Question

Q4. Paul has residual income of 60,000 per year that he can put toward the repayment of a home loan in the near future, Paul’s bank insists that he needs to set aside a buffer of 25% of this amount in case interest rates rise or emergencies occur. Assume annual compounding for the following scenarios.

a. If the current fixed interest rate is 5.2%p.a.and the term is 25 years; how much is his bank able to lend to him?

b. Assume that Paul finds an apartment for 250,000 that he is willing to renovate. What would his annual minimum repayment be? would this increase or decrease his buffer, and to what percentage? Assume the same loan terms and 20% deposit finance.

Answer 1

4a) Buffer amount =25% of 60000 = 15000

Loan repayment = 60000- 15000 = 45000

maximum loan which can be lent = present value of 45000 for 25 years

= 45000/0.052*(1-1/1.052^25)

= 621706.98   

The bank is able to lend 621706.98 to Paul

b) Deposit = 20% of 250000 = 50000

Loan Amount = 250000 - 50000 = 200000

Annual repayment (A) is given by

A/0.052*(1-1/1.052^25) = 200000

=> A = 14476.27

So, annual minimum payment will be 14476.27

This would increase his buffer to (60000 - 14476.27 ) = 45523.73 from 15000

So, buffer would increase by = (45523.73-15000)/15000 = 203.49%