Assume that you have graduated from Bridgewater State University and are a pract
ID: 2752840 • Letter: A
Question
Assume that you have graduated from Bridgewater State University and are a practicing CPA. One of your clients, Karen Sharpley, a practicing pediatrician, comes to you for consulting services. On your advice, Karen had refinanced her mortgage when interest rates were extremely low into a fixed rate, 20 year 3.875% mortgage. Karen’s monthly payments (principal and interest) are currently $3296.78 per month. She has been making extra principal payments on this mortgage since she acquired it. Her principal balance on November 30, 2014 before making her December mortgage payment is $519,057. Since Karen has been making prepayments on her principal balance, you cannot determine the original amount of the mortgage here. Karen has received a raise and has some extra money available each month. She would like to know whether she should pay down her mortgage by adding $300 per month to each payment or whether she should invest the $300 into mutual funds, where she estimates the overall return will be 8% annual. 1. How long will it take Karen to pay off the mortgage if she pays only the normal principal and interest payment? Provide an amortization schedule. 2. How long will it take Karen to pay off the mortgage if she pays the extra $300 per month to the mortgage? Provide an amortization schedule. 3. Assuming that Karen could earn 8% on any extra money that she invests, write her a letter in good form outlining the pros and cons of her choices along with any other relevant factors that she should consider in making this decision. Be sure that the quality of your advice and the letter you write demonstrate to Karen that you are worth the $200 per hour that she pays you.
Explanation / Answer
Answer: As on Dec 2014 = $519,057 Current EMI = $3,296.78 Interest on mortgage = 3.875% Numer of Years = 20 years 1 Time for her to pay off the mortage = 220.261052 months (By usine NPER function on excel) Time in years = 18.35509 Years 2 If Karen pays $300 extra every month then: Her Monthly payments would be = $300 + $3296.78 = $3,596.78 and the time required to pay off the debt = 194.5961 months Time in years = 16.21634 Years 3 If she invests $300 in mutual fund she would have made 8% By paying off $300 on her mortage she is saving time = 2.1387435 Years = 25.664922 months Which means total savings of = $84,611.60 This saving has a return of = $84611/$519057 = 0.16301 16.30% Which is just double the return she can make on her mutual fund investment. So its better for her to pay off her debt.