Andrew wants to borrow $380,000 to finance his first home.
He finds a loan that applied interest at
4.3% p.a. compounding monthly. Andrew makes monthly repayments of $2,250 to pay off the loan.
a) What is the effective annual rate of interest for this loan?
b) How long does the loan last for?
a)
i=0.043 and n=12
(( ) )
n
i
i effective= 1+ −1 × 10 0
n
(( ) )
12
0.043
i effective= 1+ −1 ×10 0
12
i effective=4.39 % p . a . compounding annually
b) There are three methods for solving part (b). You need to confidently understand all three
methods because any one of them may be used in WACE exam questions.
METHOD 1: ClassPad Finance App
N 259.81
I% 4.3
PV 380000
PMT -2250
FV 0
P/Y 12
C/Y 12
N=259.81 which rounds up to 260 months
NOTE: 259.81 means that Andrew will make 259 payments in 259 months of $2,250 but the 260th
month will be an amount less than $2,250 (i.e., the ‘leftover’ amount)
260 months is also equal to 21 years and 8 months
METHOD 2: Spreadsheet
Sometimes a WACE exam may give you an excerpt of a few rows of a spreadsheet. However, for
this activity, I’ve given you the rows from N = 1 – 10, then I’ve skipped many rows, and then have
given you the rows from N = 255 – 264
N PV I% Interest PMT FV
1 $380,000.00 0.003583 $1,361.67 $2,250.00 $379,111.67
2 $379,111.67 0.003583 $1,358.48 $2,250.00 $378,220.15
3 $378,220.15 0.003583 $1,355.29 $2,250.00 $377,325.44
4 $377,325.44 0.003583 $1,352.08 $2,250.00 $376,427.52
5 $376,427.52 0.003583 $1,348.87 $2,250.00 $375,526.39
6 $375,526.39 0.003583 $1,345.64 $2,250.00 $374,622.02
7 $374,622.02 0.003583 $1,342.40 $2,250.00 $373,714.42
8 $373,714.42 0.003583 $1,339.14 $2,250.00 $372,803.56
9 $372,803.56 0.003583 $1,335.88 $2,250.00 $371,889.44
10 $371,889.44 0.003583 $1,332.60 $2,250.00 $370,972.05
N PV I% Interest PMT FV
255 $12,924.72 0.003583 $46.31 $2,250.00 $10,721.03
256 $10,721.03 0.003583 $38.42 $2,250.00 $8,509.45
257 $8,509.45 0.003583 $30.49 $2,250.00 $6,289.94
258 $6,289.94 0.003583 $22.54 $2,250.00 $4,062.48
259 $4,062.48 0.003583 $14.56 $2,250.00 $1,827.04
260 $1,827.04 0.003583 $6.55 $2,250.00 -$416.42
261 -$416.42 0.003583 -$1.49 $2,250.00 -$2,667.91
262 -$2,667.91 0.003583 -$9.56 $2,250.00 -$4,927.47
263 -$4,927.47 0.003583 -$17.66 $2,250.00 -$7,195.12
264 -$7,195.12 0.003583 -$25.78 $2,250.00 -$9,470.91
Before we answer the question, it is important to understand how the spreadsheet is made. Here’s
an example of the values taken in the 10 th row:
The 260th row is the first instance when the Future Value (FV) turns negative. Remember, FV
represents the amount we still owe the bank. Therefore, negative FV values signify that we've
"overpaid" the bank. Therefore, the first negative FV value indicates that the loan has been fully
repaid.
METHOD 3: ClassPad Sequences App
The formula for the first-order recurrence relation is as follows:
( ni ) ×T + r ,T =P
T n+1= 1+ n 0
i = interest rate as a decimal
n = number of times in which interest is compounded per year
r = the same as PMT, it means the number of regular payments
o For investments, r is positive
o For annuities and loans, r is negative
P = principal amount (a.k.a., the starting amount)
First of all, notice the similarity between the formula for the spreadsheet in Method 2 and the
formula for the first-order recurrence relation in Method 3:
Method 2:
Method 3:
So, the formula would be:
(
T n+1= 1+
0.043
12 )×T n−2250 , T 0 =38000 0
T n+1=1.003583 ×T n−2250 , T 0=38000 0
For the first screenshot, remember you can click on the numbers in the a n column to see the full
value at the bottom of the screen. In the second screenshot, it shows that the 260 th row (i.e., the
260th month) is the first time that the value of the loan becomes negative.
TODAY’S ACTIVITY: Answer the following two questions
Question One
Olivia wants to borrow $285,000 to finance his first home. He finds a loan that applied interest at
3.35% p.a. compounding monthly. Andrew makes monthly repayments of $1,950 to pay off the
loan.
a) What is the effective annual rate of interest for this loan?
b) How long does the loan last for? [Work this out three times using the three different methods]
Question Two
John wants to invest $10,000. He finds an investment plan that applies interest at 1.35% p.a.
compounding monthly. Andrew makes monthly contributions of $980 to grow his investment.
a) What is the effective annual rate of interest for this investment?
b) When does John’s investment first reach $50,000? [Work this out three times using the three
different methods]
