Rico needs approximately $2,800 to buy a new computer. A two-year unsecured loan

Question

Rico needs approximately $2,800 to buy a new computer. A two-year unsecured loan through the credit union is available for 12.75 percent interest. The current rate on his revolving home equity line is 9.50 percent, although he is reluctant to use it. Rico is in the 15 percent federal tax bracket and the 5.75 percent state tax bracket. Which loan should he choose? Why? Regardless of the loan chosen, Rico wants to pay off the loan in 24 months. Calculate the monthly payments for him, assuming both loans use the simple interest calculation method.

Question 3- The payment on the home equity loan would be ? $(Round to the nearest cent.)

Monthly Installment Loan Tables ($1,000 loan with interest payments compounded monthly) i 6 12 18 24 30 36 48 60 72 84               96 12.75% 172.92 89.2 61.33 47.42 39.1 33.57 26.7 22.63 19.94 18.06 16.67 5.75% 169.47 85.95 58.12 44.21 35.87 30.31 23.37 19.22 16.46 14.49 13.02 15.00%

Explanation / Answer

Amount to be borrowed = Cost of Computer = $2800,

Loan Option 1: Two year unsecured loan at 12.75% per annum by credit union. (Simple Interest)

Loan Option 2: Revolving Home Equity Line at 9.5% per annum. (Simple Interest)

Interest on Loan Option 1: Interest (1) = (2800 x 12.75 x 2)/100=$714 for two years.

Interest on Loan Option 2: Interest (2) = (2800 x 9.5 x 2)/ 100 = $532 for two years.

Therefore, equated monthly payments for Loan Option 1= (2800 +714) /24 = $146.416

and equated monthly payments for Loan Option 2 = (2800+532)/24 = $138.833

NOTE: A revolving loan in practice does not have a regular repayment schedule. The borrower pays back whatever he/she can every month or at regular time intervals so as to complete repayment within a fixed time period.

Interest Tax Shield on Loan Option 1: Total Tax Rate x Annual Interest Expense = (0.15+0.0575) x (714/2) = $74.0775

Interest Tax Shiekd on Loan Option 2: Total Tax Rate x Annual Interest Expense= (0.15+0.0575) x(532/2) =$55.195

Therefore, Rico should go for the revolving credit if he is interested in lower per month installment burden however, for tax savings purposes the credit union loan is a better option.

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