Question

If you don’t repay a loan, and a lot of time passes, the debt can grow to unmanageable proportions, as happened to an unfortunate borrower in Melbourne. A grandmother has been forced to put her house up for sale after she ended up owing a massive $83 000 —on a $15 000 loan. Andrea lane, 57, borrowed the money in 2002 to pay for her father’s funeral and to buy a new oven for her Clayton home. But she could not meet the cost of the loan and 18 years later, the amount she owed had grown to $83 000 … Andrea said: ‘I borrowed the money when I was grieving for my father. I just signed the papers.’

a) Based on original loan of $15000, calculate the monthly repayments to be repaid over 5 years. Assume an interest rate of 25% p.a.

Andrea can afford to pay $600 per month into the loan, and she has been able to negotiate a new interest rate of 8% p.a.

b) How long would it take Andrea to repay the loan?

c) If she cannot afford to increase her current repayments, and is unable to negotiate a better interest rate, recommend a strategy to reduce the total length of time to repay the loan? Based on this strategy, how much interest would she save?

Answer 1

a) At the rate of 25% per annum for a loan of $15,000 over 5 years Andrea has to pay monthly instalment of $440.27.

• This is calculated by using excel. the EMI is calculated using PMT function in excel.
• In PMT function 1)rate is interest rate per month 2) nper is 60 3)PV is the loan amount of $15000 4)FV is 0
• Interest is calculated by multiplying the End loan with the interest rate. Principal is calculated by subtracting interest from EMI(payment). By this way the End loan becomes 0 after 5 years as you can see in the picture 2 below.
• In picture 2 below the payment is taken yearly just to show that the loan becomes 0 after 5 years.

Picture 1

Picture 2

b) Andrea will take 28 months to repay the loan if she agrees to pay 600$ at an interest rate of 8% per annum.

• First write Loan, interest rate
• In the amortizing schedule (table) first write 600$ under payment heading, now drag down which shows 600$ in every row.
• Now drag the whole table till the end loan becomes Zero or negative.
• As you can see in the picture below the end loan becomes negative at 28 months as you can see in the picture below..

Picture 3

c) when Andrea cannot increase her monthly payments and cannot negotiate a better interest rate, the best way to reduce the loan tenure is to make a big down payment.

• consider the question 'a', instead of $15,000 if Andrea pays $900 as down payment then the loan amount becomes $14,100. Then Andrea can save an interest of $2,022.
• When Andrea agrees to pay $440.27 same as in the question 'a'.
• For $15,000 loan amount the interest is $11,416 and for $14,100 loan amount the interest is $9,393
• Therefore after subtracting $9,393 from $11,416 Andrea can save interest of $2,022 and the loan tenure can be reduced to 54 months( approximately reduced by 6 months).
• The total interest is calculated using excel : under the interest heading drag till the loan becomes zero, then you can see the sum below your excel sheet
• For the purpose of quick understanding the big down payment was done at the beginning of the loan in the calculation.
• The most important point to remember is Andrea can repay the amount(big down payment) in between the tenure of the loan also and the payment should go towards the principal. Then the tenure of the loan and the interest rate can be reduced.