CIC3020 CASES IN FINANCE (SEM 2, SESSION 2020/2021)

Presenters: GROUP 1, TEAM 2 Siew Min Ann 17116250 Vinie Ng 17077230 Sau Jean Ying 17122710 Kartik A/L Kunasegaran 17156508

Case 3: Paying Off That Dream House

Loan Amortization

Lecturer: Dr Rozaimah Zainudin

Story Line

Mortgage

Economic Condition

Refinancing Decision

A couple: Jacqueline & Keith Sommers Decided to buy a two-story house in Midwest Price: $ 300,000

Decided to refinance their mortgage at a 2.75%, 15-year rate To reduce financing cost

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5 Years Ago

Current

Background

2 options: 30-year, 6.75% (Lower monthly payment) 15-year, 5.25% Downpayment: 20%

Worsening Mortgage rate had come down significantly

Question 1

What is Jacqueline & Keith’s monthly mortgage payment prior to the refinancing?

PMT

I

N

PV

$240,000.00

30 years x 12 mths = 360

6.75% / 12 mths = 0.5625%

$1,556.64

Question 2

The total payment paid in the first 5 years which includes the down payment made and the PMT paid for the first 5 years is $153,398.40

During the first five years of owning their dream house, how much money has the couple paid towards the mortgage? What proportion of this has been applied towards interest ?

30-year at 6.75% First 5 years

The proportion of interest paid in the first 5 years is 84.26%

Question 3

Difference between the monthly payment of 15-year at 5.25% and 30-year at 6.75% = $1,929.31 - $ 1,556.64 = $372.67

Monthly payment of 15-year at 5.25% is higher by $372.67

Had the couple opted for the original 15-year mortgage proposal (15 years, 5.25%), how much higher would their monthly payment have been?

15-year at 5.25%

30-year at 6.75%

How much of total interest would have been paid over the life of the loan?

15-years at 5.25%

30-years at 6.75%

Question 4

Total interest payments = $107,275.17

Total interest payments = $320,388.76

Total interest paid on 30-year, 6.75% mortgage is almost 3 times more than total interest paid on 15-year, 5.25% mortgage.

Question 4 (cont'd)

Tax shelter loss is $5,549.43

If the Sommers had chosen the original 15-year, 5.25% mortgage proposal, how much tax shelter would they have lost (over the last 5 years) as compared to the 30-year, 6.75% mortgage?

Question 5

*Assume Tax Rate is 24% (Source: IRS, 2021)

The excess available equity due to refinancing is $94,198.30

If the house currently worth $355,000 and most lenders are willing to lend up to 90% of home value, how much excess equity can sommers cash out?

Question 6

No,they should not cash out the excess equity as the yield after tax < cost of fund after tax However this case can be changed if they could invest in a risk free investment that yields more than 2.09% after tax.

Should Jacqueline and Keith cash out the excess equity that they have built up? Assume money market rates are 2.15%

Question 7

*Assume Tax Rate is 24% (Source: IRS, 2021)

$216,074.19

Initial monthly payment

If the Sommers had increased each payment by one-twelfth (since the beginning of the loan), what would their current loan balance amount to?

Question 8

= $1,556.64

New monthly payment

= $1,556.64 x (13/12) = $1,686.36

Current Loan Balance

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Construct Amortization Schedule using new monthly payment

Question 9

Using the assumption in question 8 , how many total years would it take for the Sommers to pay off the existing loan ? Demonstrate your answer with an amortization schedule.

Number of month = 288 months

Number of year = 288/ 12 = 24 years

With assumption in question 8, It takes 24 years for the couple to pay off the existing loan

Question 10

Should Jacqueline and Keith close the 2.75%, 15-year mortgage? Explain your answer with suitable calculations.

Without Refinance Refinance PMT $1,556.64 $2,168.20 Year of Installment 25 15 Annual Interest Rate 6.75% 2.75% Total Interest Paid $320,388.76 $70,775.30 Tax Shield $76,893.30 $16,986.07

Without Refinance

PV = $240k N = 30 x 12 I = 6.75% / 12

PV = $319k N = 15 x 12 I = 2.75% / 12

Refinance

Nominal PV Interest Saved $249,613.45 $166,027.34 Loss in Tax Shield $59,907.23 $49,953.89 Difference $189,706.22 $116,073.45

Couple should refinance their mortgage loan @ 2.75% for 15 years