Internet-based Project I. Financing a Purchase At some point in your life...

Internet-based Project

I. Financing a Purchase At some point in your life, you are likely to need to borrow money to finance a purchase. For example, most of us will finance the purchase of a car or a home. What is the mathematics behind financing a purchase? When you borrow money from a bank, the bank uses a rather complex equation (or formula) to determine how much you need to pay each month to repay the loan. There are a number of variables that determine the monthly payment. These variables include the amount borrowed, the interest rate, and the length of the loan. The interest rate is based on current economic conditions, the length of the loan, the type of item being purchased, and your credit history.

The following formula gives the monthly payment P required to pay off a loan amount L at an annual interest rate r, expressed as a decimal, but usually given as a percent. The time t, measured in months, is the length of the loan. For example, a 30-year loan requires 12 × 30 = 360 monthly payments.

1. Interest rates change daily. Many websites post current interest rates on loans. Go to www.bankrate.com (or some other website that posts lenders’ interest rates) and find the current best interest rate on a 60-month new-car purchase loan. Use this rate to determine the monthly payment on a $30,000 automobile loan.

2. Determine the total amount paid for the loan by multiplying the loan payment by the term of the loan.

3. Determine the total amount of interest paid by subtracting the loan amount from the total amount paid from question 2.

4. More often than not, we decide how much of a payment we can afford and use that information to determine the loan amount. Suppose you can afford a monthly payment of $500. Use the interest rate from question 1 to determine the maximum amount you can borrow. If you have $5000 to put down on the car, what is the maximum value of a car you can purchase?

5. Repeat questions 1 through 4 using a 72-month new-car purchase loan, a 60-month used-car purchase loan, and a 72-month used-car purchase loan.

6. We can use the power of a spreadsheet, such as Excel, to create a loan amortization schedule. A loan amortization schedule is a list of the monthly payments, a breakdown of interest and principal, along with a current loan balance. Create a loan amortization schedule for each of the four loan scenarios discussed on the previous page, using the following as a guide. You may want to use an Internet search engine to research specific keystrokes for creating an amortization schedule in a spreadsheet. We supply a sample spreadsheet with formulas included as a guide. Use the spreadsheet to verify your results from questions 1 through 5.

7. Go to an online automobile website such as www.cars.com, www.edmunds.com, or www.autobytel.com. Research the types of vehicles you can afford for a monthly payment of $500. Decide on a vehicle you would purchase based on your analysis in questions 1–6. Be sure to justify your decision, and include the impact the term of the loan has on your decision. You might consider other factors in your decision, such as expected maintenance costs and insurance costs.

Citation: Excel ©2013 Microsoft Corporation. Used with permission from Microsoft.