Compare the two payment options for a $9,500 loan to determine which option has the lower cost of credit.
Option 1: one-time payment to pay off the loan at the end of a 5-year term with a simple interest rate of 7%
Option 2: monthly payment of $166.57 with a fixed compound interest rate of 8% compounded monthly; payments made monthly over a period of 6 years
Find the lower cost of credit. Round your answer to two decimal places as needed.
Option ____ has the lower cost of credit, which is $____.
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To compare the two payment options, we need to calculate the total cost of credit for each option.
Option 1:
Loan amount: $9,500
Simple interest rate: 7%
Term: 5 years
To calculate the total cost of credit, we can use the formula:
Total cost = Loan amount * Simple interest rate * Term
Total cost = $9,500 * 7% * 5 = $3,325
Option 2:
Monthly payment: $166.57
Compound interest rate: 8% (compounded monthly)
Term: 6 years
To calculate the total cost of credit, we first need to calculate the total payments made over the 6-year term:
Total payments = Monthly payment * Months
Total payments = $166.57 * 12 * 6 = $11,995.68
We can then calculate the interest paid over the 6-year term:
Interest paid = Total payments - Loan amount
Interest paid = $11,995.68 - $9,500 = $2,495.68
Therefore, Option 2 has the lower cost of credit, which is $2,495.68.