Discussion Question CN (1) Web Investment Tracking Dow Jones Industrial Average Company Research Financial Web Sites Other Averages Online Brokers World Advertised Investment Financial Pages Personal Investment Options Technology Savings Plan Formula with Excel Computing Roots Copyright © 2011 Pearson Education, Inc.

Managing Your Money Copyright © 2011 Pearson Education, Inc.

Loan Payments, Credit Cards, and Mortgages Unit 4D Loan Payments, Credit Cards, and Mortgages Copyright © 2011 Pearson Education, Inc.

Loan Basics The principal is the amount of money owed at any particular time. An installment loan (or amortized loan) is a loan that is paid off with equal regular payments. An amortization schedule is a table of principal and interest payments over the life of a loan. Copyright © 2011 Pearson Education, Inc.

Loan Payment Formula (Installment Loans) PMT = regular payment amount P = starting loan principal (amount borrowed) APR = annual percentage rate n = number of payment periods per year Y = loan term in years The derivation of this formula can be done by simply setting the compound interest formula equal to the annuity formula and is fairly approachable for many students. Again, working through realistic scenarios that students can relate to will help them appreciate the importance of this payment formula. Copyright © 2011 Pearson Education, Inc.

Student Loan CN (1) Suppose you have student loans totaling $7500 when you graduate from college. The interest rate is APR=9% and the loan term is 10 years. a. What is your monthly payments? b. How much will you pay over the lifetime of the loan? c. What is the total interest you will pay on the loan? Copyright © 2011 Pearson Education, Inc.

Principal and Interest for Installment Loans The portions of installment loan payments going toward principal and toward interest vary as the loan is paid down. Early in the loan term, the portion going toward interest is relatively high and the portion going toward principal is relatively low. As the term proceeds, the portion going toward interest gradually decreases and the portion going toward principal gradually increases. Copyright © 2011 Pearson Education, Inc.

Principal Interest Payments CN (2) For the student loan in the prior question; calculate the portions of your payments that go to principal and to interest during the first 3 months. Copyright © 2011 Pearson Education, Inc.

Loan Amortization Example Although many financial institutions will provide the individual with an amortization schedule upon initiating the loan, there may be two important reasons that students should be able to follow the simple mathematics of a schedule. 1) Once they gain a little confidence with the flow of the columns, they are in a position to modify their own schedules using Excel or some other software and customizing it to facilitate their personal strategies of making additional payments of principal. 2) It would also be important to periodically check the accuracy of the lending institution’s monthly or annual statements to verify that everything is legitimate and up to date. Copyright © 2011 Pearson Education, Inc.

Choice of Auto Loans CN (3) You need a $6000 loan to buy a used car. Your bank offers a 3-year loan at 8%, a 4-year loan at 9%, and a 5-year loan at 10%. Calculate your monthly payment and total interest over the lean term with each option: a. 3-year b. 4-year c. 5-year Copyright © 2011 Pearson Education, Inc.

Credit Cards A minimum monthly payment is required. Credit cards differ from installment loans in that you are not required to pay off your balance in any set period of time. A minimum monthly payment is required. Monthly payment generally covers all the interest but very little principal. It takes a very long time to pay off a credit card loan if only the minimum payments are made. Copyright © 2011 Pearson Education, Inc.

Credit Card Debt Example: You have a credit card balance of $2700 with an annual interest rate of 23%. How much will you need to pay each month in order to pay off your balance over 1 year? Solution: You must pay $254.01 per month to pay off the balance in 1 year. Copyright © 2011 Pearson Education, Inc.

Credit Card Debt CN (4) You have a credit card balance of $2300 with an annual interest rate of 21%. You decide to pay off your balance over 1 year. How much will you need to pay each month? (Assume you make no further purchases) Copyright © 2011 Pearson Education, Inc.

A Deepening Hole CN (5) Paul has gotten into credit card trouble. He has a balance of $9500 and just lost his job. His credit card company charges interest of APR=21%, compounded daily. Suppose the credit card company allows him to suspend his payments until he finds a new job, How much will he owe when he starts his new job? Copyright © 2011 Pearson Education, Inc.

Mortgages A home mortgage is an installment loan designed specifically to finance a home. The down payment is the amount of money you must pay up front in order to be given a mortgage or other loan. Closing costs are fees you must pay in order to be given the loan. These include direct costs, or fees charged as points, where each point is 1% of the loan amount. Copyright © 2011 Pearson Education, Inc.

Mortgages A fixed rate mortgage is one in which the interest rate is guaranteed not to change over the life of the loan. An adjustable rate mortgage is one where the interest rate changes based on the prevailing rates. Copyright © 2011 Pearson Education, Inc.

Fixed Rate Payment Options CN (6) You need a loan of $100,000 to buy your new home. The bank offers a choice of a 30-year loan at an APR of 8% or a 15-year loan at 7.5%. Compare your monthly payments and total loan cost under the two options, a. 30-year loan b. 15-year loan Copyright © 2011 Pearson Education, Inc.

Closing Costs CN (7) Great Bank offers a $100,000, 30-year, 8% fixed rate loan with closing costs of $500 plus 2 points. Big Bank offers a lower rate of 7.9%, but with closing costs of $1000 plus 2 points. Evaluate the two options, a. Great Bank b. Big Bank Copyright © 2011 Pearson Education, Inc.

Points Decision CN (8) Continuing on the last problem, you decide to go with Great Bank’s lower closing costs. You learn that Great Bank actually offers two options for 30-year loans: an 8% interest rate with 2 points or a 7.5% interest rate with 4 points. Evaluate your options. a. 8% rate b. 7.5% rate Copyright © 2011 Pearson Education, Inc.

The Relationship Between Principal and Interest for a Payment Understanding the relationship between interest and principal and especially the general shape of the two curves is vital. The difference between home and car loans can also be pointed out due to the length of the loan process. Portions of monthly payments going to principal and interest over the life of a 30-year $100,000 loan at 8% Copyright © 2011 Pearson Education, Inc.

Alternative Strategy CN (9) An alternative strategy to the mortgage options is to take the 30=year loan at 8%, but to try to pay it off in 15 years by making larger payments than are required. A. How much would you have to pay each month? B. What are pros and cons of this strategy? Copyright © 2011 Pearson Education, Inc.

Adjustable Rate Mortgages Rate Approx. for ARM’s CN (10) You have a choice between a 30-year fixed rate loan at 8% and an ARM with a first-year rate of 5%. A. Neglecting compounding and changes in principal, estimate your monthly savings with the ARM during the first year on a $100,000 loan. Suppose that the ARM rate rises to 11% by the fourth year. B. How will your payments be affected? Copyright © 2011 Pearson Education, Inc.

Homework Class Notes 1-18 Quick Quiz 1-10 P.262:1-12 1 web 56. Credit Card Comparison 57. Home Financing 58. Online Car Purchase 59. Student Financial Aid 60. Scholarship Scams 61. Financial Scams 1 world 62. Mortgage Rates 63. Credit Card Statement 64. Bank Rates Copyright © 2011 Pearson Education, Inc.