S&S Air’s Mortgage
Mark Sexton and Todd Story, the owners of S&S Air, Inc.,
were impressed by the work Chris had done on finan- cial
planning. Using Chris’s analysis, and looking at the de- mand
for light aircraft, they have decided that their existing
fabrication equipment is sufficient, but it is time to acquire a
bigger manufacturing facility. Mark and Todd have identi- fied a
suitable structure that is currently for sale, and they believe
they can buy and refurbish it for about $35 million. Mark, Todd,
and Chris are now ready to meet with Christie Vaughan, the loan
officer for First United National Bank. The meeting is to discuss
the mortgage options available to the company to finance the new
facility. Christie begins the meeting by discussing a 30-year
mortgage. The loan would be repaid in equal monthly installments.
Because of the previous relationship be- tween S&S Air and the
bank, there would be no closing costs for the loan. Christie states
that the APR of the loan would be 6.1 percent. Todd asks if a
shorter mort- gage loan is available. Christie says that the bank
does have a 20-year mortgage available at the same APR. Mark
decides to ask Christie about a “smart loan” he discussed with a
mortgage broker when he was refinanc- ing his home loan. A smart
loan works as follows: Every two weeks a mortgage payment is made
that is exactly one-half of the traditional monthly mortgage
payment. Christie informs him that the bank does have smart loans.
The APR of the smart loan would be the same as the APR of the
traditional loan. Mark nods his head. He then states this is the
best mortgage option available to the company because it saves
interest payments.
Christie agrees with Mark, but then suggests that a bullet
loan, or balloon payment, would result in the greatest interest
savings. At Todd’s prompting, she goes on to explain a bullet loan.
The monthly payments of a bullet loan would be calculated using a
30-year traditional mortgage. In this case, there would be a 5-year
bullet. This means that the company would make the mortgage
payments for the traditional 30-year mortgage for the first five
years, but immedi- ately after the company makes the 60th payment,
the bullet payment would be due. The bullet payment is the
remaining principal of the loan. Chris then asks how the bullet
payment is calculated. Christie tells him that the remaining
principal can be calculated using an amortization table, but it is
also the present value of the remaining 25 years of mortgage
payments for the 30-year mortgage.
Todd has also heard of an interest-only loan and asks if this
loan is available and what the terms would be. Christie says that
the bank offers an interest-only loan with a term of 10 years and
an APR of 3.5 percent. She goes on to further explain the terms.
The company would be re- sponsible for making interest payments
each month on the amount borrowed. No principal payments are
required. At the end of the 10-year term, the company would repay
the $35 million. However, the company can make principal payments
at any time. The principal payments would work just like those on a
traditional mortgage. Principal pay- ments would reduce the
principal of the loan and reduce the interest due on the next
payment.
Mark and Todd are satisfied with Christie’s answers, but they
are still unsure of which loan they should choose. They have asked
Chris to answer the following questions to help them choose the
correct mortgage.
QUESTIONS:
1. What are the monthly payments for a 30-year tra- ditional
mortgage? What are the payments for a 20-year traditional
mortgage?
2. Prepare an amortization table for the first six months of
the traditional 30-year mortgage. How much of the first payment
goes toward principal?
3. How long would it take for S&S Air to pay off the smart
loan assuming 30-year traditional mortgage payments? Why is this
shorter than the time needed to pay off the traditional mortgage?
How much interest would the company save?
4. Assume S&S Air takes out a bullet loan under the terms
described. What are the payments on the loan?
5. What are the payments for the interest-only loan?
6. Which mortgage is the best for the company? Are there any
potential risks in this action?