Question

You are thinking about buying a house. You find one you like that costs $400,000. You learn that your bank will give you a mortgage for $320,000 and that you would have to use all of your savings to make the down payment of $80,000. You calculate that the mortgage payments, property taxes, insurance, maintenance, and utilities would total $1920 per month. Which of the following is true regarding your calculation of the cost of owning the house?A. It should not include maintenance, since homeowners often use their own time to fix things around the house instead of calling a professional.B. It should include your monthly income, since you must know the source of the money when trying to calculate costs.C. It should include the opportunity cost of the money used to make the down payment. This money could be earning interest in a bank.D. It should not include property taxes, since that is money that goes directly to the government and is no longer in the market.Given the information above, if the interest rate on your savings account was 4% a year, then the yearly opportunity cost of using this money for a down payment would be equal to __?

Answer 1

Answer: Option (c) is correct.

Explanation:

(a) It should include the opportunity cost of making the down payment. The opportunity cost is the benefit or cost obtained from the next best alternative. While making any big decision such as purchasing house which require huge amount, hence, one should consider the opportunity cost associated with the decision.

In our case, the buyer would deposit the down payment amount in the bank, so that he will be able to earn some interest income.

(b) Interest will be =4% of $80000

                              = $3200

so after the year amount will be 80,000 + 3,200

                                                     = $83,200

Monthly payment = $1920 per month

Year = 1,920 × 12

        = $23,040

Yearly opportunity cost will be $3,200