Rico needs approximately $2,800 to buy a new computer. A two-year unsecured loan
ID: 2793369 • Letter: R
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 - 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% 174.03 90.26 62.38 48.49 40.18 34.67 27.83 23.79 21.15 19.3 17.95Explanation / Answer
Loan Amount = $2800
Interest rate on home equity = 9.5%
In case of home Equity, there will be a draw period and there will be a repayment period.
In the draw period only interest has to be paid and prinicpal outstanding will remain $2800.
After this draw period, during repayment period both interest and principal have to be paid off.
Sometimes there is no repayment period at the end of drae period and the entire sum borrowed has to be paid off.
This is the case with Rico.
For revolving home equity line, It pays an interest = Principal * Interest rate per period = $2800 * 0.095/12 = $22.17
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Rico can go with revolving home equity line if he wants to reduce his monthly expenses as the monthly interest payments will be much smaller and the interest paid is tax deductible. Although, the total payment that he ends up making for home equity line is larger as the monthly interest payments do not amortize the principal part of the loan.
Total amount paid back in 2 years in case of unsecured loan is $47.42* (2800/1000) * 24 = $3186.624 (from the table)
Total amount paid back in 2 years in case of home equity credit line is $22.17 * 24 + $2800 = $3332
Taxes saved in case of home equity credit line = 15% of total interest payments = 0.15 * $532 = $79.8
Even with tax savings, Rico ends up paying more with home equity credit line but it's a good opion if he wants lower monthly liabilities for the next 2 years.
Unsecured loan has no tax benefits but still decreases his overall payment and must be preferred if he doesn't mind the higher monthly payments.
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