Fred and Addie have worked really hard to get where they are today and want to buy a new luxury home for themselves and their kids. Fred owns a large manufacturing firm and has a gross income of $1,500,000 annually. Addie works occasionally as an interior designer and has a net income of $52,500 annually. Freds tax rate is 50% and Addies tax rate is 23%.

Fred and Addie will have $2 million to put towards their home as a down payment, which is mainly from the sale of their existing property. The houses they are looking at have property taxes of $17,500 annually.

Although they are high income earners and have sizable savings they still carry some debt. They have a line of credit on which they make monthly payments of $500, a car loan with monthly payments of $1,200 and a private loan on which they make monthly payments of $5,000.

Their financial institution has offered them a 5-year fixed closed mortgage at a rate of 2.75%. The amortization period is 25 years.

Ignore stress test in the calculations.

Required:

1. What is the maximum mortgage they are able to obtain?

2. Explain why the ratios do not apply well to very high or low incomes. Specifically identify 3 shortfalls associated with the ratios in your response.