eBook Chapter 5 Critical Thinking Case 3 Sophia\'s Rent-or-Buy Decision Sophia H

Question

eBook Chapter 5 Critical Thinking Case 3 Sophia's Rent-or-Buy Decision Sophia Harris is a single woman in her late 20s. She is renting an apartment in the fashionable part of town for $1,100 a month. After much thought, she's seriously considering buying a condominium for $175,000. She intends to put 20 percent down and expects that closing costs will amount to another $5,000; a commercial bank has agreed to lend her money at the fixed rate of 6 percent on a 15-year mortgage. Sophia wouid have to pay an annual condominium owner's insurance premium of $560 and property taxes of $1,100 a year (she's now paying renter's insurance of $550 per year). In addition, she estimates that annual maintenance expenses will be about 0.5 percent of the price of the condo (which incluces a $30 monthly fee to the property owners' association). Sophia's Income puts her in the 25 percent tax bracket (she itemizes her deductions on her tax retums), and she earns an after-tax rate of return on her investments of around 4 percent 1. Given the information provided, use Worksheet 5.2 to evaluate and compare Sophia's aternatives of remaining in the apartment or purchasing the condo. Round the answers to the nearest dolar. (Note: Assume Sophia's security deposit is equal to one month's rent.) Round your answers to the nearest cent Annual ownership cost Annual rental cost 13750 2. Working with a friend whe is a realtor, Sophia has learned that condos like the one shes thinking of buying are appreciating in value at the rate of 3.5 percent a year and are expected to continue doing so. Would such information affect the rent-or-buy decision made in Question 12

Explanation / Answer

Soln : Step 1 : Calculate the rent on yearly basis = 1100 *12 + 550 = 13200+550 = 13750

Step 2 : Cost of condo = $175000, down payment = 20%*175000 = 35000

Loan amount = 175000 - 35000 = 140000

EMI of the loan at 6% interest and 15 year mortgage = pmt(6%,15,-140000,0) = 14414.80 = 14415

Also, rent is not tax deducted, but interest on housing loan and property taxes are coming as tax deductibles. She comes under 25% of tax bracket means , savings of tax = 25%*(8400+1100) = 2375

Interest on yearly basis = 6% of 140000 = 8400 and loan principal = 14415 - 8400 = 6015

Please refer table :

EMI 14415 Annual condo owner insurance 560 Prperty taxes 1100 Annual maintenance 875 After tax cost of downpayment and closing cost 1600 Total 18550 Deductions Tax savings (for interest payment and poperty taxes @ 25% 2375 Principal reduction in loan balance 6015.00 Net ownership cost 10160.00

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