Five (5) years ago, you bought a house for $171,000, with a down payment of $30,000, which meant you took out a loan for $141,000. Your interest rate was 5.75% fixed. You would like to pay more on your loan. You check your bank statement and find the following information:
Escrow payment
$261.13
Principle and Interest payment
$822.84
Total Payment
$1,083.97
Current Loan Balance
$130,794.68
Write a one to two (1-2) page paper in which you address the following:
Part 1
With your current loan, explain how much additional money you would need to add to your monthly payment to pay off your loan in 20 years instead of 25. Decide whether or not it would be reasonable to do this if you currently meet your monthly expenses with less than $100 left over.
•(a) Explain your strategy for solving the problem.
•(b) Present a step-by-step solution of the problem.
•(c) Clearly state your answer to Part 1. What is your decision?
Part 2
Identify the highest interest rate you could refinance at in order to pay the current balance off in 20 years and determine the interest rate, to the nearest quarter point, that would require a monthly total payment that is less than your current total payment. The interest rate that you qualify for will depend, in part, on your credit rating. Also, refinancing costs you $2,000 up front in closing costs.
•(a) Explain your strategy for solving the problem.
•(b) Present a step-by-step solution of the problem.
•(c) Clearly state your answer to Part 2. What is your decision?
Part 1:
(a) To calculate how much additional money you would need to add to your monthly payment to pay off your loan in 20 years instead of 25, you need to find the new monthly payment amount and subtract the original monthly payment from it.
(b) The step-by-step solution is as follows:
1. Calculate the number of months in 20 years: 20 years * 12 months/year = 240 months.
2. Use the loan balance and the interest rate to calculate the new monthly payment using an amortization formula. The formula is: Monthly Payment = (Loan Amount * Monthly Interest Rate) / (1 - (1 + Monthly Interest Rate)^(-Number of Months)).
- Loan Amount: $130,794.68 (current loan balance)
- Monthly Interest Rate: 5.75% / 12 months = 0.004792
- Number of Months: 240 months
3. Calculate the original monthly payment: $822.84 (given).
4. Calculate the additional money needed: New Monthly Payment - Original Monthly Payment.
(c) The answer to Part 1 is the additional money needed. If you have less than $100 left over after meeting your monthly expenses, you need to evaluate whether you can afford the additional payment.
Part 2:
(a) To identify the highest interest rate you could refinance at in order to pay the current balance off in 20 years and determine the interest rate that would require a monthly total payment that is less than your current total payment, you need to calculate the new monthly payment at different interest rates and compare it to your current total payment.
(b) The step-by-step solution is as follows:
1. Calculate the new monthly payment using an amortization formula for different interest rates. Start with a slightly higher interest rate than the current rate and increment by 0.25% until you find an interest rate that results in a lower monthly payment.
- Loan Amount: $130,794.68 (current loan balance)
- Number of Months: 240 months
- Refinancing Closing Costs: $2,000
2. For each interest rate, calculate the new monthly payment and add the refinancing closing costs.
3. Compare the new total monthly payment (including closing costs) with the current total payment.
4. Find the highest interest rate that results in a lower monthly payment.
(c) The answer to Part 2 is the highest interest rate that allows for a lower monthly payment. You need to consider whether the savings in monthly payment outweigh the cost of refinancing closing costs.
Your decision in both parts would depend on your current financial situation and your willingness to pay more in the short term (part 1) or incur refinancing costs (part 2) for the potential benefits in the long term.