Question

WS 5.1 _Ch 5_FIN 333HYB

Lana and Zack Worzala were married a year ago, and they are thinking about buying a home. They have saved $10,000 to put toward the down payment, but they are wondering if they should pay off some of their consumer debt instead. Their combined gross monthly income is $5,000, and their after-tax monthly income is $4,000. They have the following debts:

	Balance Owed	APR	Monthly Minimum Payment	Number of Payments Left
Zack’s car loan	$ 2,000	6%	$340	6
Lana’s Visa	1,300	18	35
Zack’s MasterCard	4,200	21	110
Lana’s student loan	3,370	5	37	114
Zack’s student loan	10,600	6	122	114

A) What is the Worzalas’ debt payment ratio, based on their current situation?

B) Assume mortgage lenders require that the mortgage debt service ratio for a new home purchase not exceed 28 percent of gross monthly income. Given Zack and Lana’s gross income, what is the maximum mortgage debt service amount that would be allowed by a lender (including mortgage principal and interest, property taxes, and insurance)?

C) If mortgage lenders require that total debt payments not exceed 36 percent of after-tax disposable income, will Zack and Lana have any trouble meeting this requirement? Explain. (Hint: include the mortgage payment you found in B also).

D) Zack and Lana estimate that, given the prices of homes in the area and the costs of property taxes and insurance, the minimum mortgage debt service they would have to pay is $1,000 per month (including mortgage principal and interest, property taxes, and insurance). If that is the case, will they be able to get a loan with their current debt obligations, assuming that the lender’s maximum debt payment ratio is 36 percent? Should they consider applying some of their savings to debt repayment?

(Hint: what if they pay-off car loan? )

Answer 1

a)Worzalas'debt payment ratio is 12.88%

Formula used is Debt payment ratio= Monthly debt payment/ Gross monthly Income

Gross monthly income=$5000

Monthly debt payment=$644

=> 644/5000

= 12.88%

b)according to mortgage lender the mortgage service ratio should be 28% of the gross monthly income

$644 is 12.88% therefore 28% will be $1400 ((644/12.88%)*28%)

The max mortgage debt service amount =$1400-$644=$756 (Including mortgage principal and interest, property tax and insurance)

c)If the mortgate lender wants the debt service ratio should not be more tha 36% of after tax disposable income then,36% of after tax monthly income is $1440

No i don't think Zack and lana will have problem with rule of total debt payment rate more than 36% of after tax monthly payment , as this amount $1440 is more than 28% of gross montly income ie $1400. They will have extra $40 to spend as per rule.

d)IF Zack and lana have to pay $1000 considering all things like cost, insrurance etc and assuming that the lender max debt payment ratio is 36% then they will not be able to get loan with their current obligation.As their current obligation is $644 and if $1000 is charged(given in question)

then total obligation will be $1644 and debt mortgate service ratio after tax will be 41.10%(1644/4000)

and No i would not suggest them to apply some of thier saving as the debt payment ration after tax is to high ie 41.10%.

Please refer to the attached filr for steps, explantion and calculation along with formula and cell referred .