A prospective homeowner wants to determine how much she can borrow in the form of a fixed-rate 20-year mortgage. Mortgages of that maturity carry a fixed interest rate of 9.00%. She estimates that she can afford annual pre-tax payments (interest plus principal) on her mortgage of $25,000 (for simplicity assumes that mortgage payments are made once a year at the end of the year).
A. How large a mortgage can she afford, assuming she makes steady payments of $25,000 per year for 20 years? How much total interest will be paid over the 20 year life of the mortgage? How much interest will be paid during the first year of the mortgage? How much principal will be repaid in the first year? How much of the final $25,000 payment at the end of 20 years will be interest and how much will be principal?
B. Suppose the prospective home owner expects her income to grow such that she could afford $25,000 per year of total debt service in the first five years of a 20 year mortgage, $30,000 per year in the second five years, $35,000 in the third five years, and $40,000 in the last five years. How large a mortgage at 9% could she afford under these circumstances?