For my financially inclined huddle friends

[Bring Back Pat!!!]

I've got this Finance test question I'm kind of stumped on, not sure if someone smarter than I can help:

 

 

If mortgage rates raise from 5% to 10%, but the expected rate of increase in house prices rises from 2% to 9%, are people more or less likely to buy houses? ( Show your work to receive full credits)

 

It's the show your work part I'm not sure on. Is there one formula for something like this? My text doesn't seem to be helpful. Or do I work out each scenario, with what one would pay for a hose under each of the options? I'm stumped....

[wiegie]

I've got this Finance test question I'm kind of stumped on, not sure if someone smarter than I can help:

 

 

If mortgage rates raise from 5% to 10%, but the expected rate of increase in house prices rises from 2% to 9%, are people more or less likely to buy houses? ( Show your work to receive full credits)

 

It's the show your work part I'm not sure on. Is there one formula for something like this? My text doesn't seem to be helpful. Or do I work out each scenario, with what one would pay for a hose under each of the options? I'm stumped....

more likely to buy homes

 

your capital gain on your house is +7 percentage points, while the cost of funds to buy the house has only gone up by 5 percentage points. This +2% net gain will cause people to want to buy more homes. (To make sure you get things right, make the assumption that you can buy and sell your home by owner rather than by using a real estate agent.)

[SEC=UGA]

Depends on the LTV and how much your house is worth. For me anyway...

 

BTW, don't listen to me, you will fail the test... But you can prove on an individual basis that these things can sway the opinion.

Edited November 3, 2010 by SEC=UGA

[SEC=UGA]

I've got this Finance test question I'm kind of stumped on, not sure if someone smarter than I can help:

 

 

If mortgage rates raise from 5% to 10%, but the expected rate of increase in house prices rises from 2% to 9%, are people more or less likely to buy houses? ( Show your work to receive full credits)

 

It's the show your work part I'm not sure on. Is there one formula for something like this? My text doesn't seem to be helpful. Or do I work out each scenario, with what one would pay for a hose under each of the options? I'm stumped....

 

I really think to accurately answer this question you need more info, or I need the question to be better developed...

 

Without a value on the house, LTV, or a time line on the sale (are the % increase annually and for how long, after how many years will you sell the house) and the period of the loan, it is tough to answer. (unless you go with Wiegie's logic)

 

What it sounds, to me, like he is asking one of two things...

 

Today there is a house for 500K, it is projected that by the end of the year that house will be worth 510K and the person is going to buy said house at 510K and can get a 5% interest rate should they buy this house with these terms or should they buy a house worth 500K today for 545K and pay a 10% interest rate...

 

The other scenario is that one can buy a house today for 500K, scenario 1 is that they pay a 5% IR and the house is worth 510K when they sell or they can buy a house for 500K today at a 10% rate and it is worth 545K when they sell....

 

I cn tell you with certainty that if you were to be in a 10year hold and your sale price were 510000 (the 2% increase) and you had the 5% IR at the beginning you would, equity wise, be in better shape than you would buying at 500K at 10% with a 9% price increase (545K).

 

in the 2% increase at 5% IR you will end up after 10Years (at 80 LTV) having $184,631 of equity in the house. In the other scenario you will only have $181,247 in equity in the house.

 

Not just that, but you have to consider the compuonding interest and what that is going to do to your monthly payment. Given the above scenario, your payment on the 500K at 5% is going to be roughly $2,147 vs $3,510 at the 10%, a difference of $1,363 per month or $163,559 over the 10years, which further Inflates your actual basis in the home.

 

So, in order to gain the $184,631 you pay mortgage payments of $257,674 in the other scenario you build equity of $181, 247 and pay out $421,234... Lesson here, compounding interest is a b1tch. Under a simple interest scenario the outcomes would be much different.

 

Under the Scenario I propose,it would only make sense to take the 10% IR if the gain were in 1 year and you were to flip it at the end of that 1 year (i'm not going to take the time to do it in monthly increments.) After 1 year with the 10% IR scenario you would have about $2,223 in principal payments and your total payments would be $42,123. With the value increase of 45K you would be roughly 5,100 to the good. Under the 5%/2% scenario after 1 year you would be 9,800 to the bad. After two years, you would be better off under the 5%/2% scenario.

Edited November 3, 2010 by SEC=UGA

[moneymakers]

Trick question

 

Less people will be able to afford/qualify for a house if interest rates rise thus less people will buy a house.

[wiegie]

I can tell you with certainty that if you were to be in a 10year hold and your sale price were 510000 (the 2% increase) and you had the 5% IR at the beginning you would, equity wise, be in better shape than you would buying at 500K at 10% with a 9% price increase (545K).

I think the rate of increase in housing prices is on annual basis, hence in 10 years the homes would be selling for $597,546 (with a 2% annual increase in housing prices) or $1,085,946 (with a 9% annual increase in housing prices).

[Bring Back Pat!!!]

I really think to accurately answer this question you need more info, or I need the question to be better developed...

 

Without a value on the house, LTV, or a time line on the sale (are the % increase annually and for how long, after how many years will you sell the house) and the period of the loan, it is tough to answer. (unless you go with Wiegie's logic)

 

What it sounds, to me, like he is asking one of two things...

 

Today there is a house for 500K, it is projected that by the end of the year that house will be worth 510K and the person is going to buy said house at 510K and can get a 5% interest rate should they buy this house with these terms or should they buy a house worth 500K today for 545K and pay a 10% interest rate...

 

The other scenario is that one can buy a house today for 500K, scenario 1 is that they pay a 5% IR and the house is worth 510K when they sell or they can buy a house for 500K today at a 10% rate and it is worth 545K when they sell....

 

I cn tell you with certainty that if you were to be in a 10year hold and your sale price were 510000 (the 2% increase) and you had the 5% IR at the beginning you would, equity wise, be in better shape than you would buying at 500K at 10% with a 9% price increase (545K).

 

in the 2% increase at 5% IR you will end up after 10Years (at 80 LTV) having $184,631 of equity in the house. In the other scenario you will only have $181,247 in equity in the house.

 

Not just that, but you have to consider the compuonding interest and what that is going to do to your monthly payment. Given the above scenario, your payment on the 500K at 5% is going to be roughly $2,147 vs $3,510 at the 10%, a difference of $1,363 per month or $163,559 over the 10years, which further Inflates your actual basis in the home.

 

So, in order to gain the $184,631 you pay mortgage payments of $257,674 in the other scenario you build equity of $181, 247 and pay out $421,234... Lesson here, compounding interest is a b1tch. Under a simple interest scenario the outcomes would be much different.

 

Under the Scenario I propose,it would only make sense to take the 10% IR if the gain were in 1 year and you were to flip it at the end of that 1 year (i'm not going to take the time to do it in monthly increments.) After 1 year with the 10% IR scenario you would have about $2,223 in principal payments and your total payments would be $42,123. With the value increase of 45K you would be roughly 5,100 to the good. Under the 5%/2% scenario after 1 year you would be 9,800 to the bad. After two years, you would be better off under the 5%/2% scenario.

 

This may be what he was looking for, but the question was very ambiguous. I submitted my test already, let's see what he says.

 

Thanks.

[SEC=UGA]

I think the rate of increase in housing prices is on annual basis, hence in 10 years the homes would be selling for $597,546 (with a 2% annual increase in housing prices) or $1,085,946 (with a 9% annual increase in housing prices).

 

Could very well be, would you like me to change my analysis to account for such?

 

Or, was he looking at this as a one year thing... I'm still very, very confused and probably think you were correct at the outset, Wiegie.

[wiegie]

Could very well be, would you like me to change my analysis to account for such?

 

Or, was he looking at this as a one year thing... I'm still very, very confused and probably think you were correct at the outset, Wiegie.

I'd like to see you do your analysis again (because I'm not sure why it matters at all if it is a one year thing or a 30 year thing).

 

To me it just seemed like a straightforward question of: Will I be more likely to make an investment if my return is 9% and my cost of capital is 10% than I would have been to make the same investment if my rate of return is 2% but my cost of capital is 5%? I'm not sure why the answer wouldn't have to be a simple "yes".

[SEC=UGA]

I'd like to see you do your analysis again (because I'm not sure why it matters at all if it is a one year thing or a 30 year thing).

 

To me it just seemed like a straightforward question of: Will I be more likely to make an investment if my return is 9% and my cost of capital is 10% than I would have been to make the same investment if my rate of return is 2% but my cost of capital is 5%? I'm not sure why the answer wouldn't have to be a simple "yes".

 

 

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10

9% $500,000 $545,000 $594,050 $647,515 $705,791 $769,312 $838,550 $914,020 $996,286 $1,085,947

Debt Service ($142,123) ($42,123) ($42,123) ($42,123) ($42,123) ($42,123) ($42,123) ($42,123) ($42,123) ($42,123) $722,194.56

 

IRR 5%

 

 

 

 

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10

2% $500,000 $510,000 $520,200 $530,604 $541,216 $552,040 $563,081 $574,343 $585,830 $597,546

Debt Service ($125,767) ($25,767) ($25,767) ($25,767) ($25,767) ($25,767) ($25,767) ($25,767) ($25,767) ($25,767) $272,178.03

 

IRR -4%

 

As I thought, after looking at it, 9% gain per year boost your IRR. Again, though, the question still needs to be spelled out.

Edited November 3, 2010 by SEC=UGA

[untateve]

42

[Azazello1313]

I really think to accurately answer this question you need more info, or I need the question to be better developed...

 

Without a value on the house, LTV, or a time line on the sale (are the % increase annually and for how long, after how many years will you sell the house) and the period of the loan, it is tough to answer. (unless you go with Wiegie's logic)

 

not really, because even at 100% LTV, the difference is going to favor buying. the difference just increases as LTV goes down, but at everywhere on the possible spectrum the rates stated in the problem will provide a buying incentive.

[muck]

Also, I didn't see it anywhere ... is the loan interest only or amortizing? If amortizing, over what period? What are the assumptions for property taxes? What % down payment? Cost of home owners insurance and expected rates of change with that? Future assumed maintenance costs (i.e., if those costs are not needed now, but are needed 8yrs from now, and you're supposed to assume a 10yr holding period, it may make a difference)? Etc.

[Yukon Cornelius]

42

no 17