On January 2013, Professor Lee buys a house. Here is the information Price = 250
ID: 2776957 • Letter: O
Question
On January 2013, Professor Lee buys a house. Here is the information
Price = 250,000
LTV (loan to value) = 80%
Interest Rate = 8%
Other cost = 4%
1. What is the effective interest rate?
(calculate monthly payment first) then interest rate
2. If from January 2013, Professor Lee plans to sell his house after 15 years. What is the effective interest rate for Professor Lee in Jan 2013?
3. From January 2013, after 8 years, the market interest rate is 7.5%, do you suggest Professor Lee to refinance his house (if the bank agrees to refinance for 22 years, and charge 4% of cost for refinance)?
Explanation / Answer
EAR = (1+APR/m)^m -1
= (1+0.08/12)^12 -1
= 8.33%
Effective interest rate = EAR/ (1- cost rate)
= 0.0833/(1-0.04)
=8.67%
2) Effective interest rate would be 8.67%. Since the period is quite longer it will not affect the rate.
3)
APR = 7.5%
EAR = (1+APR/m)^m -1
= (1+0.075/12)^12 -1
= 7.7633%
Effective interest rate = EAR/ (1- cost rate)
= 0.07633/(1-0.04)
=8.086%
Since this effective interest rate is greater than the rate he is currenty, paying, he should not refinance the loan.
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