List
the Pros and Cons in the table below for each of the two different
investment strategies taken by the Thomas and Jefferson families. It is
beneficial to point out the advantages of refinance opportunities that
offer lower APRs, rather than merely paying extra amounts on an original
mortgage over the term of the loan.
Procedure:
In
our brief case study, we assume the Thomas and Jefferson families have
identical mortgages (30-year term, fixed-rate 6% APR, and a loan amount
of $175,000). The Thomas family will not pay extra but the Jefferson
will. Follow the steps below prior to your analysis.
1.
Using the Payment mini calculator of the Financial Toolboxes
spreadsheet, calculate the mortgage payment (the same for both
families).
2.
Assume that the Thomas will make only the required mortgage payment.
The Jeffersons, however, would like to pay off their loan early. They
decide to make the equivalent of an extra payment each year by adding an
extra 1/12 of the payment to the required amount. Complete the
following calculations to find what they plan to pay each month:
(a) 1/12 of the required monthly payment
(b) By adding this 1/12 to the required payments, the Jefferson’s plan to pay:
3.
The Thomas will take the full 30 years to pay off their loan, since
they are making only the required payments. The Jefferson’s extra
payment amount, on the other hand, will allow them to pay off their loan
more rapidly. Use the Years mini financial calculator of the Financial
Toolbox spreadsheet to calculate the approximate number of years
(nearest 10th) it would take the Jefferson’s to pay off their loan.
For the Thomas Family:
Assume that they could afford to make the same extra payments as the
Jeffersons, but instead they decide to put that money (#2a. from
Procedures above) into a savings plan called an annuity. Use the Future
Value mini financial calculator of the Financial Toolbox spreadsheet to
calculate how much they will have in their savings plan at the end of 30
years at the various interest rates. Write your answers (to the nearest
dollar) in the appropriate cells of the table below.
For the Jefferson Family
: Assume that they save nothing until their loan is paid off, but then
after their debt is paid, they start putting their monthly payment and
1/12 (#2b. from Procedures above) into a saving plan. The time in months
they invest is equal to 360 months minus the number of months needed to
pay off the loan (#3 from Procedures above) multiplied by 12. Use the
Future Value mini financial calculator to calculate how much they will
have in their savings plan at the various interest rates. Write your
answers (to the nearest dollar) in the appropriate cells of the table
below.
1.
What generalizations can you make from the annuity amounts reflected in
the analysis table above with regards to the different strategies taken
by the families? That is, from a purely financial aspect of the
calculations in your table what generalizations could you make regarding
the two different strategies?
2.
What assumptions may not necessarily be valid for a typical family
regarding both the loan rate and savings plan rate?
3.
Discuss some basic pros and cons to these two very different approaches
the Thomas and Jefferson families made with their extra monthly
payment. Consider various ideas such as possible changes in the family’s
employment situation, market performance, tax deductions, etc.
4. Comment on the merits of the advice you read from the two financial columnists.
5. Note the dates of the advice columns. How might market performance figure in to their advice they gave at that time?
6.
Why do you think Sharon Epperson’s advice at the end specifically calls
attention to an assumption of whether you are “debt-free and maxing out
your 401(k) and IRAs?”
7.
If you were to pay extra principal on a mortgage, when is the best time
to do it (early or later in the loan process) and why?
8.
When you pay extra principal on a loan, describe whether you feel you
are actually earning interest on that money or not. That is, how does
the old adage “a penny saved is a penny earned” apply in this context?
9.
Rework your calculations using a different starting interest rate for
the mortgage and/or a different extra payment amount. Do these changes
affect any of the generalizations you have made above? Explain.
