You want to buy a house that costs $100,000. You have $10,000 for a down payment, but your credit is such that mortgage companies will not lend you the required $90,000. However, the realtor persuades the seller to take a $90,000 mortgage (called a seller take-back mortgage) at a rate of 7%, provided the loan is paid off in full in 3 years. You expect to inherit $100,000 in 3 years, but right now all you have is $10,000, and you can only afford to make payments of no more than $7,500 per year given your salary. (The loan would really call for monthly payments, but assume end-of-year annual payments to simplify things.)
A) If the loan amortized over 3 years, how large would each annual payment be? Could you afford those payments?
B) If the loan were amortized over 30 years, what would each payment be? Could you afford those payments?
C) To satisfy the seller, the 30-year mortgage loan would be written as a balloon note, which means that at the end of the 3rd year you would have to make the regular payment plus the remaining balance on the loan.What would the loan balance be at the end of Year 3, and what would the balloon payment be?