Pavel and his spouse Imani just graduated from graduate school and found jobs. Pavel is 29 years old and Imani is 32. They bought a house in San Francisco 3 years ago right after they were married for $876,000. They have a 30-year fixed mortgage for an annual rate of 4.3% on the house. They believe the house has appreciated 2%/year since they purchased it. They used the $32,360 that Pavel received for his Bar Mitzvah when he was 13 years old for the down payment on the house when they purchase it. (The entire amount of the Bar Mitzvah cash was used towards the mortgage.) Pavel never changed the savings from the investment that his parents put him in which grew at a rate of 8.5% per year. Imani grew up in the Northeast with her grandmother who she still supports today. Imani's grandmother is 84 and is in good health and expected to live until she is 105 like her great grandmother who passed away a few years before Imani was married to Pavel. Imani's grandmother has no real savings except for a house that she grew up in in upstate New York. Imani's grandmother gifted the house to Imani when Imani graduated from college so Imani pays the 5% real estate tax on it annually. Imani doesnt consider the house hers and reminds her grandmother that since the house is worth $400,000 her grandmother should always consider selling the house and living off of the proceeds if she ever needs too but also she reassures her grandmother that she will always take care of her since her grandmother's expenses incluing healthcare only cost Imani $360/mo. Imani's new job pays her $1,275,000 and she feels that she can afford to help her grandmother until she passes away. Imani's grandmother also has a life insurance policy that Imani is the beneficiary of for $500,000. Imani grew up with very little resources as her parents passed away when she was only 6 years old. Her grandmother took care of her from that point on and only earned $13,000/year that she could use towards caring for herself and Imani. Imani's grandmother, Ziri, also received a spousal pension payment from her deceased grandfather's former employer once she turned 65 years old and will continue to receive $200/mo after tax until the time of her death. Imani's grandmother retired from her job at 65 and has no other income except the grandfather's pension after that time which is why Imani assists her with her lifestyle if needed. Ziri is very humble and does not want to take advantage of Imani but she is interested in moving to San Francisco to be near her as she has no other family in the United States other than Imani. Imani does not live a lavish lifestyle but she has no savings since 4 years ago she had to fully deplete her savings in order to pay for reconstructive work on her leg after a major fall from a rock climbing excursion with her friends. She was drastically injured and wanted to fully reconstruct the damaged areas which took her entire savings. Her savings prior to being depleted was growing at a rate of 5% which Imani believed was a good rate of return. Pavel is not as close with his family and since his parents are still living and have amassed wealth themselves, he does not believe he will have to take care of anyone in the future the way that Imani does with her grandmother. Pavel is also very close with Imani's grandmother and loves her like his own. Pavel's new job is in the public sector and he is compensated a flat $230,000/year with annual increases for the first 10 years of 3%/year. Starting in the 11th year until his retirement his salary will increase at a rate of 4%/year. Pavel also has free heatlhcare and travel expenses as a perk from his employer. Pavel and Imani contribute the annual maximum contribution amount to their respective traditional IRAs as well as their employer sponsored retirement plans. Pavel has another $120,000 in savings earning 2%/annually for the next year when the savings vehicle matures and Imani has no savings to speak of. They have 1 car between them that has no payments but an annual upkeep cost and insurance cost of a total of $4300. Pavel created a spreadheet that shows that they also have a regular lifestyle spend of $180,000/year after tax. Pavel would like to purchase a larger house to accommodate Imani's grandmother so that she can move in with them and Imani would like to have a larger house to accommodate her arriving child as she is 6 months pregnant. (All of Imani's healthcare costs are covered by her employer.) The house that Pavel has found that they are interested in buying is also in the Bay area and is listed at $2,340,000 and current mortgage rates are 6.1% on 30 year fixed mortgages which they prefer. In addition to savings, Pavel has 1500 baseball cards that he collected in his youth that are worth $3000 that he paid $230 for over the years. Pavel is a freelance writer for a small local paper where he receives $250/week for his articles. He is a regular contributor for 45 out of 54 weeks in the year and expects that to continue for the next 20 years without increase. Pavel enjoys running in the morning for 15 miles everyday and buys a donut for $3.56 everyday on his way home. Pavel's family members usually live until their late 70s and are generally in good health except there is a history of heart disease on his mother's side. Pavel wants to gift to charity when he dies and has already identified the charity he would like to gift to, he is trying to convince Imani to gift to the same charity. Pavel and Imani come to you for personal financial planning advice in order to get help determining whether or not they can afford the new house. You start by answering the following questions or them:
1. What amount do each of them contribute to their retirement per year?
2. Can they contribute more towards their retirement per year in a tax-efficient manner?
3. What is their annual marginal tax rate?
4. What is their annual effective tas rate?
5. How much was their mortgage when they bought their house?
6. How much is outstanding on their current mortgage?
7. How much will the mortgage on the new house be, assuming a 10% down payment is required?
8. What is the annual cost to bring Ziri into their home?
9. What is their net income after tax and contributions?
10. If they sell the current home, what other income or savings will they have to put towards the new
home assuming Ziri has moved in with them?
11. What is their net savings after they purchase the new home?
After responding to these questions you can give Imani and Pavel a general commentary on whether
or not they should purchase the home and the reasons why or why not. What will you tell them?