In addition, you can compare the financial impacts of a future home-equity loan
(say, to pay for a child's education).
- Mortgage: Interest
-
Enter the yearly interest rate for each of the three loans.
For example, 5.75 means 5.75%.
Actually, for the Plan ARM, this will be the starting interest
rate that is used for the starting fixed-rate period.
- Mortgage: Term
-
Enter the term of the loans (the number of months within which
it must be repaid). Note that this if you make additional payments to
principal, the loan will be repaid earlier.
Typically, longer term loans have larger interest rates.
- Mortgage: Closing costs, from bank
-
Enter the closing costs (including points) of the loan (in dollars).
This will be subtracted from your starting
bank balance (which can be $0).
- Mortgage: Closing costs, rolled into loan
-
Enter the closing costs (including points) of the loan (in dollars).
This will be rolled into your loan -- which means your mortgage will
be larger.
Note that you can split your closing costs between withdraw from
bank and roll into loan, or you can allocate the entire closing
costs to one of these two categories.
- Mortgage ARM (adjustable rate)
-
An ARM is a two part loan. The first part, lasting between 3 and 7 years,
typically has a low fixed interest rate. In the second part, which lasts for the remainder
of the loan, the interest rate adjusts each year.
In real life, the new rate is often computed by adding a few percent to some
macroeconomic measure (such as the average 30 year bond rate).
In this program, the interest rate is based on the savings rate
at the beginning of each year.
You can set the size of this adjustment,
the maximum it can jump in a year, and its overall maximum.
A balloon loan is like an ARM, but the rate adjusts only once (at the
end of the fixed rate period).
Note that an ARM loan is a gamble -- you usually get a low rate now, but
you are betting that interest rates don't explode in a few years.
- Mortgage ARM: fixed rate period
-
Number of months that a fixed rate will
be used. After this many months, the interest rate will adjust (adjustments will
occur every 12 months).
For example, to specify a 3/1 ARM, use 36 months.
- Mortgage ARM: interest adjustment
-
Enter the premium, in percent. For example, 2 means 2%.
This premium is added to the bond-rate (at every 12 month interval), to compute
the next year's interest rate.
For example, assuming a 3/1 ARM, if the bond-rate in month 60 is 4%,
and your interest adjusment is 2, then (assuming no sudden
jumps have occured)
the next year's interest rate will be 6%.
Note: in most real loans, a macro indicator (such as the current 30 year Treasury
Bond Rate) is used. For simplicity, this program uses the savings
rate as a close approximation.
- Mortgage ARM: maximum rise -- per year
-
Enter the maximum the interest rate can increase, in percent.
For example, 2 means 2%.
This is used to prevent sudden jumps due to a very rapid rise in the
bond-rate.
Note: for a ballon loan, set maximum yearly increase to 0
- Mortgage ARM: maximum rise -- entire loan
-
Enter the maximum the interest rate can increase over the life of the loan, in percent.
For example, 6 means 6%.
This is used to limit the maximum interest rate you pay. For example,
if your starting rate is 4.5%, and the maximum total increase is 5%, then your
yearly interest rate can never exceed 9.5%
- Investment Strategy
-
You can choose between two investment strategies. These strategies
direct what happens to refunds (primarily
your income tax deductions due to interest payments).
- Pay off loan: refunds are used to pay down the principal
- Saved to bank: refunds are added to your bank account
Since the mortgage rate is often greater then your savings-rate,
paying off the loan will often lead to greater long-term assets.
- Principal
-
The starting principal is the amount of principal you currently have
on the house. This is included strictly for informational purposes, it does not
effect any calculation.
The remaining principal is what you owe -- it's the amount you
need to borrow.
- Starting bank balance
-
Your starting bank balance, in $. This can be $0.
Note: it is possible for your bank balance to drop below zero. The
program assumes you'll make it up from somewhere (it will not
reduce your principal automatically). Of course, your total asset value
will be reduced when your bank balance is below $0.
- Type of savings instrument
-
You can specify the type of savings instrument you use:
- Normal savings account: Money is placed into a single account.
The entire balance in this account grows at the current (monthly) rate of
tax free interest.
- Sequence of bonds: Every month, any savings are used to purchase
a long-term-fixed-rate bond. Since the bond-rate can change over time, this means
that each bond will grow at its own rate.
Note that if you model an increasing bond rate, the
bank-balance from the sequence of bonds bank balance will be lesser then
from the normal savings account. However, it may be more realistic
to assume the only tax free asset available to you is
a long-term-fixed-rate bond.
- Savings/bond rate trend
-
This program allows you to model bond-rates using a quadratic equation in time:
bond_rate = b0 + b1*t + b2*t*t
where:
- t is the month (from 1 to 180).
- b0 : starting rate
- b1 : monthly increase (in percent)
- b2 : an accelerator (or decelerator) factor
Examples |
---|
b0=3, b1=0, b2=0 | A constant 3% rate. |
b0=3, b1=0.5/12, b2=0 | Start at 3%, increase 0.5% a year (note that you
can use /12 to convert from a yearly to a monthly rate). |
b0=3, b1=0.5/12, b2=-0.0001 | Start at 3%, increase 0.5% first year, with
smaller increases in later years |
- Marginal tax rate
-
The marginal income tax rate you pay. This should be the total of all federal, state
and local income taxes. Assuming you itemize your deductions, the program will
compute this fraction of your interest payments, and add it to your savings account
or your principal (depending on what strategy you chose).
- Total Assets
-
Total assets is the sum of your principal (the amount of your house
you actually own) and money in your savings bank. Assuming no serious liquidity
concerns, one goal is to maximize total assets at the end of the loan (or
at a point in time you intend to sell the house).
- Mortgage Payment
-
The size (in $ per month) of your mortgage payments.
In order to make it easy to compare loans, this amount will
be paid for each loan plan, regardless of the payment required by the bank.
Thus, if the payment required by the bank is less then
this value, the excess will be used to pay down the principal.
Conversely, if the required payment is greater then this value,
the shortfall will be withdrawn from your
savings account (note that your savings account can drop below $0).
If you leave this blank, the maximum first-month-mortgage-payment, of the three loan plans,
will be used.
- Extra Savings
-
You can add this much (in $ per month) to your savings account each
month. This can complement, or substitute for, paying down your principal using
a larger then required mortgage payment.
- Home Equity Loan
-
As an optinal feature, this program allows you to take out a home equity
loan (say, to pay a child's tuition).
You can set the amount of this loan, when to borrow, how long to take
pay it back, and the interest rate.
- Home Equity Loan: Size of Loan
-
The amount of cash you need. The program will first withdraw cash from
your bank account. If there is not enough in your bank, it will obtain
the remainder using a home-equity loan. Note that your
total asset value will be reduced by the amount you owe on an outstanding
home-equity loan.
- Home Equity Loan: Month it is needed
-
Enter the month you'll need to (possibly) take a home-equity loan.
If you do not intend to take a home-equity loan, leave this
field blank.
- Home Equity Loan: Months to pay it off
-
Enter the number of months needed to pay off the home equity loan.
Thus, if you take a home equity loan in month 70, and
use 74 months to pay it off, your final home-equity loan payment
will occur in month 144.
- Home Equity Loan: Interest premium
-
Enter a premium, in percent. For example, 2 means 2%.
This premium is added to the bond-rate (at every 12 month interval), to compute
the home-equity loan interest rate (note that this will be a fixed rate,
good for the life of the home-equity loan).
For example, if the bond-rate in month 80 is 4.25%,
and your home-equity loan interest adjusment is 1.5, then
the home-equity loan interest rate will be 5.75%.
- Home Equity Payments
-
If you choose to take out a home equity loan at some point,
this value is used to pay it back ($ per month). As with the mortgage payment,
extra amounts are used to pay down the home equity loan, and shortfalls
are withdrawn from your savings account.
Leave this blank and the program will figure out a value (using the
home-equity-loan payment computed for plan B).