QUESTION

Fundamentals of Financial Planning (FIN 1011)

Case Study: Lam & Cara Nguyen

This case study is to develop your ability to analyze, calculate credit cost, and choose the best
credit options.  

Objectives: After completing this case study activity, you will be able to:

·        Calculate if the client will have enough fund for down payment.

·        Calculate the monthly mortgage payment and amortization period.

·        Analyze if the client is qualified for a home equity line of credit.

·        Choose the better option between mortgage and home equity line of credit.

Introduction

Lam and Cara, work for the Town of Brace bridge, with an annual gross salary of $40,000 each.
The expected annual salary increase is 2.5%. Below is a list of their assets and liabilities.

Assets:

Cash (annual rate of return 0.25%)                                                            $6,000

GICS (annual rate of return 1.5%)                                                                 5,000

CSBS (annual rate of return 2.75%)                                                              7,000

Automobiles                                                                                                 32,000

House (current)                                                                                       230,000
Liabilities:

Credit cards (18% annual rate, 3% minimum payment on balance)           $10,000

Car loans ($500 per month, three years left)                                    15,000

Current property taxes (per year) outstanding bill                                          2,400

Mortgage (contracted 2 years ago)                                                           165,000

Amortization period, 25 years

Three years left on the 7% five year mortgage term

Lam and Cara want to purchase a new house costing $320,000. They qualify for a 3-year fixed
term mortgage at 5.75% with a 20-year amortization period. Property taxes on the new house is
$3,600 per year.

The market price for their current house is $247,900, with legal fees, real estate and land transfer
fees totaling $7,500. They hope the net proceeds from the sale of the current house, will give
them at least $80,000, which would be used as a down payment for the new house.

If the net proceed is less than $80,000, they will use their cash savings to ensure that the down
payment is $80,000.

Case study instructions and questions:

1.   Will Lam and Cara have the $80,000 down payment needed from the sale of the current
residence?

2.   What is the monthly mortgage payment on the new house, assuming they have the $80,000
down payment? Will they qualify for the new mortgage loan? (Hint: include GDS and TDS
calculation)

3.   Suppose Lam and Cara have a provision in their new mortgage agreement, that allows a
mortgage renewal in three years at current rate, and then at five years, by making a payment of
$20,000 three years from today and $25,000 eight years from today. If the monthly payment
remains the same, how long will it take them to pay off the new mortgage?

4.   Lam and Cara is considering another alternative. Instead of buying a new house, they should
get a home equity line of credit for $55,000, which has 4% interest and a minimum monthly
payment that is twice the interest payment. The $55,000 will be use to purchase a condominium
that will have a conventional mortgage. Would they be qualified for the home equity line of
credit? What would be the maximum purchase price for the condominium (ignore legal and real
estate fees)? 
ANSWER

Question 1.

No. Lam and Cara will not have the $80,000 down payment needed from the sale of the new

house. This is because:

Income generated from the sale of the house:

Income = Market price of the house - legal fees - outstanding mortgage - outstanding property

tax

Income = 247,900 - 7,500 - 165,000 - 2,400 = 73,000

Income = $73,000.

The income generated from the house sale is $73,000 which is less than the $80,000 down

payment required.

Question 2

GDS = Annual mortgage expenses/Annual Income

Annual gross salary = $ 40,000 each

Annual gross salary for both = $80,000

Annual mortgage expenses = Fixed term mortgage + mortgage annual payment + property tax

Fixed-term mortgage = 5.75%(every 3 years)

Fixed-term mortgage = (0.0575 * 240,000)/3 = 4,600.00

Mortgage annual payment = (320,000 - 80,000 down payment)/20 years = $12,000

Property tax - $3600 per year

Annual mortgage expenses = 4600 + $12,000 + 3600 = $20200

GDS = 20,200/80,000 = 25.25%

TDS = (Annual Mortgage payments + property tax + other debts) / gross total income

Other debts - car loan + credit card

Other debts - 6000 + 11800

Other debts = 17,800

TDS = (12,000 + 3600 + 17800)/80,000

TDS = 41.75%

The monthly mortgage payment of the house is 12000/12 = 1000 excluding interest rates and

(4600/12 = 383.33 + 1000) = 1383.22 including interest rates.

They will qualify for their new mortgage loan because the TDS ratio is below 43% and the GDS

is lower than 28% which is necessary to obtain a mortgage loan.

Question 3

The total payment for the 1st 3 years will be = mortgage payment + interest

= (12000*3) + (0.0575*240,000)

=$49,800 + 20,000 = $69,800

Payment for the next 5 years (after the 3 years above)

= (12,000 * 5) + (0.0575 * 240,000)

= $60,000 + 13800

=$73,800 + 25,000

= $87,600

Total payment after 8 years = 87600 + 69800 = $ 157,400

Expected payment after 20 years was = 240,000 + (0.0575*240*6 times)

=$322,800

Unpaid mortgage = 165,400

12000* p + ((0.0575*240,000*p years)/3) = 165,400

12000p + 4600p = 165,400

16600p = 165400

p = 9.96 years

They would have paid off the mortgage in the next 10 years.

Totaling to 10 +8 = 18 years of mortgage payment.

Answer = 18 years in total

Question 4

Would Lam and Cara be qualified for the home equity line of credit?

Equity of Home = Value of Home - Mortgage balance

Equity of Home = $247,900 - $165,000

Equity of Home = $82,900

Loan-to-value = (82,900 / 165,000) * 100

Loan-to-value = 50.24%

Lam and Cara will qualify for the loan since many lenders allow up to 80% of loan to value.

Maximum purchase price:

Maximum available borrowing amount = (Current home value) * 80% - mortgage balance

Maximum available borrowing amount = 247,900 * 0.8 - 165,000

Maximum available borrowing amount = 33,320

Maximum purchase price for the condominium = $33,320