Learning Goal: I’m working on a mathematics case study and need the explanation and answer to help me learn.
Two years ago, Angus and Nadie purchased their first home for a purchase price of $686,850, which they paid with a $71,550 down payment and a $615,300 mortgage. At that time, Angus and Nadie both had student loans and needed to borrow money from their parents to fund most of the down payment.
Anguss parents lent them $18,500 at 0% interest, with the expectation that the loan be paid back in five annual payments of $3,700, made at the end of each year. Nadies parents lent them $25,000 at 2.75% simple interest. They agreed that Angus and Nadie would make payments of $5,000 plus interest at the end of each year for five years, with the first payment due two years from the date of the loan.
The purchase of the house was a good decision. As a result of a strong real estate market, Angus and Nadie now have $130,000 of equity in their house. Unfortunately, after purchasing the house, Angus and Nadie made some poor financial decisions that resulted in substantial credit card debt. This included using their credit cards to make purchases that they could not afford and using cash advances to make payments on their various loans.
A summary of Angus and Nadies loans and credit card debts as of the first day of year 3 since the house purchase is shown in the table below. All interest rates are simple interest.
|
Debt |
Current Balance |
Simple Interest Rate on Debt |
Monthly Payment |
Yearly Payment |
|
Anguss parents |
$11,100 |
0% |
$3,700 |
|
|
Nadies parents |
$20,000 |
2.75% |
$5,000 |
|
|
Anguss student loan |
$10,000 |
Prime + 3% |
$300 |
|
|
Nadies student loan |
$7,000 |
Prime + 3% |
$250 |
|
|
Credit card 1 |
$12,000 |
27% |
Minimum 5% of balance plus interest |
|
|
Credit card 2 |
$7,500 |
18% |
Minimum 3% of balance plus interest |
|
|
Credit card 3 |
$14,000 |
18% |
Minimum 3% of balance plus interest |
|
|
Credit card 4 |
$3,350 |
2% |
$200 plus interest |
As Angus and Nadie are at ends trying to pay their bills, they reach out to their local not-for-profit credit counselling society for help. After reviewing Angus and Nadies case, their credit counsellor proposes the following course of action:
- Leverage the equity in Angus and Nadies home to obtain a home equity line of credit (HELOC). The credit counsellor can help Angus and Nadie acquire a HELOC with payments of $300 plus interest per month, with a simple interest rate of prime + 3%.
- Use the HELOC to pay off the credit card balances and loans that carry a higher interest rate than the HELOC and close the associated accounts so no further debt can be accrued.
- Convert all remaining loans to a monthly payment schedule.
Tasks
As an intern working for the credit counselling society, youve been tasked with working out the details for Angus and Nadies debt consolidation plan, which you will then present in a written report. Your tasks are as follows:
- Find and report the current Bank of Canada prime rate, including the date and the source you used. (5 marks)
- Calculate the equivalent payment that would be necessary to pay off the loans from Angus and Nadies parents if the loans were to be paid off today using the HELOC. Also, calculate the monthly payments on each of the loans from Angus and Nadies parents, given that the loans are paid back with monthly payments over the original time frames of the loans. (5 marks)
- For each student loan and credit card balance, calculate the current monthly payments and interest charges on the debts. (5 marks for each student loan and credit card; total: 30 marks)
- For each student loan and credit card balance, calculate the monthly payments and interest charges on the debt that would result from using the HELOC to pay off the current balance. (5 marks for each loan and credit card; total: 30 marks)
- Identify which debts should be consolidated; that is, identify which loans and credit card balances should be paid off using the HELOC and which loans and credit card balances should remain with the original lenders. (5 marks)
- Determine the change in Angus and Nadies total monthly payment as a result of the debt consolidation. (5 marks)
- Determine the change in Angus and Nadies total payment over the next nine months as a result of the debt consolidation. (5 marks)
- Determine how much total interest is saved over the next nine months as a result of the debt consolidation. (5 marks)
- Determine the change in the average interest rate Angus and Nadie would pay before and after they consolidate their debts. (5 marks)
- Prepare a report written in MS Word for Angus and Nadie outlining the debt consolidation plan. (15 marks) The report should include
- an explanation of the rationale behind the best plan for Angus and Nadie to reduce their monthly burden of debt;
- a table summarizing each individual debt and the total debt before and after consolidation; and
- a summary detailing how the debt consolidation impacts Angus and Nadies monthly cash flow, and how much money they will save over the next nine months.
Your report should include all supporting calculations (i.e., tasks 19) in an appendix.
