- This problem needs a structured and a step by step approach to solve this problem. First of all let us look at what is known and what is unknown. The interest rate is given, the monthly payment is given and since the five years have already elapsed the remaining time maturity is 20 years under the revised scenario and 25 years under the original scenario. This means that under the original scenario the total time period was 30 years.
- An important point in this problem is that since the loan payments are on a monthly basis we need to convert the annual rate of compounding to a monthly rate. The annual rate is 5.75% so the monthly rate is 0.47916667% and the time period remaining under original scenario is 300 months and under the revised scenario is 240 months.. Under the original scenario the monthly payment is 822.84 dollars where as under the revised scenario we need to solve for the monthly payment. With 240 months,0,479166 % interest rate and present value of 130,794.68 dollars the monthly payment is 918.28 dollars. Hence the extra payment per month is the difference between 918.28 and 822.84 dollars which is 95.44 dollars.
- I don’t think it would be wise to restructure the loan as a 20 year loan because the extra payment comes out to 95.44 dollars which means that since you already have less than 100 dollars to meet the meet monthly expenses this 95.44 dollars would be an extra burden on your budget.
Part 2
- This problem needs to be solved using a structured approach. First recognize that we need to solve for the interest rate while the minimum monthly payment is known which is 822.84 dollars, the loan balance is also known plus there are refinancing costs of 2000 dollars as well and finally the time to maturity of the loan is also known. Hence we can proceed to step 2.
- For step 2 the time to maturity of the loan is 240 months and the outstanding balance of the loan after refinancing costs are accounted for is 132794.68 dollars. The monthly payment is 822.68 dollars. Hence we can solve for interest rate using a calculator or using a spreadsheet.
- Interest is 0.354588% on a monthly basis which can be converted to a yearly rate of 4.225%. The current rate is less than the existing rate and hence you should refinance your loan.
REFERENCES
Richard,A.B. Stewart ,C.M and Franklin,A.(2006).Principles of Corporate Finance. McGraw-Hill/Irwin.
