Financial Markets and Institutions
Financial Markets and Institutions
6th Edition
ISBN: 9780077641825
Author: SAUNDERS
Publisher: Mcgraw-Hill Course Content Delivery
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Chapter 7, Problem 11P

a)

Summary Introduction

To determine: The best option from the given two options.

a)

Expert Solution
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Explanation of Solution

For both the mortgage the down payment will be 20% of the buying price, or a down payment of $39,000(0.20×195,000) at closing and borrow $156,000 through the mortgage.

In case if the option 2 is selected and make payment of $2,340 ($156,000×0.015) in points and gets $153,660($156,000$2,340) at closing, although the mortgage principal is $156,000. To ascertain the best option, initially the monthly payments for both options should be ascertained as follows:

  • Option 1:

$156,000=PMT{[1(1(1+0.055012)30(12))](0.055012)}Solve for PMT, we get $885.75.

  • Option 2:

$156,000=PMT{[1(1(1+0.053512)30(12))](0.053512)}Solve for PMT, we get $871.13.

In exchange for $2,340 upfront, option 2 decreases the monthly payments of mortgage by $14.625. The present value of these savings (ascertained at 5.35%) over the 30 years is as follows:

PV=$14.625{[1(1(1+0.053512)30(12))](0.053512)}=$2,619.11

Option 2 is best choice because the present value of monthly savings, $2,619.11, is greater than the points paid up front, $2,340.

b)

Summary Introduction

To determine: The best option from the given two options.

b)

Expert Solution
Check Mark

Explanation of Solution

In case if the option 1 is selected and make payment of $1,560 ($156,000×0.01) in points and gets $154,440($156,000$1,560) at closing, although the mortgage principal is $156,000. If the option 2 is selected and make payment of $3,120 ($156,000×0.02) in points and gets $152,880($156,000$3,120) at closing. The difference in savings on the point is $1,560. To identify the best option the monthly payments should be computed for both options as follows:

  • Option 1:

$156,000=PMT{[1(1(1+0.053512)30(12))](0.053512)}Solve for PMT, we get $871.125.

  • Option 2:

$156,000=PMT{[1(1(1+0.052512)30(12))](0.052512)}Solve for PMT, we get $861.438.

In exchange for $1,560 upfront, option 2 decreases the monthly payments of mortgage by $9.687. The present value of these savings (ascertained at 5.25%) over the 30 years is as follows:

PV=$9.687{[1(1(1+0.052512)30(12))](0.052512)}=$1,754.24

Option 2 is best choice because the present value of monthly savings, $1,754.24, is greater than the points paid up front, $1,560.

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Mortgages explained UK; Author: Finder - UK;https://www.youtube.com/watch?v=mdmIDvgRRLs;License: Standard Youtube License