Economic Analysis Team Project

1
Economic Analysis Team Project

• TEAM 3

Home Financing Options
2
Team Members

• From left to right
• Jason de la Guerra Organizer
• Michael Jauregui Summarizer
• Jerry Lessley Techie
• Kevin Navares Techie

3
The Big Questions???

• Youre in the market to purchase a home.
• What type of loan should you choose?
• What is the difference between an FRM and an
  ARM?

4
Definitions

• FRM
• (Fixed Rate Mortgage)
• Rate is constant for 30 years
• Current Rate 5.36

• ARM
• (Adjustable Rate Mortgage)
• Fixed rate for 7 yrs then indexed for 23 years
• Fixed rate 4.36
• Adjustable rate index of 2.25 3.0

Both require a FICO score of 700 or above
5
Analysis Assumptions

• Loan amount of 400,000
• Down payments are equal to 10 of loan
• Payment is based on a 30 year term
• Options of selling at 7 and 10 years
• Average tax benefit of 28
• All rates are based on current market values and
  historical trends

6
Future Value

• Assuming a Conservative California Average growth
  of 10
• FV of a 400,000 would be 716,339.08 in 10 years
• FV of a 400,000 would be 601,452.10 in 7 years
• Combined with monthly payments and our initial
  down payment the amount owed at the end of 10
  years would be
• FRM 296,646 ARM 273,871
• For 7 year FRM 113,181 ARM 124,120

7
Benefit Cost Ratio

• The most beneficial option will have the highest
  ratio.
• B/C (sale benefit tax benefit) / (down
  payment total of amount paid)
• 10 yr FRM B/C (31633961280)/(40000241503)
  1.34
• 10 yr ARM B/C (31633958531)/(40000241503)
  1.33
• 7 yr FRM B/C (20145248271)/(40000169052)
  1.19
• 7 yr ARM B/C (20145237332)/(40000169052)
  1.14

8
Rate Of Return
FRM Interest 5.36 Arm Interest
4.36,5.51,6.66,7.81
ROR based on initial down payment of 40,000 less
our annual tax benefit and equity earned at
sale of the home FRM ARM ROR at 10
years 31 30 ROR at 7 years 36 35
9
Principal vs. Interest Contribution
Principal and interest sum total yearly payment
of 24,150 for both FRM and ARM
10
Fixed Rate Mortgage (FRM) Benefits

• Predictable cash flows for term of loan
• Higher tax benefits
• The rate of return after 10 years with no sale is
  higher.
• Greater investment return at 7 year sale
• Higher profit than ARM after 10 year sale.

11
Adjustable Rate Mortgage (ARM) Benefits

• Initial interest rate is lower than FRM
• Interest rate paid will generally decrease as
  prevailing interest go down.
• Typically offer lower down payment option
• Generally easier qualification criteria
• Competitive ARM market coupled with low rates
  increase affordability.

12
Conclusions

• FRM overall better alternative given analysis
  assumptions
• Long term home-owners receive greater benefit
  form FRM
• Assuming the same FRM and ARM payment the FRM has
  greater return on investment.
• Short Term home-owners benefit from ARM due to
  lower initial costs and higher payments to
  principle.
• Current market provides ARM advantage through
  affordability and competitive markets

13
Resources

• www.myfico.com
• www.cnnmoney.com
• www.hud.gov
• www.lendingexpo.net
• D. Newnan, J. Lavelle, and T. Eschenbach. (2002).
  Essentials of Engineering Economic Analysis
  Oxford University Press, Oxford, NY.