Debt Management

Transcript Debt Management

Lecture No.13

Debt Management Credit card debt and commercial loans are among the most significant financial transactions involving interest.

Example 4.12 Loan Balance, Principal, and Interest: Tabular Approach

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Given : P = $5,000, i = 12% APR, N = 24 months

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Find : A, and loan repayment schedule A = $5,000(A/P, 1%, 24) = $235.37

Calculating the Remaining Loan Balance after Making the n

Payment

The interest payment in period n is, I n = i x B n-1 = A x (P/A, i, N-n+1) x i

Example 4.13 Loan Balance, Principal, and Interest: Remaining –Balance Method

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Given : P = $5,000, i = 12% APR, N = 24 months

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Find : Loan balance, principal, and interest payment for the 6 th payment A = $5,000(A/P, 1%, 24) = $235.37

Example 4.13 Continued To compute I 6 , we first need to find B 5 , B 5 = $235.37 x (P/A, 1%, 19) = $ 4,054.44

Then, I 6 = $ 4,054.44 x 0,01 = $ 40,54. Note that the principal payment is the remaining part of the total monthly payment amount $235.37. Thus, P 6 = $235.37 – 40.54 = $194.83

The remaining balance after the 6 th payment, B 6 , is equal to $3,859.62 as computed on the previous slide.

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Example 4.15 Financing your Vehicle

Given : Three financing options, r = 4.5%, payment period = monthly, and compounding period = monthly Find : Which option?

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Issue : Which interest rate to use in calculating the equivalent cost of financing for each option

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Option A : Conventional Debt Financing:

debt = $4,500 + $736.53(P/A, 4.5%/12, 42) - $17,817(P/F, 4.5%/12, 42) = $17,847

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Option B : Cash Financing:

cash = $31,020 - $17,817(P/F,4.5%/12,42) = $15,795

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Option C : Lease Financing:

lease = $1,507.76 + $513.76(P/A, 4.5%/12, 42) + $395(P/F, 4.5%/12, 42) = $21,336

Home Mortgage

Types of Home Mortgages

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Fixed-rate mortgage Adjustable-rate mortgage Hybrid Mortgage The Cost of a Mortgage

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Loan amount Loan term Payment frequency Points (prepaid interest) Fees Types of mortgages

Example 4.16 An Interest-Only versus a Fully Amortized Mortgage

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(b) Interest payments:

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Given : P = $200,000, APR = 6.6% or 0.55% per month, and N = 30 years

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Find : (a) monthly payment; (b) interest payments during the first year of ownership of the home.

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Option 1: A fully amortized payment option.

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Option 2: A five-year interest-only option.

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(a) Monthly payments.

Calculating the Monthly Payments with Adjustable-Rate Mortgage (ARMs)

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Index – a guide that lenders use to measure interest rate changes Margin – an interest rate that represents the lender’s cost of doing business plus the profit Adjustment period year thereafter.) – the period between potential interest rate adjustments (e.g., 3/1 means your interest rate is fixed for the first 3 years then could be adjusted every Interest rate cap – a limit on the amount your interest can change (a periodic cap and a lifetime cap) Payment cap – how much your monthly payment can increase at each adjustment

Example 4.18 A 5/1 Hybrid Adjustable Mortgage Plan

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Given : Varying annual mortgage rates and N = 30 years

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Monthly payments under 5/1 Hybrid mortgage

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Find : (a) the monthly payment; (b) the total interest payment over the 10-year ownership