Question

Shannon and Duncan Fisher were concerned about their level of debt. They had borrowed from their bank to purchase their house, car, and computer. For these three loans, the Fishers must make regular monthly payments. The couple also owe $6000 to MasterCard and $2500 to Visa. Shannon and Duncan decided to meet with a consumer credit counsellor to gain control of their debts. The counsellor explained to them the details of their loans and credit card debts. Shannon and Duncan were shocked to discover that whereas their computer and car loans had an interest rate of 7.95% p.a., their credit cards had an interest rate of 19.99% pa. The counsellor pointed out that the interest rate on their three loans was reasonable. However, because the interest rate on the credit cards was so high, she advised Shannon and Duncan to borrow money at a lower interest rate and pay off the credit card debts. The credit counsellor suggested that they should consider obtaining a home equity line of credit (HELOC). She explained that the rate of interest on the line of credit would likely be a few percentage point higher than the prime rate, but much lower than the rate of interest charged on their credit card balances. Shannon and Duncan would have to make a minimum payment every month, similar to that of a credit card. The payment would then be applied to pay all the interest and a portion of the principal balance owing on the line of credit. The line of credit would allow them to make monthly payments higher than the minimum so that they could pay as much toward the principal balance as they could afford. Due to the much lower interest rate on a line of credit as compared to a typical credit card, the money they would save on interest each month could be paid toward the principal. A line of credit appealed to Shannon and Duncan, as it helped them feel more in control of the finance and gave them the resolve to pay off their credit card debts. Shannon and Duncan then met with their bank manager and were approved for a S15000 line of credit. Immediately, they paid off the $6000 owed to MasterCard and the $2500 owed to Via with money from the line of credit. They then decided to pay off the line of credit over the next ten months by making monthly payments equal to one tenth of the original line of credit balance plus the simple interest owed on the remaining line of credit balance The simple interest rate on the line of credit is expected to be 6.25% over the next ten months. Shannon and Duncan agreed to cut up their credit cards and not charge any more purchases until they had paid off their line of credit.

QUESTIONS

1. Suppose Shannon and Duncan pay off their credit cards with their line of credit on April 20. They will make their monthly payments on the 20th of each month, beginning in May. Create a schedule showing their monthly payment for the next ten months. How much interest will they pay using this repayment plan?

2. Suppose Shannon and Duncan had not gotten a line of credit but kept their credit cards. They decided not to make any more credit card purchases. Instead, they borrowed $8500 from Shannon's parents to pay off the MasterCard and Visa and made monthly payments equal to one-tenth of the original credit card debt plus simple interest of 5% pa on the remaining monthly balance. They will make their monthly payments on the 20th of each month, beginning in May. Create schedule showing their monthly payments for the next ten months. How much interest would they have paid using this repayment plan?

3. How much money did Shannon and Duncan save on interest by borrowing from Shannon's parents?

Answer 1

Shannon and Duncan have interests on two credit cards to be paid. However, the interest rates on these credit cards is to high. Thus, they have two options in hand. The first option is to take a line of credit from the bank and use it to repay the credit card amount due immediately and then repay the remaining line of credit in 10 equally monthly installments.

The second option is to take a loan from Shannon's parents and use it to repay the credit card amount due immediately and then repay the loan amount in 10 equally monthly installments.

(1)

Shannon and Duncan pay $8500 on credit cards immediately. The remaining $6500 of $15000 credit they use to make the principal and interest payments. The monthly repayment scedule is shown as below:

Amount pending on April 20	15000		Interest	6.25%
	20-May	20-Jun	20-Jul	20-Aug	20-Sep	20-Oct	20-Nov	20-Dec	20-Jan	20-Feb
Principal paid	1500	1500	1500	1500	1500	1500	1500	1500	1500	1500
Principal remaining	13500	12000	10500	9000	7500	6000	4500	3000	1500	0
Interest	937.5	843.75	750	656.25	562.5	468.75	375	281.25	187.5	93.75
Interest +Principal	2437.5	2343.75	2250	2156.25	2062.5	1968.75	1875	1781.25	1687.5	1593.75

The sum of interests paid is sum of all the values of the below row

937.5

843.75

750

656.25

562.5

468.75

375

281.25

187.5

93.75

Therefore, the sum of interests paid is $ 5156.25.

However, if we assume that the amount left after the credit cards have been paid $6500 is used for principal repayment and interest payment, Duncan and Shannon do not have to pay any interest in their own till 2 months.

$6500 - $2437.5 - $2343.75 = $1718.75 - $1500 for third month payment = $218.75 remaining

This amount is used for interest payment

Thus, the interest paid by Shannon and Duncan = (750 - 218.75) + 656.25 + 562.5 + 468.75 + 375 + 281.25 + 187.5 + 93.75 = $ 3156.25

However, let us consider the simple case where the sum of interests paid is $ 5156.25.

(2)

Shannon and Duncan borrow from Shannon's parents at 5% interest rate.

The table below shows the repayment schedule.

Amount pending on April 20	8500		Interest	0.05
	20-May	20-Jun	20-Jul	20-Aug	20-Sep	20-Oct	20-Nov	20-Dec	20-Jan	20-Feb
Principal paid	850	850	850	850	850	850	850	850	850	850
Principal remaining	7650	6800	5950	5100	4250	3400	2550	1700	850	0
Interest	425	382.5	340	297.5	255	212.5	170	127.5	85	42.5

The sum of interests paid is sum of all the values of the below row

Interest

425

382.5

340

297.5

255

212.5

170

127.5

85

42.5

Therefore, the sum of interests paid is $ 2337.5.

(3)

The difference in the interests paid is $ 5156.25 - $ 2337.5 = $2818.75

This is the amount of money that they have saved on interest by taking loan from Shannon's parents.