Q1) Kim and Dan Bergholt are both government workers. They are thinking of buying a home in Washington D.C. area for about $280,000. They evaluate monthly expenses for utilities at $220, maintenance at $100, property taxes at $380, and home insurance payments at $50. Their only debt comprises of car loans requiring a monthly payment of $350.
Kim's gross income is= $55,000/year and Dan's is $38,000/year. They have saved about $60,000 in money market fund on which they earned $5,840 last year. They plan to use most of this for 20% down payment and closing costs. Lender is offering 30-year variable rate loans with the initial interest rate of 8% given 20% down payment and closing costs equal to $1,000 plus 3 points.
Before making purchase offer and applying for this loan, they would like to have some idea whether they might qualify.
Real estate agent tells Bergholts that if they do not care to buy, they might consider renting. Rental option would cost $1,400/month plus utilities evaluated at $220 and renter's insurance of $25/month. Bergholts believe that neither of them is probable to be transferred to another location within next five years. After that, Dan perceives that he might move out of government service into private sector. Suppose they remain in same place for the next five years, the Bergholts would like to know if it is better to buy or rent the home. They expect that price of housing and rents will rise at annual rate of 3% over next five years. They expect to earn annual rate of 5% on money market fund. All other prices, comprising utilities, maintenance, and taxes are expected to increase at 3% annual rate. After federal, state, and local taxes, they get to keep only 55% of marginal dollar of earnings.
Evaluate whether it is financially more attractive for Bergholts to rent or to purchase home over five-year holding period. (Suppose contract interest rate of 8%, monthly interest payments over five-year period would total $87,574.)