Ms. Sally Firth has worked as a design engineer since graduating from North Central State.She has shifted jobs twice, and she expects to shift again in the near future. All of these jobsare in the same area where she has decided she wants to live for at least the next five years.Thus, she is ready to buy herself asmallhome and move out of her rented apartment.Ms. Firth has found a home she likes, and she believes that she should buy it before shechanges jobs. If she waits to buy, some financial institutions may down rate her due to a shortof time on the job in spite of the salary increase she expects. She knows she could get amortgage, but difficulties in qualifying might restrict her choice of home.This really concerns her because the home she wants to buy will cost about $96,500 plusclosing costs. In fact, the current owner has accepted her offer and given her six weeks tofinalize the financing and arrange for closing. He also provided details on the upkeep costs ofthe house, which she included in her budgeting.She has set aside about $7500 for a down payment, and she has budgeted for a monthlypayment of $900. She expects that her salary will increase about 5% per year in real terms,but she would like to use that increase for fun purposes. Until last year, she was still payingoff her student loans, and she has not been able to live in the style to which she would like tobecome accustomed.She has identified three financing possibilities, but she must compare their effectiveannual interest rates and other differences to determine which is best. Dream85Current mortgages cover a 30-year period and are available at 10% interest rates with a5% down payment. With new financing, title insurance is 0.5% of the propertys value, andthe loan origination fee is 1% of the loans face value.However, when the current owner purchased the home, interest rates were only 7%. Thatmortgage has 25 years to run, with a remaining balance of $68,747.38. The monthlypayments also include a reserve allowance for fire and liability insurance and for propertytaxes. Annually these total $675 for insurance and $850 for taxes.While the mortgage can be assumed, with the only cost being a $350 charge for creditchecks and paperwork, the current owners equity has to be covered somehow. The bank withthe original loan will issue a second mortgage at 12% for a term to match the first mortgage.The requirements for down payments, title insurance, and loan origination fees match thosefor new first mortgages.The current owner is also willing to accept a second mortgage directly. While the up-front fees can be omitted, the loan has a 12% interest rate and a 10-year term.Use annual payments to simplify the analysis. Options1.The loan office of the bank has just called Ms. Firth to mention another financingpossibilitythe graduated payment mortgage. Terms, interest rates, and fees are thesame as a normal mortgage. However, by lowering the payments in the early years, itis somewhat easier to qualify for and to afford the home of your dreams. For the first4 years, the payments are only 80% of the level of a normal mortgage; then for thenext 6 years, the payments for both mortgages are the same; and then for the last 20years, the graduated payment mortgage has higher payments.2.Although she ignored inflation initially, Ms. Firth recognizes that the rates of thevarious mortgages include allowances for expected levels of future inflation. Thiswas really made obvious when a friend, George, described his new variable ratemortgage. Everything was similar to what she was used to except that the initial rate(last month) was only 6%. In turn, he agreed that once a year the bank could adjusthis rate according to movement of the prime rate. Thus if inflation is high ormoney is tight, his rate could rise as much as 1% per year. There is a lifetime capof 5% on these increases. 3. Sally is also wondering whether she is better off using some of her extra savings to reduce the loan by increasing her down payment, or whether she should use it to early payments.