Economic Analysis Team ProjectTeam MembersThe Big Questions???DefinitionsAnalysis AssumptionsFuture ValueBenefit Cost RatioRate Of ReturnPrincipal vs. Interest ContributionFixed Rate Mortgage (FRM) BenefitsAdjustable Rate Mortgage (ARM) BenefitsConclusionsResourcesEconomic Analysis Team ProjectEconomic Analysis Team Project TEAM 3TEAM 3 Home Financing OptionsHome Financing OptionsTeam MembersTeam MembersFrom left to rightFrom left to rightJason de la Guerra – OrganizerJason de la Guerra – OrganizerMichael Jauregui – SummarizerMichael Jauregui – SummarizerJerry Lessley – TechieJerry Lessley – TechieKevin Navares – TechieKevin Navares – TechieThe Big Questions???The Big Questions???You’re in the market to purchase a home.You’re in the market to purchase a home. What type of loan should you choose?What type of loan should you choose? What is the difference between an FRM and What is the difference between an FRM and an ARM?an ARM?DefinitionsDefinitionsFRMFRM (Fixed Rate Mortgage)(Fixed Rate Mortgage)Rate is constant for 30 Rate is constant for 30 yearsyearsCurrent Rate 5.36Current Rate 5.36ARMARM (Adjustable Rate Mortgage)(Adjustable Rate Mortgage)Fixed rate for 7 yrs then Fixed rate for 7 yrs then indexed for 23 yearsindexed for 23 yearsFixed rate 4.36Fixed rate 4.36Adjustable rate index of Adjustable rate index of 2.25 – 3.02.25 – 3.0** Both require a FICO score of 700 or aboveAnalysis AssumptionsAnalysis AssumptionsLoan amount of $400,000Loan amount of $400,000Down payments are equal to 10% of loanDown payments are equal to 10% of loanPayment is based on a 30 year termPayment is based on a 30 year termOptions of selling at 7 and 10 yearsOptions of selling at 7 and 10 yearsAverage tax benefit of 28%Average tax benefit of 28%All rates are based on current market values All rates are based on current market values and historical trendsand historical trendsFuture ValueFuture ValueAssuming a Conservative California Average growth of 10%Assuming a Conservative California Average growth of 10%FV of a $400,000 would be $716,339.08 in 10 yearsFV of a $400,000 would be $716,339.08 in 10 yearsFV of a $400,000 would be $601,452.10 in 7 yearsFV of a $400,000 would be $601,452.10 in 7 yearsCombined with monthly payments and our initial down Combined with monthly payments and our initial down payment the amount owed at the end of 10 years would be:payment the amount owed at the end of 10 years would be:FRM $296,646 ARM $273,871FRM $296,646 ARM $273,871For 7 year FRM $113,181 ARM $124,120For 7 year FRM $113,181 ARM $124,120Benefit Cost RatioBenefit Cost Ratio The most beneficial option will have the highest ratio.The most beneficial option will have the highest ratio. B/C = (sale benefit + tax benefit) / (down payment + total of amount paid)B/C = (sale benefit + tax benefit) / (down payment + total of amount paid)10 yr FRM B/C = (316339+61280)/(40000+241503) = 1.3410 yr FRM B/C = (316339+61280)/(40000+241503) = 1.3410 yr ARM B/C = (316339+58531)/(40000+241503) = 1.3310 yr ARM B/C = (316339+58531)/(40000+241503) = 1.337 yr FRM B/C = (201452+48271)/(40000+169052) = 1.197 yr FRM B/C = (201452+48271)/(40000+169052) = 1.197 yr ARM B/C = (201452+37332)/(40000+169052) = 1.147 yr ARM B/C = (201452+37332)/(40000+169052) = 1.14Rate Of ReturnRate Of ReturnFRM 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 homeFRM ARMROR at 10 years 31% 30%ROR at 7 years 36% 35%Principal vs. Interest ContributionPrincipal vs. Interest ContributionPrincipal and interest sum = total yearly payment of $24,150 for both FRM and ARMFixed Rate Mortgage (FRM) Fixed Rate Mortgage (FRM) BenefitsBenefitsPredictable cash flows for term of loanPredictable cash flows for term of loanHigher tax benefitsHigher tax benefitsThe rate of return after 10 years with no sale is The rate of return after 10 years with no sale is higher.higher.Greater investment return at 7 year saleGreater investment return at 7 year saleHigher profit than ARM after 10 year sale.Higher profit than ARM after 10 year sale.Adjustable Rate Mortgage (ARM) Adjustable Rate Mortgage (ARM) BenefitsBenefitsInitial interest rate is lower than FRMInitial interest rate is lower than FRMInterest rate paid will generally decrease as Interest rate paid will generally decrease as prevailing interest go down.prevailing interest go down.Typically offer lower down payment optionTypically offer lower down payment optionGenerally easier qualification criteriaGenerally easier qualification criteriaCompetitive ARM market coupled with low Competitive ARM market coupled with low rates increase affordability.rates increase affordability.ConclusionsConclusionsFRM overall better alternative given analysis FRM overall better alternative given analysis assumptionsassumptionsLong term home-owners receive greater benefit form Long term home-owners receive greater benefit form FRMFRMAssuming the same FRM and ARM payment the Assuming the same FRM and ARM payment the FRM has greater return on investment.FRM has greater return on investment.Short Term home-owners benefit from ARM due to Short Term home-owners benefit from ARM due to lower initial costs and higher payments to principle.lower initial costs and higher payments to principle.Current market provides ARM advantage through Current market provides ARM advantage through affordability and competitive marketsaffordability and competitive marketsResourcesResourceswww.myfico.comwww.myfico.comwww.cnnmoney.comwww.cnnmoney.comwww.hud.govwww.hud.govwww.lendingexpo.netwww.lendingexpo.netD. Newnan, J. Lavelle, and T. Eschenbach. D. Newnan, J. Lavelle, and T. Eschenbach. (2002). “Essentials of Engineering Economic (2002). “Essentials of Engineering Economic Analysis” Oxford University Press, Oxford, Analysis” Oxford University Press, Oxford,
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