Kendall is considering the purchase of a home. He has saved $22,000 for a down payment on a home and will finance the remainder of the purchase price with a home mortgage loan. Kendall currently rents an apartment for $1,200 per month and does not
anticipate an increase in his monthly income. He wants to make sure that the monthly payment on his new home does not exceed $1,200, after-tax. Kendall has a marginal tax rate of 25 percent and an average tax rate of 22 percent. Assuming the monthly mortgage payment (before-tax) will be equal to 1 percent of the initial mortgage balance and the entire amount of each monthly payment will be deductible home mortgage interest, what is the maximum amount that Kendall can spend on a new home?
$182,000, determined as $22,000 down payment + $160,000 mortgage loan. The amount of the mortgage loan is calculated as follows: $1,200 (maximum after-tax payment possible) / (100% - 25% marginal tax rate) = $1,600 maximum monthly payment possible, before tax. Monthly payment of $1,600 represents 1% of the mortgage balance; therefore, the mortgage balance must be $160,000.
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