Question

Rico needs approximately ​$2 comma 500 to buy a new computer. A​ two-year unsecured loan through the credit union is available for 13.00 percent interest. The current rate on his revolving home equity line is 9.75 ​percent, although he is reluctant to use it. Rico is in the 15 percent federal tax bracket and the 5.75 percent state tax bracket. Which loan should he​ choose? Why? Regardless of the loan​ chosen, Rico wants to pay off the loan in 24 months. Calculate the monthly payments for​ him, assuming both loans use the simple interest

Answer 1

In case of monthly payment with simple interest, the amount of interest after each payment will keep on reducing.

The amount of monthly payment can be calculated with the use of PMT function/formula of EXCEL/Financial Calculator or with the use of Monthly Instalment Loan Tables. The function/formula for PMT is PMT(Rate,Nper,PV,FV) where Rate = Interest Rate, Nper = Period, PV = Present Value and FV = Future Value (if any).

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Monthly Payment with Revolving Home Equity Loan

Here, Rate = 9.75%/12, Nper = 24, PV = $2,500 and FV = 0

Using these values in the above formula/formula for PMT, we get,

Monthly Payment with Revolving Home Equity Loan = PMT(9.75%/12,24,2500,0) = $115.07

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Monthly Payment with Unsecured Loan through Credit Union

Here, Rate = 13%/12, Nper = 24, PV = $2,500 and FV = 0

Using these values in the above formula/formula for PMT, we get,

Monthly Payment with Revolving Home Equity Loan = PMT(13%/12,24,2500,0) = $118.85

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Conclusion:

Rico should select the Revolving Home Equity Loan as it results in lower monthly payment of $115.07. Also, Rico would be able to save tax [(118.85*24 - 2,500)*(15%+5.75%) = $73.25] on the amount of total interest paid.