Three borrowers qualify for the mortgage rates of 3.5% on a 15-year and 6.0% on

Question

Three borrowers qualify for the mortgage rates of 3.5% on a 15-year and 6.0% on a 30-year. Suppose that they can all make the payments on the loan that has higher payments. They are each buying a house for $150,000, but each of them has a different opportunity cost of capital. Based on each opportunity cost give your recommendation for the length of the mortgage. a. Smith has an outstanding credit card balance that has an interest rate of 28.99% b. Williams has no outstanding debt and invests all her money in a money market account that averages a return of 0.85% c. Brown has an investment account in equities. He has an average return of 17.5%.

Explanation / Answer

a) Smith is paying very high interest rate of 29% on its credit card. It means that he lacks funds to pay off its current outstanding debt. Hence, it is unlikely for him to pay a higher monthly payment associated with a lower duration loan. So, he should opt for 30-year rate.

b) Williams has no debt and invests his money at 0.85%. As he has surplus funds, he is likely to benefit with lower interest cost associated with 15 year loan.

c) Brown invest in risky assets like equities and earns 17.5%. Hence, he is very comfortable with his current financial situation and should borrow at lower rate with 15-year loan.

Related Questions

Navigate

• Browse (All)
• Browse T
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.