Kim and Dan Bergholt are government workers. They are considering purchasing a home in the Washington, D.C., area for about $280,000. They estimate monthly expenses for utilities at $220, maintenance at $100 and home insurance payments at $50. Their only debt consists of car loans requiring a monthly payment of $350.Kim 's gross income is $55,000 per year and Dan's is $38,000 per year. Their marginal tax rate is 30%. They have saved about $60,000 in a mutual fund on which they earned $3,000 last year. They plan to use most of this for a 20 percent down payment and closing costs. A lender is offering 30-year variable rate loans with an initial interest rate of 8 percent given a 20 percent down payment and total closing costs equal to 2% of purchased amount. Before making a purchase offer and applying for this loan, they would like to have some idea whether they could afford it.

Questions

a. Calculate the monthly mortgage payment if they take the lenders offer. Will you consider it as an affordable mortgage. Explain.

b. What other factors might they consider before purchasing and taking out a home mortgage?

c. What future changes might present problems for the Bergholts?

The real estate agent tells theBergholts that if they don't care to purchase, they might consider renting. The rental option would cost $1,200 per month plus utilities estimated at $220 and renters insurance of $25 per month. There is also a security deposit of two month security deposit, with no interests.

The Bergholts believe that neither of them is likely to be transferred to another location within the next five years. After that, Dan perceives that he might move out of government service into the private sector. Assuming they remain in the same place for the next five years, the Bergholts would like to know if it is better to buy or rent the home. They expect that the price of housing and rents will rise at an annual rate of 3 percent over the next five years. They expect to earn an annual rate of 5 percent on the mutual fund. All other prices, including utilities, maintenance, and taxes are expected to increase at a 3 percent annual rate. After federal, state, and local taxes, they get to keep only 70 percent of a marginal dollar of earnings.

Question

d. Given this further information, estimate whether it is financially more attractive for the Bergholts to rent or to purchase the home over a .five-year holding period. (Assuming the contract interest rate of 8%, monthly interest payments over five-year period would total $87,574. Hint: Mortgage interest is tax deductible. Hence, they have a tax savings of 30% of the interest paid if they purchase the home. There will be a selling expenses of [1%] of sales commission when they sell their home.)