Buying a First Home: Case Study - Essay Example

Buying a First Home: Case Study Fred and Wilma are both aged 35 years and have a total of five children. Both will retire at the age of 62 and their life expectancy is 90 years. Fred earns a total of $125,000 as an employee which increases with 4% until his retirement. Wilma earns a total of $15,000 as a self employed tutor, with 3% increases until January 2015 when her income will increase to $26,000 followed by 3% increase until she retires. a. Buying a First Home (Using conventional standards) How much one can afford in terms of a mortgage is based on his or her debt profile and income. Prequalification for a mortgage is usually intended to give the buyers an idea of how much they can borrow in terms of the mortgage. Fred and Wilma deferred their Dream Home plans and wishes to buy their First Home. They have assumed a property tax of 1% of the purchase price of the home, annual insurance premium of $1,000 and 3% depreciation of the property. Mortgage lenders do no usually look at the home buyer’s incomes, down payment or assets. They usually look at obligations and liabilities like credit card debts, child support payments, auto loans, overall credit rating, insurance premiums and potential property taxes. Wilma, Fred’s wife is self employed. To qualify for a mortgage, she should provide a 24 month history of her salary. Their credit score is 780 which are above the recommended one of 720 and hence they conform to the requirements. The biggest emphasis of credit score is given to the last 12 months. To qualify for a mortgage, it is also important to provide information about any mortgage history, credit cards and installment loans. Combined gross income for 2011 Federal Wages   Quarry $125,000 401(k) -3,600 Interest   Bedrock Bank 500 Self-Employment   Income 20,000 Expenses -5,000 Self-Employment Adjustment -921   Adjusted Gross Income 135,979 Fred contributes 6% of his salary to 401(k) which is $3,600 School loans calculated using loan repayment method i) Opening date: 6/01/2010 ii) Original loan balance: $100,000 iii) Loan length: 10 years (monthly) iv) Interest rate: 8.0% Solving for the middle part 0.00666666 + ((1.00666666^120)-1) x 100,000 = (0.00666666)/ ((1.00666666^120)-1) = (0.00666666)/ (2.219640058-1) =0.005466093505 Put into the remaining equation: = (0.0066666666 + 0.005466093505) x 100,000 Monthly pay= $1, 213.28 Annual loan repayment will be $14,559.30 Car loans v) Original loan balance: $30,000 vi) Loan length: 5 years (monthly) vii) Interest rate: 5.0% viii) Current value of cars: $20,000 Monthly payments Monthly auto loan payment is $608.29 which translates to $7,299.48 per year. Expenses: Living expenses $68,000 per year and $5,666.7 per month Special expenses $20,000 per year and $1,666.7 per month Income and debt obligations of Fred and Wilma To arrive at the affordable home for Fred and Wilma, we have allowed a total debt to income ratio of 36 percent. A payment to income ratio of 28% has also been allowed. We have also assumed that Fred and Wilma will put a down payment amount of $2000 and annual property taxes of $200. Gross annual income 135,979 Down payment 2,000 Monthly debt 9,154.97 Mortgage rate 3% Annual property taxes 200 Annual home owner insurance 1,000 With these values, a home affordability calculator was used and the following are the results: Conservative Aggressive Minimum price of the house $1,225,598.64 1,171,843.26 Loan amount 1,227,598.64 1,173,843.26 Monthly payment of mortgage 5,176.40 4,949.03 Home owner payment/taxes 100 100 Total monthly payment 5,076.40 4,849.03 a. How much is needed to save in order to send Pebbles and Bentley To determine what one wants in education planning, one should know the number of children, how old the children are, when they will be attending school and how many years the children will take in preparatory, high school, college, graduate, the cost of education and which schools they will attend. The five children/pebbles will start college at the age of 18 and will spend four years living at Bentley University. School Loans i) Opening date: 6/01/2010 ii) Original loan balance: $100,000 iii) Loan length: 10 years (monthly) iv) Interest rate: 8.0% v) College: b) Starts at age 18 c) 4 years living at Bentley University d) 6% inflation e) No student contribution In determining how much Fred and Wilma need to save for the education of their children, we will assume that the children will require a room and meals since they will be living away from home. We will also assume that Fred and Wilma will start saving in 2013 and we will also assume the years in which they were born. Saving for the first 4 children Source: http://www.getsmarteraboutmoney.ca/tools-and-calculators/resp-calculator/#.UUyQajcXY7A The above table shows the assumed names of the first four children and their assumed year of birth. The children are expected to attend Bentley University in Massachusetts. A 6% inflation rate will be used to determine the percentage by which the costs of education will be rising each year due to tuition and inflation increases and to calculate how much is needed to be saved. The family income after taxes, the year when they plan to start saving, total amount saved so far and the inflation rate are relevant in this regard. Using the above information, Fred and Wilma will need to save an estimated amount of $14,645 each year in order to cater to the entire education process of their four children. This amount of savings includes the 6% inflation rate in which cost of education is expected to rise. Source: http://www.getsmarteraboutmoney.ca/tools-and-calculators/resp-calculator/#.UUyQajcXY7A The total cost of the education of the four children will be $262,396.61 This cost is inclusive of costs of transportation, supplies, purchase of books and entertainment or personal costs. The rise in cost per each year 6% Income of the family after taxes above 74,357 Year when saving begins 2013 Total amount saved so far $0 Rise in savings in each year 6% Yearly Investment Required $14,645.00 Year Child Cost of post-secondary studies How much you need to invest each year' Government grants What you may make investing Total you have saved in your child's RESP 1 2 3 4 2013 15 13 10 8 $0.00 $14,645.00 $2,000.00 $998.70 $17,643.70 2014 16 14 11 9 $0.00 $14,645.00 $2,000.00 $2,057.32 $36,346.02 2015 17 15 12 10 $0.00 $14,645.00 $2,000.00 $3,179.46 $56,170.48 2016 18 16 13 11 $12,998.75 $14,645.00 $1,500.00 $4,338.93 $63,655.66 2017 19 17 14 12 $13,778.67 $14,645.00 $1,500.00 $4,788.04 $70,810.03 2018 20 18 15 13 $29,210.79 $14,645.00 $1,000.00 $5,187.30 $62,431.54 2019 21 19 16 14 $30,963.44 $14,645.00 $1,000.00 $4,684.59 $51,797.70 2020 22 20 17 15 $16,410.62 $14,645.00 $1,000.00 $4,046.56 $55,078.64 2021 23 21 18 16 $34,790.52 $14,645.00 $500.00 $4,213.42 $39,646.55 2022 24 22 19 17 $18,438.97 $14,645.00 $500.00 $3,287.49 $39,640.06 2023 25 23 20 18 $34,527.54 $14,645.00 $0.00 $3,257.10 $23,014.63 2024 26 24 21 19 $36,599.20 $14,645.00 $0.00 $2,259.58 $3,320.01 2025 27 25 22 20 $16,834.04 $14,645.00 $0.00 $1,077.90 $2,208.87 2026 28 26 23 21 $17,844.08 $14,645.00 $0.00 $1,011.23 $21.03 Saving for the last child Holding all the above assumptions, the parents will be required to save an estimated amount of $3,430 per year for the child and this includes the 6% increase in the cost of education and inflation. Source: http://www.getsmarteraboutmoney.ca/tools-and-calculators/resp-calculator/#.UUyl_zcXY7A Total cost of the child’s education $96,071.43 This cost is inclusive of costs of transportation, supplies, purchase of books and entertainment or personal costs. Rise in education cost per year 6% Family income taxes less $37,178 This amount is estimated after the education of the other four children is paid for. Year when saving will begin 2013 No amount has been saved so far towards the child’s education Savings towards the child’s education will increase by 6% per year. Yearly Investment Required $3,430.00 Year Child Cost of post-secondary studies How much you need to invest each year' Government grants What you may make investing Total you have saved in your child's RESP 5 2013 6 $0.00 $3,430.00 $500.00 $235.80 $4,165.80 2014 7 $0.00 $3,430.00 $500.00 $485.75 $8,581.55 2015 8 $0.00 $3,430.00 $500.00 $750.69 $13,262.24 2016 9 $0.00 $3,430.00 $500.00 $1,031.53 $18,223.78 2017 10 $0.00 $3,430.00 $500.00 $1,329.23 $23,483.00 2018 11 $0.00 $3,430.00 $500.00 $1,644.78 $29,057.78 2019 12 $0.00 $3,430.00 $500.00 $1,979.27 $34,967.05 2020 13 $0.00 $3,430.00 $500.00 $2,333.82 $41,230.87 2021 14 $0.00 $3,430.00 $500.00 $2,709.65 $47,870.52 2022 15 $0.00 $3,430.00 $500.00 $3,108.03 $54,908.56 2023 16 $0.00 $3,430.00 $500.00 $3,530.31 $62,368.87 2024 17 $0.00 $3,430.00 $500.00 $3,977.93 $70,276.80 2025 18 $21,961.11 $3,430.00 $0.00 $4,422.41 $56,168.10 2026 19 $23,278.78 $3,430.00 $0.00 $3,575.89 $39,895.20 2027 20 $24,675.51 $3,430.00 $0.00 $2,599.51 $21,249.21 2028 21 $26,156.04 $3,430.00 $0.00 $1,480.75 $3.93 c. The allocation targets for their investable assets Assets: a. (J) Checking Account, Taxable, Money Market, $50,000. b. (H) 401(k), Tax Deferred, Employee portion (fully vested), Money Market, $39,000. c. (H) 401(k), Tax Deferred, Company portion (fully vested), Money Market, $52,000. d. (W) IRA, Tax Deferred, Money Market, $9,000. Investment Returns: e. Pre-retirement return:7.0% f. Worst case risk level :( 7.9%) (2 Standard Deviations) d. Planning recommendations and advice i) House purchase ii) Debt management iii) Educational funding iv) Investment Allocation Read More