Problem 1:James Hunt's Dream Apartment

Part 1

James Hunt currently earns a yearly salary of $100,000 (paid on a monthly basis at the end of each month) and his average income tax rate is 25% (taxes are withheld by the employer from theemployee'sgross monthly pay). He wishes to buy an apartment in Boston. He can obtain from his bank a 30-year fixed rate mortgage loan at a nominal interest rate of 4.75% per annum, with equal monthly payments paid at the end of each month.

James also has accumulated $150,000 in savings, which he holds in a separate bank account.

He figures that all other housing-related expenses (e.g., condominium fees, utilities, insurance, and property taxes) should come up to a total of about $500/month (assume that these expenses are all paid at the end of each month).

As he is trying to figure out how much he can afford to pay for the apartment of his dreams, he suddenly remembers the advice his mother once gave him:

-Do not spend more than 1/3 of your monthly disposable take-home pay on housing costs (mortgage and all other housing-related expenses); and,

-Alwayskeepaminimumof$50,000availableatalltimesinyoursavingsaccount,incaseofan emergency.

Given all the information above, and if hefollows his mother's advice, what is the maximum price that James can afford to pay for the apartment?

Part 2

Four years after having purchased the apartment, James learns that mortgage interest rates havesubstantially declined due to the recession and to the Federal Reserve Bank's aggressive expansionarymonetary policy. He currently still owes $283,333 on his loan principal.

The 30-year mortgage interest rate is now at 4% and a 15-year rate at 3.50%. In addition, his annual salary base is now $125,000, as a result of a recent promotion, and his savings account was partially replenished and now stands at $80,000.

Rather than lowering his monthly mortgage payments, James is more interested in shortening the maturity of his mortgage, so as to save a substantial amount of future interest payments. As a result, he wishes to switch from a 30-year to a 15 year mortgage at 3.50%.

Assume that his average tax rate is now 30% , that housing-related costs are now $600 instead of $500, and that the closing costs (legal and processing fees to modify the mortgage) are approximately $5,000, payable at closing (when the new loan is approved).

Assuming that James continues to strictlyfollow his Mom's recommendations,

a) How much of the existing loan principal would he have to repay upfront before setting up the new loan? (Include the closing costs to the amount

b)What is the total amount of money that he would save over the entire duration of the loan if he were to refinance it (i.e., switch to the 15-year mortgage loan mentioned above)?

c)Can he afford to refinance his loan, all things considered? Should he do it? Explain.

(Important: Please be as detailed and as clear as possible. You need to walk me through your step-by- step process on how you get to the final answers. You will be graded on that basis. Giving me just a final answer without a clear explanation, even if correct, will not be worth any credit. As I mentioned in class,"pretend that you are explaining this to your grandmother!")

Also, please round all calculated dollar amounts to the nearest dollar, and all calculated interest rates to 4 decimal points- 4 digits after the point).