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Two years ago, you purchased a $20,000 car, putting $4,000 down and borrowing the rest. Your...

Two years ago, you purchased a $20,000 car, putting $4,000 down and borrowing the rest. Your loan was a 36-month fixed rate loan at a stated rate of 7.0% per year. You paid a non-refundable application fee of $100 at that time in cash. Interest rates have fallen during the last two years and a new bank now offers to refinance your car by lending you the balance due at a stated rate of 5.5% per year. You will use the proceeds of this loan to pay off the old loan. Suppose the new loan over the residual loan life requires a $200 non-refundable application fee. Given all this information, should you refinance? How much do you gain/lose if you do?

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Expert Solution

Old loan scheme Amount($)
Car Purchase     20,000.00
Down Payment        4,000.00
Borrowing     16,000.00
Interest Per year        1,120.00
Interest Payable for 3 years        3,360.00
Outflow under old loan        3,360.00
New Scheme
Principle amount to payoff old loan     16,000.00
New loan interest per year           880.00
Interest cost for 3 years        2,640.00
Additional Application fee           200.00
Total outflow under new loan Option        2,840.00
Gain on converting old loan to new loan           520.00

jeff jeffy answered 2 years ago
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