Contemporary Engineering Economics, 6 th edition Park Copyright © 2016 by Pearson Education, Inc. All Rights Reserved Debt Management Lecture No. 13 Chapter 4 Contemporary Engineering Economics Copyright © 2016

Contemporary Engineering Economics, 6 th edition Park Copyright © 2016 by Pearson Education, Inc. All Rights Reserved Credit Card Debt Management Credit card debt and commercial loans are among the most significant financial transactions involving interest.

Contemporary Engineering Economics, 6 th edition Park Copyright © 2016 by Pearson Education, Inc. All Rights Reserved Example 4.14: Loan Balance, Principal, and Interest  Given: o P = $5,000, o i = 12% APR, o N = 24 months  Find: A

Contemporary Engineering Economics, 6 th edition Park Copyright © 2016 by Pearson Education, Inc. All Rights Reserved Solution  Monthly Payment: A = $5,000(A/P, 1%, 24) = $235.37

Contemporary Engineering Economics, 6 th edition Park Copyright © 2016 by Pearson Education, Inc. All Rights Reserved Calculating the Remaining Loan Balance after Making the n th Payment

Contemporary Engineering Economics, 6 th edition Park Copyright © 2016 by Pearson Education, Inc. All Rights Reserved Example 4.15: Loan Balance at End of Period 6  Given: P = $5,000, i = 12% APR, N = 24 months  Find: Loan balance, principal, and interest payment for the 6 th payment

Contemporary Engineering Economics, 6 th edition Park Copyright © 2016 by Pearson Education, Inc. All Rights Reserved Solution  Monthly payment: $  Interest payment at n = 6 Loan balance at the end of n = 5, or beginning of n = 6 Interest payment Principal payment

Contemporary Engineering Economics, 6 th edition Park Copyright © 2016 by Pearson Education, Inc. All Rights Reserved Example 4.17: Financing Your Vehicle  Given: Three financing options r = 4.5% Payment period = monthly Compounding period = monthly  Find: Which option is best?

Contemporary Engineering Economics, 6 th edition Park Copyright © 2016 by Pearson Education, Inc. All Rights Reserved Solution Option A: Conventional Debt Financing: P debt = $4,500 + $736.53(P/A, 4.5%/12, 42) − $17,817(P/F, 4.5%/12, 42) = $17,847 Option B: Cash Financing P cash = $31,020 − $17,817(P/F,4.5%/12,42) = $15,845 Option C: Lease Financing P lease = $1, $513.76(P/A, 4.5%/12, 42) + $395(P/F, 4.5%/12, 42) = $21,336

Contemporary Engineering Economics, 6 th edition Park Copyright © 2016 by Pearson Education, Inc. All Rights Reserved Home Mortgage Types of Home Mortgages Fixed-rate mortgage Adjustable-rate mortgage Hybrid mortgage The Cost of a Mortgage Loan amount Loan term Payment frequency Points (prepaid interest) Fees Types of mortgages

Contemporary Engineering Economics, 6 th edition Park Copyright © 2016 by Pearson Education, Inc. All Rights Reserved Example 4.16: An Interest-Only Versus a Fully Amortized Mortgage  Given: P = $200,000, APR = 6.6% or 0.55% per month, and N = 30 years  Find: (a) monthly payment; (b) interest payments during the first year of ownership of the home. Option 1: A fully amortized payment option. Option 2: A five-year interest-only option.

Contemporary Engineering Economics, 6 th edition Park Copyright © 2016 by Pearson Education, Inc. All Rights Reserved Solution (a) Monthly payments

Contemporary Engineering Economics, 6 th edition Park Copyright © 2016 by Pearson Education, Inc. All Rights Reserved Solution (b) Interest payments

Contemporary Engineering Economics, 6 th edition Park Copyright © 2016 by Pearson Education, Inc. All Rights Reserved Calculating the Monthly Payments with an Adjustable-Rate Mortgage (ARMs) 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: 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 year thereafter) 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

Contemporary Engineering Economics, 6 th edition Park Copyright © 2016 by Pearson Education, Inc. All Rights Reserved Example 4.18: A 5/1 Hybrid Adjustable Mortgage Plan  Given: Varying annual mortgage rates and N = 30 years  Find: (a) the monthly payment; (b) the total interest payments over the 10-year ownership

Contemporary Engineering Economics, 6 th edition Park Copyright © 2016 by Pearson Education, Inc. All Rights Reserved Solution (a) Monthly payments under a 5/1 hybrid mortgage

Contemporary Engineering Economics, 6 th edition Park Copyright © 2016 by Pearson Education, Inc. All Rights Reserved (b) Total Interest Payment over 10 Years