John wants to buy a property for $105,000 and wants an 80% loan. The lender indi
ID: 2721868 • Letter: J
Question
John wants to buy a property for $105,000 and wants an 80% loan. The lender indicates that a fully amortizing loan can be obtained for 30 years at 12% MEY, with loan origination fees (all lender controlled fees) of $3,500.
a. How much will the lender actually disburse?
b. What is the effective interest cost to the borrower, assuming that the mortgage is paid off after 30 years?
c. If John pays off the loan after 5 years, what is the effective interest charge? Why is it different from the APR in b?
d. Assume the lender also imposes a prepayment penalty of 2% of the outstanding balance if the loan is repaid within the first 8 years of closing. What is the effective cost of the loan if John repays after 5 years?
Explanation / Answer
Lender will actually disburse: $105,000 x 80% + $3500 = $87,500
Effective interest cost = $236501.52
If he repays the loan after five years, he will pay an interest of $51957.52 and principal to be rapid will be $85455.02
hence effective interest rate will be: A = P (1 + rt)
139457.52 = 87500 (1 + r x 60)
1.59 = 1+ r x 60
r = 0.59/60 = 0.98% per month i.e 11.80%
since the loan is repaid earlier in the tenure the borrower does not incur addtional interest charges and hence the effective interest rate is lower
If there is a prepayment penalty then additional charge of $85455.02 x 2% = 1709.10
Hence total payment will be interest + prepayment penalty and principal = $51957.52 + $1709.10 + $87500 = $141,166.62
Effective cost is interest + pre payment penalty = $53666.62
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