Question

Lou wants to set up his own landscaping business and needs to borrow $2500 to buy equipment. He wants to keep on top of his payments so he would prefer to pay off the loan on a weekly basis. Option A: 2 year term at 3.99% Option B: 1 year term at 3.99% What effect does the term length have on his loan? What should he choose and why? (Answers will vary) Lou wants to set up his own landscaping business and needs to borrow $2500 to buy equipment. He wants to keep on top of his payments so he would prefer to pay off the loan on a weekly basis. Option A: 2 year term at 3.99% Option B: 1 year term at 3.99% What effect does the term length have on his loan? What should he choose and why? (Answers will vary)

Answer 1

Option A
Amount to be borrowed			$2,500
term of loan			2 years
Interest Rate per annum			3.99%
Rate of Interest per week			0.08%
Payment to be made weekely basis,in 2 years or 104 weeks
Instament amount =			(2500*0.08%*(1+0.08%)^104)/((1+0.08%)^104-1)
Installment			=	$    25.02
Total Amount			$ 2,602.04
interest for 2 years			$102.04
Option B
Amount to be borrowed			$2,500
term of loan			1 year
Interest Rate per annum			3.99%
Rate of Interest per week			0.08%
Payment to be made weekely basis,in 1 years or 52 weeks
Instament amount =			(2500*0.08%*(1+0.08%)^52)/((1+0.08%)^52-1)
Installment payment			=	$    49.06
Total Amount			$ 2,551.17
interest for 1 years			$51.17
Effect of term on the loan
The borrower have to pay $49.06 per week to close the loan in one year term.
However the Installment payment gets reduced to $ 25.02 when he chooses to borrow for 2 year
In the above scenario, the interest rate for both the options remains same.
What should he choose and Why?
Normally Interest rate increases with the increase of term of loan.
However under option A interest rate for 2 year remains same with that of 1 year loan. It is a benefit to the borrower
in terms of lower interest rate.
Hence Option A (2 year term) should be chosen for borrowing money