Question

Five years have passed and Jamie Lee, 34, is considering taking the plunge--not only is she engaged to be married, but she is also deciding on whether to purchase a new home.

Jamie Lee’s cupcake café is a success! It has been open for over a year now and has earned itself rave reviews in the local press and from its regular customers who just cannot get enough of her delicious varieties of cupcakes. One such customer, who stopped by on a whim in the café’s first week of business, is Ross. After a whirlwind courtship, Ross, a self-employed web designer, proposed, and Jamie Lee agreed to be his wife.

The bungalow that Jamie Lee has been renting for the past five years is too small for the soon-to-be newlyweds, so Jamie Lee and Ross have purchased a brand new three-bedroom, 2 ½ bath home in a quiet neighborhood for $280,000.

Use the provided information and the table below to calculate the affordable mortgage amount that would be suggested by a lending institution based on Jamie Lee and Ross’s income. You will need to make note of the purchase price (above) of their home for future questions.

Use the following for Jamie Lee and Ross's calculations:

10% down payment

$400 per month for estimated combined property taxes and insurance

6% interest rate for 30 years

Refer to Exhibit 9-9 for current mortgage rates

Current Financial Situation

Assets (Jamie Lee and Ross combined): Income:

Checking account $5,000 Gross income (Jamie Lee) $52,000

Savings account $55,900 Net income after taxes (Jamie Lee) $36,400

Emergency fund savings account $19,800 Gross income (Ross) $77,000

IRA balance $24,700 Net income after taxes (Ross) $65,450

Car (Jamie Lee) $12,700 Monthly Expenses (Combined):

Car (Ross) $20,700 Utilities $135

Liabilities (Combined): Food $360

Student loan balance $0 Gas/Maintenance $310

Credit card balance $0 Credit card payment $0

Car loans $8,700 Car loan payment $296

Entertainment $335

Step 1

Determine your monthly gross income (annual gross income / 12)

Step 2

With a down payment of at least 5%, lenders use 33% of monthly gross income as a guideline for PITI (principal, interest, taxes, and insurance) and 38% of monthly gross income as a guideline for PITI plus other debt payments. Enter 33% or 38% depending upon whether other debt payments are present. x

Step 3

Subtract other debt payments (such as payments on an auto loan), if applicable. -

Subtract estimated monthly costs of property taxes and homeowner's insurance. -

Affordable monthly mortgage payment

Step 4

Divide this amount by the monthly mortgage payment per $1,000 based on the current mortgage rates (see Exhibit 9-9). For example, for a 10%, 30-year loan, the number would be $8.78). /

Multiply by $1,000 x

Affordable mortgage amount

Step 5

Divide your affordable mortgage amount by 1 minus the fractional portion of your down payment (for example, 0.9 for a 10 percent down payment). /

Affordable home purchase price

Answer 1

1.Calculating  monthly gross income (annual gross income / 12)

combined annual gross income = annual gross income of Lee + annual gross income of Ross

= $52,000 + $77,000 = $129,000

= annual gross income / 12

= $129,000 / 12

= $10,750

Step 2

CalculatingWith a down payment of at least 5%, lenders use 33% of monthly gross income as a guideline for PITI (principal, interest, taxes, and insurance) and 38% of monthly gross income as a guideline for PITI plus other debt payments. Enter 33% or 38% depending upon whether other debt payments are present. x

Hence, 38% is used.

monthly gross income * 38%

= $9,583.33 * 38%

= $4,085

Step 3]

Subtract other debt payments (such as payments on an auto loan), if applicable. -Subtract estimated monthly costs of property taxes and homeowner's insurance. -

Affordable monthly mortgage payment

Monthly taxes and insurance = $400

car loan payment = $296

= $4,085 - $296 - $400

= $3,389

Step 4]

Calculating amount by the monthly mortgage payment per $1,000 based on the current mortgage rates (see Exhibit 9-9). For example, for a 10%, 30-year loan, the number would be $8.78). /

Multiply by $1,000 x

Affordable mortgage amount

Monthly mortgage payment per $1,000 based on 5% interest rate for 30 years = $5.37

($3,389 / $5.37) * $1,000

=$631.098696462 x1000

=$631,098.69

Affordable mortgage amount =$631,098.69

Step 5]

Calculating mortgage amount by 1 minus the fractional portion of your down payment (for example, 0.9 for a 10 percent down payment). /

Affordable home purchase price

Portion of down payment = 10%, or 0.10

= $531,222.84 / (1 - 0.10)

= $701,220.76

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