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K-3 Finance: Installment LoansPart A: Installment Loans SummaryQuestions Explored:What will the monthly payments be for my student loan? Car loan? Mortgage?How much interest will I pay? What is the payment schedule?How much interest can I save by making extra payments?Terms:Installment loan: loan paid off with equal regular paymentsMortgage: home loanDown payment (on home): typically 10%-20% of the purchase priceClosing: time at which the loan beginsPoint: fee used to negotiate your interest rate; one point is 1% of the loan amount (the amount paid toward points does not go toward your down payment or your mortgage; it goes to the lender)Fixed rate mortgage (FRM): guaranteed that interest rate will not change over the life of the loanAdjustable rate mortgage (ARM): interest rate you pay changes when prevailing rates changeUsually includes a rate cap that can’t be exceededEscrow account: required on almost all mortgagesMoney deposited monthly in this account covers property taxes and insuranceThis money is added to the monthly payment, which is why the monthly payment found by the loan payment formula is an underestimate of what you’ll actually pay each monthSome things to consider:If your down payment is less than 20%, you may have to pay PMI (private mortgage insurance) each month. This insures the lender against a default. Make sure you know the rules if you will be paying PMI.ARMs can surprise people. Make sure you know what type of mortgage you are getting into. If your payments are low now but you have an ARM and the prevailing interest rates rise, they can significantly increase! You may hear that it’s “always better to buy than to rent.” Even if this is economically true in your situation, it’s not always just a matter of the math. It depends on your preferences, lifestyle, what you’re comfortable with, etc.Rule for an installment loan: The amount of interest paid each payment period of an installment loan is computed on the remaining balance of the loan. The amount paid toward the remaining balance of the loan is found by subtracting the interest payment from the fixed monthly payment. Comparison from (July 2016) Exercises: Finance: LoansOpen the Excel file that has the loans payment calculator to answer the first question. The payment calculator is the first sheet in the workbook.Suppose you purchase a home for $150,000. The lender requires 20% down plus 1 point due at closing. The loan is a 4% fixed-rate mortgage over 30 years. In addition, other closing cost fees total about $4,000. Find the total closing costs, monthly payment, and how much you paid total for the home. How much interest will you pay over the life of the loan, assuming no extra payments were made? Create an amortization schedule for the loan for the first 5 months. Discuss how the portion of the payment made up of interest changes over the life of the loan. We will be creating an amortization table in great detail with an Excel activity next. PeriodStarting BalanceInterest Payment Principal PaymentRemaining BalanceAccumulated Interest0120,0000.000.00120,0000.0012345Notice the sum of these columns is always the same (your monthly payment)Now return to the Excel file with the Payment Calculator and Amortization Activity. Use the sheet provided for the Excel activity to plan your Excel formulas and create a working amortization table. You are going to purchase a home for $200,000. You will put 20% down on this home. Identify the amount you will have to borrow.A bank (or credit union) advertises a 30-year fixed mortgage at 3.4% APR and a 15-year fixed mortgage at 2.7% APR. Use those numbers to fill in the table below.15-year FRM at 2.7%30-year FRM at 3.4%Monthly payment Total interest over the life of the loan (assuming no extra payments) What are the obvious advantages and disadvantages of each loan? Discussion: What are several things you might think about before purchasing a home? Suppose that you have taken out subsidized Stafford loans totaling $20,000 over your four years in college. Your rate is a fixed 3.86% and you will repay using a standard 10-year repayment plan. Find your after-graduation monthly payment and explain why your principal is still $20,000 (as opposed to $20,000 plus accrued interest) when you graduate, assuming you haven’t paid anything toward the principal of the loan during school. Suppose that you have taken out unsubsidized Stafford loans totaling $45,000 (you can do this if you’re an independent) for your four years in college. Your loans were: $9500 the first year, $10,500 the second year, and $12,500 for the third year and again for the fourth year. Your rate is a fixed 3.86% (suppose it stays that way for each new loan you take out for simplicity, although the rate on each new loan can be different) and you will repay using a standard ten-year repayment plan. What is an unsubsidized loan? Who is responsible for the interest while you are in school? Suppose that you do not pay any interest payments while in school. This means that when you graduate the interest that accrued while you were in school is added to your principal, i.e. it is “capitalized.” Let’s first find the interest that has accrued over the four years. For capitalization purposes, the interest on these loans is computed using simple interest. Loan AmountNumber years interest is accruingRate Total interest accrued upon graduation$9500$10,500$12,500$12,500TotalUsing the table, what is your principal upon graduation?_____________Compute your monthly payment and total interest paid assuming you are on a standard ten-year repayment plan. Now suppose that you had made interest payments throughout your college career so that your principal is $45,000 upon graduation. Find the monthly payment and total interest paid assuming you are on a standard ten-year repayment plan. How much less interest would you pay? You can afford $250 loan payments for a car with an auto loan at 2% interest for 60 months. How expensive of a car can you afford? You can afford $850 loan payments for a home with a mortgage at 3.5% for 30 years. How expensive of a house can you afford? (Keep in mind we’re neglecting other costs in addition to the loan payment for simplicity.) Suppose you purchase a home with a $220,000 mortgage at 4% for 30 years. What will be the remaining home balance after 10 years (assuming you haven’t paid extra)? How much interest have you paid after 10 years? After 30 years? Decreasing interest paid and payoff time: Suppose that you make a payment toward the principal of $3000 dollars at the end of the third year. How much interest does this one payment save? How much time does this save to pay off the loan? (Note: making at least one extra payment will decrease your payoff time. This means you will have to find the period in the table with the last positive remaining balance.) Decreasing interest paid and payoff time: Suppose that every payment period you pay $10 extra toward the principal. How much interest do these payments save? How much time does this save to pay off the loan? (Note: making at least one extra payment will decrease your payoff time. This means you will have to find the period in the table with the last positive remaining balance.) Recall from the simple and compound interest that annual percentage yield (APY) is slightly higher than the annual percentage rate (APR). This is of course true with installment loans as well. Given this information, would a bank be more likely to emphasize the APY of a loan or the APR of a loan? Excel Activity: Installment Loan Amortization Table Part I: PlanningNow that you’ve done an exercise creating the first few lines of an amortization table, use the image below to plan out your Excel formulas in order to create an amortization table. This table will also give you the ability to make extra payments. The six empty cells that have bold borders are the ones that need formulas. Think carefully about what cells need absolute references, what cells need relative references, and what cells, if any, need both types of references. Part II: Creating the SpreadsheetNow that you have your formulas planned, open up the Excel file that contains the payment calculator and amortization table. Type your formulas into the same boxes and pull the formulas down. Did you do it correctly? Test it out entering the information from Problems 1 and 2 on the in-class loan problems. Do the numbers match the numbers from the activity? Part III: Using the TableNow continue answering the questions on your In-Class Problems sheet using the payment calculator at the top of the spreadsheet and/or examining how the amounts in the table change after changing information at the top. ................
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