Question 3:

a.)
Alan Salary Karen Salary Karen Bonus Total Income Max. Loan 52,000.00 38,500.00 5,000.00 95,500.00 310,375.00 Savings Karens Flat Price Outstanding Mort. Potential Profit Total Finance 73,000.00 189,000.00 102,000.00 87,000.00 160,000.00

In order to calculate the maximum loan, I assume that their income consists of their salaries and Karens bonus and that they both remain constant during the period. Afterwards, the total income is multiplied by 3.25 which is how much banks are usually willing to lend for a joint salary. The result is the maximum available loan at the banks best rate of 75%.

b.)
First, the different mortgages available have to be calculated before giving an advice. Mortgage Rate Available Balance Net Finance Flat 75% 90% 75% 90% 75% 90% Studio 108,750.00 130,500.00 201,625.00 179,875.00 123,750.00 145,500.00 1 Bedroom 172,500.00 207,000.00 137,875.00 103,375.00 102,500.00 137,000.00 2 Bedroom 281,250.00 337,500.00 29,125.00 -27,125.00 66,250.00 122,500.00 3 Bedroom 382,500.00 459,000.00 -72,125.00 -148,625.00 32,500.00 109,000.00 4 Bedroom 510,000.00 612,000.00 -199,625.00 -301,625.00 -10,000.00 92,000.00 The green colour indicates which mortgages Alan and Karen can afford, the rest are limited by the 310,375.00 maximum loan constraint. Therefore, they are able to afford the Studio, the 1 and 2 Bedroom flats. The Available Balance column shows the difference between the maximum allowance and the taken mortgage. The Net Finance column shows the total savings plus the mortgage minus the cost of the flat. The figure represents what is left from the savings after the purchase. Note, I assume Karen will sell his flat as soon as possible and before the next monthly payment occurs. Alan and Karen are able to afford the 2-Bedroom mortgage and they might be also considering having children in the future so they should reflect on that recommendation. Therefore, they should take the mortgage at 75% rate, which is 281,250.00. It has to be noted that if they reduce the rate this will result in lower debt but also in much lower net finance. A higher rate will result in higher figures of net finance, however because of the rate penalty, which occurs after 75% - the debt will be much higher.

c.)
Repayment Mortgage Interest Only Type 1 Type 2 Type 3 Intro. Payment 1,454.99 1,586.69 Interest 839.06 Fixed Payment 1,639.30 1,642.23 Sinking Fund 788.59 Monthly Payment 1627.65 Total Payment 389,008.78 390,802.83 Total Payment 390,637.11 The best mortgage so far is Type 1, which is a repayment mortgage with an introductory period of 2 years and 2.24%, which then reverts to 3.69%. Type 1 is clearly better then type 2 because both its monthly

payments are smaller and also in the end Alan and Karen have to pay less. By taking Type 3, they will pay less monthly fees, which are insignificant, and also by the end of the period they will again pay more than Type 1. Therefore, Type 1 repayment mortgage remains the best choice.

d.)
In order to evaluate if the decision will remain the same if interest rate changes I am going to construct a table, which will show the changes in total payments if interest rates went up or down by 1% and 2%.

Type 1
Decrease Increase Decrease Increase 323,259.73 461,959.08 355,210.42 424,610.67

Type 2
324,954.23 463,808.14 356,960.02 426,437.94

Type 3
323,974.45 464,343.87 356,399.76 426,638.45

2% 1%

Type 1 still remains the best choice as its total payment continues to be the smallest. However, it has to be noted that if the change occurs and Alan and Karen have taken either Type 1 or Type 2, which are repayment mortgages, nothing will change since the rate is fixed. The situation is different with the interest only mortgage. Here is a table showing the potential saving or losses: Interest only Increase No change Decrease 2% -72,950.30 0 65,749.05 33,798.36 1% -35,601.89

It can be observed that the potential losses are higher than the savings. The risk is bigger and rates cannot be easily predicted so Alan and Karen should not gamble on that. In conclusion Type 1 mortgage remains the best choice.