Your mother is buying a house for $400,000 and intends to pay $100,000 down, and borrow the
Question:
Your mother is buying a house for $400,000 and intends to pay $100,000 down, and borrow the remaining $300,000 (including all closing costs). She is evaluating two loan options: borrow $300,000 at 8 percent on a 25-year term loan (i.e., a mortgage, with monthly payments), or borrow the same amount at 7 percent, but with a loan fee equal to 3 percent of the loan amount. This fee is payable upon closing and cannot be financed. Her opportunity cost on her money is 7 percent, and she has asked your assistance. Please ignore any tax effects.
a. How much will her monthly payments be if she chooses the 8 per- cent loan? (Hint: the monthly interest rate equals the annual rate divided by 12.)
b. How much will her monthly payments be if she chooses the 7 per- cent loan?
c. Your mother expects to stay in this house for only five years, at which time she plans to sell her house. Ignoring any differences in the principal values of the loans in five years, which mortgage would you advise her to take? Why?AppendixLO1
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