Assignment 13-1: Loan Amortization Activity
Assignment 13-1: Loan Amortization Activity
Instructions: After completing the reading, video, and audio assignments, use the economic way of thinking to answer each of the following questions. A question may have more than one part. Be sure to answer each in one or two complete sentences. Provide page references to Common Sense Economics (2010) and other learning materials when appropriate.
Objectives: Use the excel spreadsheet for Module 13-1 and economic reasoning to make strategic choices when buying a new versus an existing home or a new versus a used car. Evaluate how changes in loan duration, loan amount, interest rates, and credit history impact the cost of borrowing money and the total cost of homes and cars.
According to the U.S. Census (http://www.census.gov/construction/chars/), the 2013 median sales price of new single-family homes sold was $268,900 while the average price was $324,500. To learn more about the characteristics of new housing in 2013, visit http://www.census.gov/construction/chars/interactive/. The Federal Reserve reports that 3.94% rate of interest was the average for a 30-year fixed rate mortgage on new and existing homes while 3.07% was the interest rate for the 15-year counterpart. For current and historic data on interest rates, visit http://research.stlouisfed.org/fred2/
Scenario 1. Imagine that you are a first-time home buyer. Rather than buy a new home, you decide to purchase an existing one. You find a nice home in a good location for $163,125. You have a down payment of 20% (which is $32,625) and you decide on a 30-year fixed rate loan. This means that you need to borrow a loan amount of $130,500. You shop around and learn that you qualify for an interest rate of 4.8%. Your monthly (12) mortgage payments will begin next year on January 1st. Use the loan amortization template excel sheet to answer the questions by entering the above amounts indicated in each question in cells D5-D8.
1. What are your scheduled monthly payments on a $130,500 loan at 4.8% over 30 years?
See cell H5 in the Excel spreadsheet.
2. Look at the first payment you’ll make (row 18 in the excel sheet). How much of the payment goes toward interest and how much toward principal?
3. How much total interest will you pay over the course of the loan on $130,500 at 4.8% over 30 years? See cell H9.
4. Considering total interest paid, what is the total cost of the home? Add total interest to the purchase price of the home.
Scenario 2. Now, you want some cash to buy some new furniture and carpeting for your home. So you choose to make a down payment of only 10% rather than 20%. Change the loan amortization schedule so now you borrow $147,000. Leave all other entries the same.
5. What are your scheduled monthly payments on $147,000 at 4.8% over 30 years? See cell H5.
6. How much total interest will you pay over the course of the loan on $147,000 at 4.8% over 30 years? See cell H9.
7. Taking the down payment of 10% into account, what is the total price of the house? To answer, add the total price of the home to the total interest paid.
8. Compare the total interest paid with 20% down to the total interest paid with 10% down. In 30 years, do you think the purchase of furniture and carpeting today is worth it? Use economic reasoning to answer.
Scenario 3. After thinking about all the interest paid over a 30 year span, you begin considering a 15-year loan. After putting 20% down on a $163,125 house, imagine that you borrow $130,500 for 15 years. The interest charged will be lower given the shorter life of the loan. So you find a 4% mortgage rate.
9. What are your scheduled monthly payments on $130,500 at 4% over 15 years? See cell H5.
10. Look at the first payment you’ll make (row 18 in the excel sheet). How much of the payment goes toward interest and how much toward principal on a loan of $130,500 at 4% over 15 years?
11. How much total interest will you pay over the course of a 15-year loan on $130,500 at 4% when monthly payments are made? See cell H9.
12. How much total interest do you save with a 15-year loan at 4% compared to a 30-year loan at 4.8% on $130,500? Compare the interest paid on the 15 and 30 year mortgages.
Scenario 4. Let’s turn to thinking about a car loan. A car loan is repaid (amortized) over a shorter period of time. Now, you are choosing between buying a new or used car. The used car has relatively low mileage and is in good condition. Both vehicles come with good warranties. You can borrow either $15,000 (new) or $5,000 (used) over 3 years at 6.5% interest.
13. What is your monthly payment if you borrow only $5,000 over 3 years at 6.5% interest for a used car? See cell H5.
14. How much in total interest will you pay over the three years on a $5,000 loan over 3 years at 6.5% interest? See cell H9.
15. What are your monthly payments if you borrow $15,000 over 3 years at 6.5% interest for a new car? See cell H5.
16. How much total interest will you pay over the three years on a $15,000-loan over 3 years at 6.5% interest? See cell H9.
17. Will you buy new or used? Explain by comparing benefits and costs. Also discuss from where the funds will come in your zero-based budget when you purchase a car.
Scenario 5. Your credit history will impact the interest rate that lenders are willing to offer you. If you have a high credit score, you’ll pay a lower interest rate. If you have a low credit score, you’ll pay a higher interest rate.
18. What are your monthly payments and total interest if you borrow $15,000 over 3 years at 13.0% interest because of bad credit? See cells H5 and H9, respectively. Using this data and comparing it to the lower interest earned by a positive credit history, describe what you think about the relationship between your credit score and interest rates. Use economic reasoning to answer.
Assignment 13-1: Loan Amortization Activity
Answer Section
SHORT ANSWER
1. ANS:
Your scheduled monthly payment is $684.69.
PTS: 1
2. ANS:
Only $162.69 of the payment goes toward paying down the principal and $522.00 is interest. Notice that the interest payments are greater than the principle payments until 9/1/2027! As time passes and you pay off more and more of the loan’s principal, your interest payments do decrease.
PTS: 1
3. ANS:
The total interest is $115,987.78.
PTS: 1
4. ANS:
The total interest is $115,987.78. Add in the price of the existing home, $163,125. This means the total price of the house is $279,112.78.
PTS: 1
5. ANS:
Your scheduled monthly payment is $771.26.
PTS: 1
6. ANS:
The total interest is $130,652.91.
PTS: 1
7. ANS:
The total interest is $130,652.91. Add in the price of the home, $163,125. This raises the total price of the existing house to $293,777.91.
PTS: 1
8. ANS:
In total interest, you’d be paying $115,987.78 with 20 percent down and $130,652.91 with 10% down over 30 years. This is a difference of $14,665.13 in additional interest. Recall, this is on top of the $16,500 you used to buy furniture and carpet 30 years ago. In other words, you’ll need to pay back $1.89 over the lifetime of the loan for each $1 you borrow. Answers will vary on whether students think it is worth it. Evaluate based on discussions about present-day benefits versus overall costs.
PTS: 1
9. ANS:
Your scheduled monthly payment is $965.29.
PTS: 1
10. ANS:
For a 15-year loan, the principal payment is greater than the interest payment from the start. The interest is $435 and the principal is $530.29 for the first payment.
PTS: 1
11. ANS:
Your interest payments will total $43,252.69. This means for each $1 borrowed, you’ll need to pay back $1.33 over the lifetime of the loan.
PTS: 1
12. ANS:
The 15-year loan will save you $115,987.78 - $43,252.69 = $72,735.09 in interest payments over the 30-year loan!
PTS: 1
13. ANS:
Your monthly payment is $153.25.
PTS: 1
14. ANS:
You will pay $516.82 in total interest over the three years on a $5,000-loan over 3 years at 6.5% interest.
PTS: 1
15. ANS:
The monthly payment increases to $459.74 if you borrow $15,000 over 3 years at 6.5% interest for a new car.
PTS: 1
16. ANS:
$1,550.46 is what you will pay in total interest on a $15,000-loan over 3 years at 6.5% interest.
PTS: 1
17. ANS:
Answers will vary. Evaluate based on ability to employ cost/benefit analysis to answer.
PTS: 1
18. ANS:
Your monthly payments jump to $505.41 and total interest increases to $3,194.73 if you borrow $15,000 over 3 years at 13.0% interest because of bad credit.
There is an inverse relationship between credit history and interest rates. Individuals with positive credit histories are usually able to find relatively low interest rates compared to their counterparts with negative credit histories.
PTS: 1
1