for 5 years:
Year 1: $16,800
Year 2: $16,800 + $504
Year 3: $16,800 + $504 + $526.32
Year 4: $16,800 + $504 + $526.32 + $549.78
Year 5: $16,800 + $504 + $526.32 + $549.78 + $574.38
2. Buying Option:
a. Down Payment and Closing Costs:
The down payment is calculated as 20% of the condo price: $280,000 x 20% = $56,000.
b. Loan Amount:
The loan amount would be the remaining purchase price after the down payment: $280,000 - $56,000 = $224,000.
c. Monthly Mortgage Payment:
To calculate the monthly mortgage payment, we need to use the loan amount, interest rate, and loan term. Assuming a monthly interest payment for 5 years, the total interest paid over 5 years would be $87,574. Therefore, the monthly mortgage payment can be calculated as follows:
$224,000 + $87,574 / 60 months = $5,526.23
d. Annual Property Taxes:
The annual property taxes are expected to increase by 3% each year. Assuming the initial property tax is $0, we can calculate the annual property tax for each year:
Year 1: $0 x 3% = $0
Year 2: ($0 + $0) x 3% = $0
Year 3: ($0 + $0 + $0) x 3% = $0
Year 4: ($0 + $0 + $0 + $0) x 3% = $0
Year 5: ($0 + $0 + $0 + $0 + $0) x 3% = $0
e. Total Annual Costs (Mortgage + Taxes + Insurance):
Year 1: $5,526.23 + $0 + $25 = $5,551.23
Year 2: $5,526.23 + $0 + $25 = $5,551.23
Year 3: $5,526.23 + $0 + $25 = $5,551.23
Year 4: $5,526.23 + $0 + $25 = $5,551.23
Year 5: $5,526.23 + $0 + $25 = $5,551.23
f. Equity Gained:
The equity gained each year can be calculated by subtracting the mortgage principal payment from the total monthly mortgage payment:
Year 1: $5,526.23 - ($224,000 x 8% / 12) = $2,417.23
Year 2: $5,526.23 - ($224,000 x 8% / 12) = $2,441.85
Year 3: $5,526.23 - ($224,000 x 8% / 12) = $2,466.71
Year 4: $5,526.23 - ($224,000 x 8% / 12) = $2,491.82
Year 5: $5,526.23 - ($224,000 x 8% / 12) = $2,517.18
3. Compare the Total Costs:
Calculate the total costs for each option over the 5-year holding period:
Renting Option: Total Annual Rent Expense for 5 years + Total Utilities Expense + Total Insurance Expense
Buying Option: Total Annual Costs (Mortgage + Taxes + Insurance) - Equity Gained
Compare the total costs of both options to determine which one is more financially attractive over the 5-year period.
To determine whether it is financially more attractive to rent or purchase the home over a 5-year period, we need to calculate the total costs and benefits for each option.
1. Renting Option:
- Monthly rent: $1,400
- Monthly utilities: $220
- Monthly insurance: $25
Total monthly cost of renting: $1,400 + $220 + $25 = $1,645
Total annual cost of renting: $1,645 * 12 = $19,740
Estimated increase in rent and utilities over 5 years (3% annually):
- Rent increase per year: $1,400 * 0.03 = $42
- Utilities increase per year: $220 * 0.03 = $6.6
Total estimated increase in rent and utilities over 5 years: ($42 + $6.6) * 5 = $240
Total cost of renting over 5 years: $19,740 * 5 + $240 = $99,240
2. Buying Option:
- Condo price: $280,000
- Down payment (20% of condo price): $280,000 * 0.2 = $56,000
- Closing costs: $1,000 + (3% of condo price) = $1,000 + ($280,000 * 0.03) = $8,400
- Loan amount: $280,000 - $56,000 = $224,000
- Annual interest rate: 8%
To calculate the monthly mortgage payment, we need to use the loan amount, the interest rate, and the loan term. Since the term is not provided, we'll assume a 30-year fixed-rate mortgage.
- Number of monthly payments: 30 years * 12 months = 360 months
- Monthly interest rate: 8% / 12 = 0.67%
Using the loan amount, monthly interest rate, and number of payments, we can use the formula for the monthly payment on an amortizing loan:
Monthly mortgage payment: $224,000 * (0.0067 * (1 + 0.0067)^360) / ((1 + 0.0067)^360 - 1)
To calculate the total monthly payments over 5 years, multiply the monthly mortgage payment by the number of months in 5 years (60 months).
Total monthly payments over 5 years = Monthly mortgage payment * 60
Total monthly payments over 5 years: [Insert calculation]
Next, let's calculate the total costs associated with owning the condo over 5 years:
- Total down payment and closing costs: $56,000 + $8,400 = $64,400
- Total monthly mortgage payments over 5 years: [Insert calculation]
- Total property tax increase over 5 years (3% annually): [Insert calculation]
- Total insurance cost over 5 years: $25 * 12 months/year * 5 years = $1,500
Total cost of owning over 5 years = Total down payment and closing costs + Total mortgage payments + Total property tax increase + Total insurance cost
Finally, let's calculate the total investment value after 5 years if they invest their money market fund:
- Initial investment: $60,000
- Annual interest rate: 5%
- Number of compounding periods: 5 years
Total investment value after 5 years = Initial investment * (1 + Annual interest rate)^Number of compounding periods
Once you have both the total cost of renting over 5 years and the total cost of owning over 5 years, compare them to determine which option is financially more attractive.