Your FICO score makes a big difference in how lenders determine what interest ra

Question

Your FICO score makes a big difference in how lenders determine what interest rate to charge you. Consider the situation faced by Edward and Jorge. Edward has a fairly poor FICO score of 660 and, as a result, pays 1 8.0% APR on the unpaid balance of his credit card. Jorge has a FICO score of 740 and pays only 7.1% APR on the unpaid balance of his credit card. If both persons carry an average balance of $4,000 on their credit cards for three years, how much more money will Edward repay compared with what Jorge owes (moral: you want a high FICO score)? Assume monthly compounding of interest. Edward will repay $ more. (Round to the nearest dollar.)

Explanation / Answer

We need to calculate the difference between the future value of payment by both Edward and Jorge in order to determine the excess amount paid by Edward. The formula for calculating future value is:

Future Value = C*(1+r)^n where C = Average Credit Balance, r = Monthly Rate of Interest and n = Total Months

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Solution:

Using the values provided in the question, we get,

Future Value (Total Amount Paid by Edward) = 4,000*(1+18%/12)^(12*3) = $6,836.56 (we use 12 because compounding is monthly)

Future Value (Total Amount Paid by Jorge) = 4,000*(1+7.1%/12)^(12*3) = $4,946.43 (we use 12 because compounding is monthly)

Excess Amount Paid by Edward = 6,836.56 - 4,946.43 = $1,890.13 or $1,890

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Edward will repay $1,890 more.

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