Eric decided that now that home prices are finally falling it’s time to buy his first home. A so-so house in Pomona costs about $500,000. A decent house in Fullerton costs about $700,000. A nice house in Diamond Bar costs about $900,000. To buy a house Eric would need to pay a 20% downpayment from his savings – the amount he already has – and for the remaining amount he will take a mortgage loan. The loan will require fixed payments at the end of each month. He has calculated that with his current job he will be able to spend not more than $3,500 per month on the loan payments.
If the annual mortgage rate on a 20-year loan is 6% (compounded monthly), which one of the three homes would Eric be able to afford? Calculate and explain.
Would the answer change if the mortgage loan was instead for 30 years? Calculate and explain in words all calculations.