Problems and activities

Question

Rico needs approximately $2,500 to buy a new computer. a 2-year unsecured loan through the credit union is available for 12 percent interest. The current rate on his revolving home equity line is 8.75 percent, although he is reluctant to use it. Rico is in the 15 percent federal fax 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 payments for him, assuming both loans use the simple interest calculation method...

Answer 1

Using simple interest:

Formula:

Interest = Principal × Rate × Time

Credit union loan — 12%

Interest = 2500 × 0.12 × 2 = $600

Total repaid = 2500 + 600 = $3,100

Monthly payment = 3100 ÷ 24 = $129.17

Home equity loan — 8.75%

Interest = 2500 × 0.0875 × 2 = $437.50

Total repaid = 2500 + 437.50 = $2,937.50

Monthly payment = 2937.50 ÷ 24 = $122.40

The home equity line has the lower interest rate and lower monthly payment. If the interest qualifies for a tax deduction, its after-tax cost could be even lower, although current tax rules should be checked before assuming deductibility.

Answer: Credit union = $129.17/month; Home equity = $122.40/month.