Question

When purchasing a $260,000 house, a borrower is comparing two loan alternatives. The first loan is a 90% loan at 8.5% for 25 years. The second loan is an 85% loan for 7.75% over 15 years. Both have monthly payments and the property is expected to be held over the life of the loan. What is the incremental cost of borrowing the extra money?

Answer 1

Answer : Calculation of Incremental cost of borrowing the extra money :

Using CUMIPMT function of Excel :

Calculating cumulative interest for the first loan :

=CUMIPMT(rate,nper,pv,start_period,end_period,type)

where

rate is the rate of interest per period i.e 8.5%/12

nper is the number of payments i.e 25*12 = 300

pv is the amount borrowed i.e 260000 * 90% = 234,000

startperiod is 1

end period 300

type 0 (assuming payments are paid at the end of month)

=-CUMIPMT(8.5%/12,300,234000,0,300,0)

Interest paid is 331269.41.

Calculating cumulative interest for the second loan :

=CUMIPMT(rate,nper,pv,start_period,end_period,type)

where

rate is the rate of interest per period i.e 7.75%/12

nper is the number of payments i.e 15*12 = 180

pv is the amount borrowed i.e 260000 * 85% = 221000

startperiod is 1

end period 180

type 0 (assuming payments are paid at the end of month)

=-CUMIPMT(7.75%/12,180,221000,0,180,0)

Interest paid is 153439.49

Incremental cost of Borrowing is 177829.92 (331269.41. - 153439.49)