Evaluating a
Mortgage Loan for the Dunns

Michelle and Ken Dunn, both in their mid-20s,
have been married for 4 years and have two preschool-age children. Ken has an
accounting degree and is employed as a cost accountant at an annual salary of
$62,000. They’re now renting a duplex but wish to buy a home in the suburbs of
their rapidly developing city. They’ve decided they can afford a $215,000 house
and hope to find one with the features they desire in a good neighborhood.

The insurance costs on such a home are
expected to be $800 per year, taxes are expected to be $2,500 per year, and
annual utility bills are estimated at $1,440—an increase of $500 over those
they pay in the duplex. The Dunns are considering financing their home with a
fixed-rate, 30-year, 6% mortgage. The lender charges 2 points on mortgages with
20% down and 3 points if less than 20% is put down (the commercial bank the
Dunns will deal with requires a minimum of 10% down). Other closing costs are
estimated at 5% of the home’s purchase price. Because of their excellent credit
record, the bank will probably be willing to let the Dunns’ monthly mortgage
payments (principal and interest portions) equal as much as 28% of their
monthly gross income. Since getting married, the Dunns have been saving for the
purchase of a home and now have $44,000 in their savings account.

Critical Thinking Questions

1. How much would the Dunns have to put down if
the lender required a minimum 20% down payment? Could they afford it?

2. Given that the Dunns want to put only $25,000
down, how much would closing costs be? Considering only principal and interest,
how much would their monthly mortgage payments be? Would they qualify for a
loan using a 28% affordability ratio?

3. Using a $25,000 down payment on a $215,000
home, what would the Dunns loan-to-value ratio be? Calculate the monthly
mortgage payments on a PITI basis.

4. What recommendations would you make to the
Dunns? Explain.