DOWN PAYMENT
(Phillip Storms) A perplexing analysis concerns how much to put down on a
loan, how much to pay per month and what are the ways to determine which
might be best. An example shows how to do the analysis.
Assume a purchase of a $110,000 home, down payment of 5%- $5,000, loan of $108,990 (3.8% insurance), payments of $883 per month (8.5% + $45) and a balance of $96,568 at the end of 10 years.
Second alternative of 10% down- $11,000, loan of $101,178 (includes insurance
of 2.2%), payments of $778 per month (8.5%) and a balance of $89,646 at the
end of 10 years.
Third alternative of 20% down- $22,000, loan of $88,000, payments of $677
per month (8.5%) and balance of $77,970 at the end of 10 years.
Loan 1 Loan 2 Loan 1- 2
Down $5,000 $11,000 -$6,000
Monthly 883 778 105
10 year 96,568 89,646 6,922
By using an HP 12c with PV of $6,000, PMT = $105, FV = 6,922 and N = 120,
the investment of an additional $6,000 of higher down equates to a 21.45%
annual return.
Loan 2 Loan 3 Loan 2- 3
Down $11,000 $22,000 -$11,000
Monthly 778 677 101
10 year 89,646 77,970 11,676
The return on the extra $11,000 down equates to a 11.35% annual return. Assuming
the homeowner could do this (requires separate analysis in itself) it certainly
appears to be worthwhile to put more down- particularly at the lower end
of the scale.
REFINANCE: This same method can be used to determine if a refinance is
financially worthwhile. Assume:
Current loan $200,000
Interest rate 9.875%
Remaining term 29.5 years
Estimated occupancy 8 more years
Monthly payment $1,742
Balance in 8 years $186,087
New Loan $200,000
Interest rate 9.125%
Term 30 years
Occupancy 8 more years
Monthly Payment $1,627
Refinancing costs $1,400
Balance in 8 years $185,033
The homeowner is making a $1,400 investment to save $114 and have an increased
equity of $1,054 at the end of eight years. By using the same calculations,
the effective interest rate on the investment is 97.7% per year- obviously
a wise decision. But you have to reasonably "know" how long you intend to
live in the house- otherwise the calculations are invalid.
POINTS: This same scenario can be used for points on a loan.
Option 1 Option 2 Opt. 1- 2
8.5% 8.25+1pt
Cash $22,000 $22,880 $880
Monthly 677 661 16
10 years 77,970 77,570 380
The client invests $880 per month for a $16 per month reduction in mortgage
payments and $380 additional equity at the end of 120 payments.
Using PV= - $880, N= 120, PMT= 16 and
FV= 380, i= a 20.01% annual return.
Under the conditions stated, paying an extra $880 is worthwhile due to the high return produced over 10 years.