Question

Could you answer Question 3, and the information about question 1 has been given.

Question 1

Bill has bought a new home in Canberra. He borrowed $600000 at a rate of 3.5% p.a., which is to be repaid in annual instalments over a thirty year period. The first instalment is due on 19 March 2020.

What are Bill’s annual repayments? the annual repayment is  $32622.8

Question 3

The recently released recommendations of the Banking Royal Commission (the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry) include the elimination of commission pay- ments to mortgage brokers.

Returning to the details of question 1 above: Theresa was Bill’s mortgage broker. Bill’s bank will pay her commission amounts of $1 000 annually from 19 March 2020 through to 19 March 2049 (inclusive).

If we view the bank’s mortgage business as making neither a profit nor a loss, then (in the absence of any internal capital transfers) Theresa’s com- mission payments have to effectively come from Bill.

a. As at 19 March 2019, what is the total value of Theresa’s commission (use a valuation interest rate of 3.5% p.a.)?

If the value of Theresa’s commission comes from Bill, then the total amount of Bill’s loan is $600 000 plus your answer to part a above. But Bill’s pay- ments are only of an amount calculated by you in question 1 above. This suggests that the effective interest rate the bank requires on its funds is not the 3.5% p.a. that it communicates publicly.

b. Is the effective interest rate that bank requires on its funds higher or lower than the 3.5% p.a. that it communicates publicly? Why?

c. Calculate the effective interest rate discussed in part b above. Carefully explain how you reached your answer.

d. If Bill had been offered the effective rate discussed in part b above, by how much would his annual payments increase or decrease?

Answer 1

Please refer to below spreadsheet for calculation and answer. Cell reference also provided.

Cell reference -

Hope this will help, please do comment if you need any further explanation. Your feedback would be appreciated.