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FINA 385 Lecture Notes - Lecture 14: Reverse Mortgage, Life Annuity, Accrued Interest

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School
Concordia University
Department
Finance
Course
FINA 385
Professor
John Turri

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Document Summary

The ground rules for retirement planning are changing rapidly. Even a 3 percent rate of inflation will cause prices to double every 24 years. A reverse mortgage is designed exclusively for homeowners age 60 and older. It provides the homeowner with a taxfree income in the form of a loan that is paid back (with interest) when the home is sold or the homeowner dies. You can receive up to 40 percent of the appraised value of your home. Reverse annuity mortgages (ram) are used to buy a life annuity from an insurance company that pays out a given sum of money on a regular basis for as long as the homeowner lives. When the homeowner dies or the house is sold, the mortgage and accrued interest must be repaid. The amount you can borrow increases as you grow older, usually in the range of 15 to. 45 percent of the equity in your home.

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Related Questions

Assume you are planning on your retirement today, you decide to invest part of your salary every month in your retirement account. Suppose you will retire when you are 67 years old, your life expectancy is 87 if you are male and 90 if you are female and the inflation rate will be 2.5% a year. For your retirement account the rate of return is 6.5% a year before you retire and after retirement, you will invest more conservatively and the rate of return will be 4.5% a year. To figure out how much you need to save in your retirement account a month before you retire, you ask yourself the following questions

1. Tell us you age today

2. You believe you will live comfortable today with $2,000 a month, how much do you need a month after you retire at 67? Assuming you will need the same amount during the retirement period

3. How much do you need when you are at 67 so you can withdraw the amount we discussed in the question 2 until the last day of your life?

4. Suppose your salary will increase 3% a year and your saving will also increase 3% a year, tell us how much do you need to save in the first month so you will have the same amount we calculated in question 3. (Hint suppose your saving will be increasing .5% a month)

5. Redo question 4 if you will start to save 10 years, instead of today, how much do you need to save in the first month?

Your clients, Jerry and Jenny, are 25 years old. They have come to you for assistance with planning for the cost their child’s education and their retirement. They would like to know if they are on track to reach these two goals. Below are the facts about the family.

Jenny currently earns $150,000 and they expect to need $150,000 per year in today’s dollars in retirement. Jerry is a stay-at-home dad.

Jenny plans to retire at age 67, and they expect to live until age 100.

They also expect that Social Security will provide $40,000 of benefits in today’s dollars at age 67.

Jenny has been saving $5,000 annually in her 401(k) plan.

Their son, Jazz, was just born and is expected to go to college in 18 years.

They want to save for Jazz’s college education, which they expect will cost $20,000 in today’s dollars per year and they are willing to fund 5 years of college. They want all funds needed for Jazz’s college education available the first year Jazz starts college.

They were told that college costs are increasing at 7% per year, while general inflation is 3%.

They currently have $100,000 saved in total and they are averaging a 10% rate of return and expect to continue to earn the same return over time.

1. Calculate the current cost of Jazz’s college education.

2. Calculate the capital needs of the couple at retirement and the current value (today’s value) of their retirement needs.

3. Provide the couple with a summary of their goals with the current total amount needed to reach their goals, showing how you arrived at the total.

4. Given their current resources, does the couple have sufficient resources to achieve their goals? Using calculations, show and explain your answer to the couple.

5. Using calculations and explanations provide the couple with three alternatives for meeting their goals.

6. In your own words, provide the couple with the advantages and disadvantages of two accounts and/or investment instruments that are used specifically to save for college education expenses. Which would you recommend and why?

BUSI 320 Comprehensive Problem 3 SUMMER D

Use what you have learned about the time value of money to analyze each of the following decisions:

Decision #1: Which set of Cash Flows is worth more now?

Assume that your grandmother wants to give you generous gift. She wants you to choose which one of the following sets of cash flows you would like to receive:

Option A: Receive a one-time gift of $ 9000 today.

Option B: Receive a $1400 gift each year for the next 10 years. The first $1400 gift would be

received 1 year from today.

Option C: Receive a one-time gift of $18,000 10 years from today.

Compute the Present Value of each of these options if you expect the interest rate to be 3% annually for the next 10 years. Which of these options does financial theory suggest you should choose?

Option A would be worth $__________ today.

Option B would be worth $__________ today.

Option C would be worth $__________ today.

Financial theory supports choosing Option _______

Compute the Present Value of each of these options if you expect the interest rate to be 7% annually for the next 10 years. Which of these options does financial theory suggest you should choose?

Option A would be worth $__________ today.

Option B would be worth $__________ today.

Option C would be worth $__________ today.

Financial theory supports choosing Option _______

Compute the Present Value of each of these options if you expect to be able to earn 10% annually for the next 10 years. Which of these options does financial theory suggest you should choose?

Option A would be worth $__________ today.

Option B would be worth $__________ today.

Option C would be worth $__________ today.

Financial theory supports choosing Option _______

Decision #2 begins at the top of page 2!

Decision #2: Planning for Retirement

Tom and Tricia are 22, newly married, and ready to embark on the journey of life. They both plan to retire 45 years from today. Because their budget seems tight right now, they had been thinking that they would wait at least 10 years and then start investing $1800 per year to prepare for retirement. Tricia just told Tom, though, that she had heard that they would actually have more money the day they retire if they put $1800 per year away for the next 10 years - and then simply let that money sit for the next 35 years without any additional payments – then they would have MORE when they retired than if they waited 10 years to start investing for retirement and then made yearly payments for 35 years (as they originally planned to do). Please help Tom and Tricia make an informed decision:

Assume that all payments are made at the END of the year, and that the rate of return on all yearly investments will be 8% annually.

(Please do NOT ROUND when entering “Rates” for any of the questions below)

How much money will Tom and Tricia have in 45 years if they do nothing for the next 10 years, then put $1800 per year away for the remaining 35 years?

How much money will Tom and Tricia have in 10 years if they put $1800 per year away for the next 10 years?

b2) How much will the amount you just computed grow to if it remains invested for the remaining

35 years, but without any additional yearly deposits being made?

c)How much money will Tom and Tricia have in 45 years if they put $1800 per year away for each of the next 45 years? (This amount can be referred to as their “retirement nest egg”)

Using your solution to question C, what is the value in today's dollars, assuming 3% average inflation, of Tom and Tricia's retirement nest egg? (“Today” Tom and Tricia are 22 years old. Retirement is 45 years away!)

e)If Tom and Tricia wait 25 years (after the kids are raised!) before they put anything away for retirement, how much will they have to put away at the end of each year for 20 years assuming an annual interest rate of 8% in order to have $700,000 saved up on the first day of their retirement 45 years from today?