Chapter 5 Financial Planning Exercise 4 Rent vs. buy home Use Worksheet 5.2 and Exhibit 5.9. Denise Green is currently renting an apartment for $625 per month and paying $350 annually for renter's insurance. She just found a small townhouse she can buy for $175,000. She has enough cash for a $10,000 down payment and $4,300 in closing costs. Denise estimated the following costs as a percentage of the home's price: property taxes, 2.5 percent; homeowner's insurance, 0.5 percent; and maintenance, 0.7 percent. She is in the 25 percent tax bracket. Using Worksheet 5.2, calculate the cost of each alternative and recommend the least costly option - rent or buy - for Denise. Assume Denise's security deposit is equal to one month's rent of $625. Also assume a 4% after tax rate return on her savings, a 3% annual appreciation in home price, and a 6% mortgage interest rate for 30 years. a. Cost of renting. Round the answer to the nearest dollar. $ 7,875 b. Cost of buying. Round the answer to to the nearest dollar c. Denise should rent the home. EXHIBIT 5.9 A Table of Monthly Mortgage Payments (Monthly Payments Necessary to Repay a $10,000 Loan) The monthly loan payments on a mortgage vary not only by the amount of the loan, but also by the rate of interest and loan maturity. Rate of Interest 5.0% 5.5 30 Years $53.68 56.79 59.96 63.21 10 Years $106.07 108.53 111.02 113.55 116.11 118.71 121.33 123.99 126.68 129.40 132.16 15 Years $79.08 81.71 84.39 87.11 89.88 92.71 95.57 98.48 101.43 104.43 107.47 LOAN MATURITY 20 Years 25 Years $66.00 $58.46 68.79 61.41 71.64 64.43 74.56 67.52 77.53 70.68 80.56 73.90 83.65 77.19 86.79 80.53 89.98 83.92 93.22 87.37 96.51 90.88 66.53 69.93 73.38 76.90 80.47 84.09 87.76 Instructions: (1) Divide amount of the loan by $10,000; (2) find the loan payment amount in the table for the specific interest rate and maturity, and (3) multiply the amount from stcp 1 by the amount from stcp 2. Example: Using the steps just described, the monthly payment for a $98,000, 55 percent, 30-year loan would be determined as: (1) $98,000/$10,000 5 9.8; (2) the payment associated with a 5.5 percent, 30-year loan, from the tablc, is $56.79; (3) the monthly payment required to repay a $98,000, 5.5 percent, 30-year loan is 9.8 X $56.79 - $556.54. RENT OR BUY ANALYSIS A. COST OF RENTING 1 Annual rental costs ( 12 x monthly rental rate of $ 2. Renter's insurance 3. Opportunity cost of security deposit: $ xafter tax savings rate Total cost of renting dine A.1 + line A2 + line A3) B. COST OF BUYING $ 1 Annual mortgage payments (Terms: 1 12 x monthly mortgage payment of 2. Property taxes of price of home) 3. Homeowner's insurance % of price of home) 4. Maintenance of price of home) 5. After tax cost of interest on down payment and dosing costs % after tax rate of return) 6. Total costs (sum of lines B.1 through BS) 7. Principal reduction in loan balance see note below) 8. Tax savings due to interest deductions Pinterest portion of mortgage payments s . x tax rate of 9. Tax savings due to property tax deductions line 8.2 x tax rate of 10. Total deductions (sum of lines 8.7 through 8.9) 11. Annual after tax cost of home ownership dine 8.6 line 8.10) 12. Estimated annual appreciation in value of home of price of home) Total cost of buying line 8.11-line .12) Note: Find monthly mortgage payments from Exhibit 5.11. An easy way to approximate the portion of the annual loan payment that goes to interest (line 8.8) is to multiply the interest rate by the size of the loan. To find the principal reduction in the loan balance (line 8.71, simply subtract the amount that goes to interest from total annual mortgage payments. "Tax Shelter items Chapter 5 Financial Planning Exercise 4 Rent vs. buy home Use Worksheet 5.2 and Exhibit 5.9. Denise Green is currently renting an apartment for $625 per month and paying $350 annually for renter's insurance. She just found a small townhouse she can buy for $175,000. She has enough cash for a $10,000 down payment and $4,300 in closing costs. Denise estimated the following costs as a percentage of the home's price: property taxes, 2.5 percent; homeowner's insurance, 0.5 percent; and maintenance, 0.7 percent. She is in the 25 percent tax bracket. Using Worksheet 5.2, calculate the cost of each alternative and recommend the least costly option - rent or buy - for Denise. Assume Denise's security deposit is equal to one month's rent of $625. Also assume a 4% after tax rate return on her savings, a 3% annual appreciation in home price, and a 6% mortgage interest rate for 30 years. a. Cost of renting. Round the answer to the nearest dollar. $ 7,875 b. Cost of buying. Round the answer to to the nearest dollar c. Denise should rent the home. EXHIBIT 5.9 A Table of Monthly Mortgage Payments (Monthly Payments Necessary to Repay a $10,000 Loan) The monthly loan payments on a mortgage vary not only by the amount of the loan, but also by the rate of interest and loan maturity. Rate of Interest 5.0% 5.5 30 Years $53.68 56.79 59.96 63.21 10 Years $106.07 108.53 111.02 113.55 116.11 118.71 121.33 123.99 126.68 129.40 132.16 15 Years $79.08 81.71 84.39 87.11 89.88 92.71 95.57 98.48 101.43 104.43 107.47 LOAN MATURITY 20 Years 25 Years $66.00 $58.46 68.79 61.41 71.64 64.43 74.56 67.52 77.53 70.68 80.56 73.90 83.65 77.19 86.79 80.53 89.98 83.92 93.22 87.37 96.51 90.88 66.53 69.93 73.38 76.90 80.47 84.09 87.76 Instructions: (1) Divide amount of the loan by $10,000; (2) find the loan payment amount in the table for the specific interest rate and maturity, and (3) multiply the amount from stcp 1 by the amount from stcp 2. Example: Using the steps just described, the monthly payment for a $98,000, 55 percent, 30-year loan would be determined as: (1) $98,000/$10,000 5 9.8; (2) the payment associated with a 5.5 percent, 30-year loan, from the tablc, is $56.79; (3) the monthly payment required to repay a $98,000, 5.5 percent, 30-year loan is 9.8 X $56.79 - $556.54. RENT OR BUY ANALYSIS A. COST OF RENTING 1 Annual rental costs ( 12 x monthly rental rate of $ 2. Renter's insurance 3. Opportunity cost of security deposit: $ xafter tax savings rate Total cost of renting dine A.1 + line A2 + line A3) B. COST OF BUYING $ 1 Annual mortgage payments (Terms: 1 12 x monthly mortgage payment of 2. Property taxes of price of home) 3. Homeowner's insurance % of price of home) 4. Maintenance of price of home) 5. After tax cost of interest on down payment and dosing costs % after tax rate of return) 6. Total costs (sum of lines B.1 through BS) 7. Principal reduction in loan balance see note below) 8. Tax savings due to interest deductions Pinterest portion of mortgage payments s . x tax rate of 9. Tax savings due to property tax deductions line 8.2 x tax rate of 10. Total deductions (sum of lines 8.7 through 8.9) 11. Annual after tax cost of home ownership dine 8.6 line 8.10) 12. Estimated annual appreciation in value of home of price of home) Total cost of buying line 8.11-line .12) Note: Find monthly mortgage payments from Exhibit 5.11. An easy way to approximate the portion of the annual loan payment that goes to interest (line 8.8) is to multiply the interest rate by the size of the loan. To find the principal reduction in the loan balance (line 8.71, simply subtract the amount that goes to interest from total annual mortgage payments. "Tax Shelter items