a) Ethel and Fred have found their "dream house" and it has a purchase price of $250,000. Assume that they make a $50,000 down payment but must finance the remainder with a mortgage. They are presented with two mortgage options. Option 1 is a 30-year fixed rate mortgage with an interest annual percentage rate (apr) of 4.5% and $3,000 in points to be paid at closing. Option 2 is a 30-year fixed rate mortgage with an apr of 4.8% and no points. What are the monthly payments that will be paid under options 1 and 2?

b) What is the present value cost of the monthly payment differential if Ethel and Fred were to elect option 2 rather than option 1 (described in question 2 above)? That is, what is the cost differential measured in today's dollars? In answering this question assume a 3% real annual interest rate. Would you advise Ethel and Fred to take option 1 or option 2? Justify your choice using economic logic.