Inflation on Mortgage

Question 1
Bill and Ben are twin brothers aged 30 who live rent-free with their mother who also pays all the household bills. Bill and Ben now plan to buy their own home and live together. They aim to buy a two-bedroom flat in their local area. They have found out that flats like this are currently on the market for £130,000. The general inflation rate is 2% a year but property-price inflation in their area is 5% a year. Both of these rates are expected to stay the same on average in the foreseeable future. The brothers are confident they will be able to get a fixed interest rate on their mortgage. 
•    1.1  Briefly explain the impact of inflation on their mortgage. (2 marks)
•    1.2  One possibility is to build up a 25% deposit over three years. First, calculate what the 25% deposit would be now for a flat that is currently on the market for £130,000. Then use the ‘Inflation calculator’ to calculate the amount (nominal value) of the deposit they would need to save up assuming the relevant inflation rate, and that similar flats would still be on sale at the end of the three years. (4 marks)
•    1.3  Please do the following: 
a.    Using the ‘Saving and borrowing calculator’, calculate the rate of return needed to reach their target deposit if they put aside £225 each month and invested their joint savings of £13,000 cash as a lump sum investment as well. (3 marks)
b.    Briefly explain which types of financial products could be used to achieve this goal and whether the goal is realistic. (4 marks)
•    1.4  Bill and Ben are considering whether, instead of waiting, they could buy the flat today, using all of their £13,000 joint savings as a deposit and taking out a higher mortgage. Bill and Ben have found a bank willing to offer a repayment mortgage or interest-only mortgage for the flat. Both mortgages would have a 20 year term and a 6% fixed interest rate. Using the ‘Mortgage calculator’, fill in the table below and briefly discuss the feasibility of each type of mortgage repayment and the risks associated. 
Question 2
The Blanks have received a final demand of £850 for unpaid energy bills, which they must pay immediately to stop the provider installing a prepayment meter. They assess their financial situation, which is as follows: 
•    Market value of home £180,000
•    Collectable artwork worth £400
•    Expected expenditure next month (not including the £850 repayment) £1750
•    Mortgage secured on home (repayable in 10 years’ time): £150,000
•    Savings account (1 month’s notice): £200
•    Expected income next month £1800
•    Unsecured debt (to be repaid in 14 months): £1200
•    Current account: £40
•    2.1  Draw up the Blanks’ balance sheet, including the £850 owed immediately. Distinguish liquid assets from other types of assets, and short-term liabilities from other types of liabilities. (5 marks)
•    2.2  Using the ‘Balance sheet analyser’ or a calculator, calculate the Blanks’ financial net worth, gearing, and current asset ratio. (3 marks)
•    2.3  The Blanks come up with the following plan for paying the £850:
•    Sell the collectable artwork for £360 (discounted for immediate sale)
•    Pay £340 by cheque, after arranging a £300 overdraft limit on the current account 
•    Borrow £150 from a local lender, who asks for repayment of £300 (after adding interest) at the end of two years.
d.    Draw up the Blanks’ new balance sheet after they implement this plan and have paid off the £850. (3 marks)
e.    Briefly comment on the change in the Blanks’ balance sheet, identifying any ways in which their short-term and long-term situation has improved and/or deteriorated. (6 marks)
•    2.4  Briefly explain to what extent the Blanks could be described as financially vulnerable to any adverse events in the next 12–15 months? (3 marks)
•    2.5  Suggest another way that the Blanks could have repaid their £850 energy debt. Identify at least one advantage or one disadvantage compared to the approach the household actually chose. (5 marks)


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