Reducing balance loans

15
VCE coverage
Area of study
Units 3 & 4 Business related mathematics

In this chapter
15A 15B 15C 15D Loan schedules The annuities formula Number of repayments Effects of changing the repayment 15E Frequency of repayments 15F Changing the rate 15G Reducing balance and at rate loans

712

Further Mathematics

Introduction

When we invest money with a nancial institution the institution pays us interest because it is using our money to lend to others. Conversely, when we borrow money from an institution we are using the institutions money and so it charges us interest. In reducing balance loans, interest is usually charged every month by the nancial institution and repayments are made by the borrower also on a regular basis. These repayments nearly always amount to more than the interest for the same period of time and so the amount still owing is reduced. Since the amount still owing is continually decreasing and interest is calculated on a daily balance but debited monthly, the amount of interest charged decreases as well throughout the life of the loan. This means that less of the amount borrowed is paid off p in the early stages of the loan compared to the end. If we graphed the amount owing against time for a loan it would look like the graph at right. That is, the rate at which the loan is paid off increases as the loan progresses.
Amount owing Time

The terms below are often used when talking about reducing balance loans: Principal, P = amount borrowed ($) Balance, A = amount still owing ($) Term = life of the loan (years) To discharge a loan = to pay off a loan (that is A = $0) It is possible to have an interest only loan account whereby the repayments equal the interest added and so the balance doesnt reduce. This option is available to a borrower who wants to make the smallest repayment possible. Though the focus of this chapter is reducing balance loans, note that the theory behind reducing balance loans can also be applied to other situations such as superannuation payouts, for people during retirement, and bursaries. In each of these situations a lump sum is realised at the start of a period of time and regular payments are made during that time. Regular payments are called annuities. So these situations are often called annuities in arrears because the annuity follows the realisation of the lump sum.

Chapter 15

Reducing balance loans

713

Loan schedules
The rst amount of interest is added to the balance of a loan account one month after the funds are provided to the customer. The rst repayment is usually made on the same day. Consider a loan of $800 that is repaid in 5 monthly instalments of $165.81 at an interest rate of 1.2% per month, interest debited each month. A loan schedule can be drawn for this information, showing all interest debits and repayments. From the schedule the amount owing after each month is shown and the total interest charged can be calculated. For any period of the loan: Total repayments = Interest paid + Principal repaid

Month 1 2 3 4 5

Balance at start of month ($) 800.00 643.79 485.71 325.73 163.83

Interest (1.2% of monthly starting balance) ($) 9.60 7.73 5.83 3.91 1.97

Total owing at end of month ($) 809.60 651.52 491.54 329.64 165.80

Repayment ($) 165.81 165.81 165.81 165.81 165.80

Balance after repayment ($) 643.79 485.71 325.73 163.83 0.00

Each month interest of 1.2% of the monthly starting balance is added to that balance and the repayment value is subtracted, leaving the starting balance for the next month. This process continues until the loan is paid off after the 5 months. Note that the amount of interest charged falls each month and so the amount of principal paid each month increases as outlined earlier. Another method can be used to analyse this account, but it doesnt display interest amounts. Since the interest rate is 1.2% per month the balance increases by this rate each month. Recalling the work covered in the previous chapter about the growth factor, we can write: r Growth factor, R = 1 + -------where 1 represents the original amount and 100 =1+
1.2 -------100

r represents the increase per period

= 1.012 So: Balance at start of second month = balance at start of rst month R repayment A2 = 1 R Q where Q is the regular repayment.

714

Further Mathematics

WORKED Example 1
An $800 loan is repaid in 5 monthly instalments of $165.81 at an interest rate of 1.2% per month, interest debited each month. Calculate: a the amount still owing after the 4th month b the total interest charged during the 5 months. THINK a
1

WRITE a r R = 1 + -------100 1.2 = 1 + -------100 = 1.012 A1 = A0 R Q = 800(1.012) 165.81 A1 = $643.79 A2 = A1 R Q = 643.79(1.012) 165.81 A2 = $485.71 A3 = A2 R Q = 485.71(1.012) 165.81 A3 = $325.73 A4 = A3 R Q = 325.73(1.012) 165.81 A4 = $163.83 The amount still owing at the end of the 4th month is $163.83 b Total interest = 165.81 5 800 = 829.05 800 = $29.05

Calculate the growth factor. r R = 1 + -------100

Find the balance, A1, at the start of the 2nd month. A0 = starting principal A0 = $800 Find the balance, A2, at start of the 3rd month. Continue this process to nd A3, A4 and A5.

The amount still owing at the end of the 4th month is A4.

b Total interest = Total repayments Principal repaid

As mentioned earlier, institutions usually debit a loan account with interest each month. In this chapter we also consider situations in which interest is debited fortnightly and quarterly. The frequency with which a customer can make repayments may be weekly, fortnightly or monthly, and we also consider quarterly repayments. In all cases in this chapter the frequency of debiting interest will be the same as the frequency of making repayments, although this is not necessary in practice. It simply makes calculations easier. The calculations outlined for monthly repayments would follow exactly the same pattern for other repayment frequencies. In worked example 1, the loan was paid off with only a few repayments. In practice, the repayment of most loans takes considerably longer than this. The process outlined in the example continues throughout any part of the term of the loan.

Chapter 15

Reducing balance loans

715

WORKED Example 2
A loan of $16 000 is repaid by monthly instalments of $430.83 over 4 years at an interest rate of 1.1% per month, interest debited monthly. Calculate: a the amount still owing after the 5th repayment b the decrease in the principal during the rst 5 repayments c the interest charged during this time. THINK a
1

WRITE a r R = 1 + -------100 1.1 = 1 + -------100 = 1.011

Calculate the growth factor, R.

Find the balance, A1, at the end of the 1st month (or the start of the 2nd month). A0 = 16 000, Q = 430.83. (a) Find A2 from A1. (b) Repeat until A5 is found. (A5 is the balance at the end of the 5th month.)

A1 = A0 R Q = 16 000(1.011) 430.83 A1 = $15 745.17 A2 = A1 R Q = 15 745.17(1.011) 430.83 A2 = $15 487.54 A3 = 15 487.54(1.011) 430.83 = $15 227.07 A4 = 15 227.07(1.011) 430.83 = $14 963.74 A5 = 14 963.74(1.011) 430.83 = $14 697.51 The amount owing after 5 months is $14 697.51. b Decrease in principal = A0 A5 = 16 000 14 697.51 = $1302.49 The principal has decreased by $1302.49 in the rst 5 months of the loan. c Interest charged = 430.83 5 1302.49 = $851.66 The interest charged during the rst 5 months is $851.66.

Write a statement. The decrease in the principal is the difference between the amount owing initially, A0, and after the 5th month, A5. Write a statement.

Interest charged = Total repayments Principal repaid Write a statement.

716

Further Mathematics

More often than not a nancial institution provides the nominal interest rate per year rather than the interest rate per period. As outlined in the previous chapter in the compound interest formula section, the rate per period can be obtained from the nominal annual rate as follows: Nominal interest rate per annum Interest rate per period, r = ------------------------------------------------------------------------------------Number of interest periods per year It is important to note that while a loan can be drawn at a certain interest rate, that rate will generally not remain the same for the life of the loan. This means that when we consider borrowing we should be aware that the amount of the repayments may increase (due to an increase in the interest rate) during the term of the loan and we should be condent that repayments can be met even if the rate rises. It has been said that if a potential borrower can maintain repayments for a rate of 11% p.a. over the term of the loan then the borrower can withstand rate changes that may range from perhaps 5% p.a. to 17% p.a. Let us now look at how quickly the principal decreases at the end of a loan compared with the earlier stages.

a A family take out a loan of $40 000 to extend their home. The loan is made at a rate of interest of 10% p.a. (debited monthly) and is repaid over 10 years by monthly instalments of $528.60. For the 3rd repayment nd: i the amount of principal repaid ii the amount of interest paid. b After 8 years the amount still owing is $11 455.71. Assuming the same conditions apply as in part a, for the 97th repayment nd: i the principal repaid ii the interest paid. THINK a i
1

WORKED Example 3

WRITE Calculate the monthly interest rate, r. 10 a i r = ----12 = 0.833 33% per month

(a) Calculate the monthly growth factor, R. (b) Store in your calculator memory if it is recurring. Calculate the amount owing after each of the rst 3 months A1, A2 and A3.

r R = 1 + -------100 0.833 33 = 1 + ------------------100 = 1.008 333 3 A1 = A0 R Q = 40 000(1.008 333 3) 528.60 A1 = $39 804.73 A2 = 39 804.73(1.008 333 3) 528.60 = $39 607.84 A3 = 39 607.84(1.008 333 3) 528.60 = $39 409.31

Chapter 15

Reducing balance loans

717

THINK
4

WRITE Principal repaid = A2 A3 (3rd repayment) Principal repaid = 39 607.84 39 409.31 = $198.53 ii Interest = 528.60 1 198.53 = $330.07

ii Interest paid = Total repayments Principal repaid b i

1

Monthly repayment = 8 years 12 payments/year = 96. So, A96 = $11 455.71. Find A97. Principal repaid = A96 A97 (97th repayment)

b i A97 = A96 R Q = 11 455.71(1.008 333 3) 528.60 = $11 022.57 Principal repaid = 11 455.71 11 022.57 = $433.14 ii Interest = 528.60 433.14 = $95.46

ii Interest paid = Repayments Principal repaid

As mentioned in the introduction, a greater percentage of each repayment made in the early part of a loan is interest, compared with the repayments toward the end. This is conrmed by the calculations made in the last example. In summary, with each of 120 repayments being $528.60; for the 3rd repayment: interest = $330.07, principal repaid = $198.53 for the 97th repayment: interest = $95.46, principal repaid = $433.14. That is, the principal decreases faster towards the end of the loan.

remember remember
1. In a loan schedule: (a) the interest charged each period increases the amount owed (b) the repayment each period decreases the amount owed. r - where 1 represents the original amount and 2. Growth factor, R = 1 + -------100 r represents the increase per period in %. 3. Balance at the end of the month = balance at start of the month R Q An + 1 = An R Q where Q = repayment 4. Total repayments = Interest paid + Principal repaid Nominal interest rate per annum 5. Interest rate per period, r = ---------------------------------------------------------------------------------Number of interst periods per year

718

Further Mathematics

15A
WORKED

Loan schedules

Example

1
EXCE

Mat

reads L Sp he

d hca

1 A loan of $1000 is repaid in ve monthly instalments of $206.04 at a rate of 1% per month, interest debited monthly. Calculate: a the amount still owing after the 4th repayment b the total interest charged during the 5 months. 2 Dimitri takes out a loan of $1500 and repays it in ve monthly instalments of $309.97 at a rate of 1.1% per month, interest debited monthly. Calculate: a the amount still owing after the 4th repayment b the total interest charged during the 5 months. 3 A loan of $2000 is repaid in four quarterly instalments of $525.25 at a rate of 2% per quarter, interest debited quarterly. Calculate: a the amount still owing after the 3rd repayment b the total interest charged during the 4 quarters. 4 Gaetana borrows $900 which she repays in ve quarterly instalments of $193.72 at a rate of 2.5% per quarter, interest debited quarterly. Calculate: a the amount still owing after the 4th repayment b the total interest charged during the 5 quarters. 5 Joshs loan of $3000 is repaid in four halfyearly instalments of $807.08 at a rate of 3% per half-year, interest debited half-yearly. Calculate: a the amount still owing after the 3rd repayment b total interest charged during the 4 repayments. 6 Rebecca takes out a loan of $2500 to purchase a new computer. The loan is repaid in four 6-monthly instalments of $696.86 at a rate of 4.5% per 6-months, interest debited 6-monthly. Calculate: a the amount still owing after the 3rd repayment b the total interest charged during the 4 repayments.

Reducing balance loans

et

Chapter 15

Reducing balance loans

719

WORKED

Example

7 a A loan of $20 000 is repaid by monthly instalments of $444.89 over 5 years at an interest rate of 1% per month, interest debited monthly. Calculate: i the amount still owing after the 5th repayment ii the decrease in the principal during the rst 5 repayments iii the interest charged during this time. b A loan of $20 000 is repaid by quarterly instalments of $1344.31 over 5 years at an interest rate of 3% per quarter, interest debited quarterly. Calculate: i the amount still owing after the 5th repayment ii the decrease in the principal during the rst 5 repayments iii the interest charged during this time. 8 a Jose borrows $30 000 which he repays in fortnightly instalments of $206.45 over 10 years at an interest rate of 0.5% per fortnight, interest debited fortnightly. Calculate: i the amount still owing after the 5th repayment ii the decrease in the principal during the rst 5 repayments iii the interest charged during this time. b A loan of $30 000 is repaid by quarterly instalments of $1350.84 over 10 years at an interest rate of 3.25% per quarter, interest debited quarterly. Calculate: i the amount still owing after the 5th repayment ii the decrease in the principal during the rst 5 repayments iii the interest charged during this time.

9 a Angela takes out a loan of $20 000 to set up a catering business. The loan is repaid by monthly instalments of $664.29 over 3 years at an interest rate of 1% per month, interest debited monthly. Calculate: i the amount still owing after the 5th repayment ii the decrease in the principal during the rst 5 repayments iii the interest charged during this time. b Emad borrows $20 000 to establish a pet-minding business. The loan is repaid by monthly instalments of $325.06 over 8 years at an interest rate of 1% per month, interest debited monthly. Calculate: i the amount still owing after the 5th repayment ii the decrease in the principal during the rst 5 repayments iii the interest charged during this time. c Hank takes out a loan of $20 000 which he repays in monthly instalments of $286.94 over 10 years at an interest rate of 1% per month, interest debited monthly. Calculate: i the amount still owing after the 5th repayment ii the decrease in the principal during the rst 5 repayments iii the interest charged during this time. d In parts ac above the three loan accounts are the same except for the term. As the term of the loan increases how does this affect: i the repayment? ii the amount still owing after the 5th repayment? iii the amount of interest paid during the 5 repayments?

720

Further Mathematics

10 a Jaques borrows $30 000 which he repays in quarterly instalments of $1373.05 over 8 years at an interest rate of 2.5% per quarter, interest debited quarterly. Calculate: i the amount still owing after the 5th repayment ii the decrease in the principal during the rst 5 repayments iii the interest charged during this time. b Isabel borrows $30 000 and repays it by quarterly instalments of $1195.09 over 10 years at an interest rate of 2.5% per quarter, interest debited quarterly. Calculate: i the amount still owing after the 5th repayment ii the decrease in the principal during the rst 5 repayments iii the interest charged during this time. c George takes out a loan of $30 000 which he repays in quarterly instalments of $1080.18 over 12 years at an interest rate of 2.5% per quarter, interest debited quarterly. Calculate: i the amount still owing after the 5th repayment ii the decrease in the principal during the rst 5 repayments iii the interest charged during this time. d In parts ac above the 3 loan accounts are the same except for the term. As the term of the loan increases how does this affect: i the repayment? ii the amount still owing after the 5th repayment? iii the amount of interest paid during the 5 repayments? In questions 1113 nd: i the amount still owing after the 4th repayment ii the decrease in the principal during the rst 4 repayments iii the total interest paid during this time. 11 A loan of $50 000 is to be paid by monthly instalments of: a $525.13 over 15 years at 0.8% per month (interest debited monthly) b $487.13 over 18 years at 0.8% per month (interest debited monthly) c $440.33 over 25 years at 0.8% per month (debited monthly) d $639.22 over 15 years at 1.1% per month (debited monthly) e $607.15 over 18 years at 1.1% per month (debited monthly) f $571.46 over 25 years at 1.1% per month (debited monthly). 12 A loan of $60 000 is to be repaid by monthly instalments of: a $429.86 over 20 years at 0.5% per month (interest debited monthly) b $472.41 over 20 years at 0.6% per month (interest debited monthly) c $516.90 over 20 years at 0.7% per month (interest debited monthly) d $563.20 over 20 years at 0.8% per month (interest debited monthly) e $635.73 over 20 years at 0.95% per month (interest debited monthly) f $685.92 over 20 years at 1.05% per month (interest debited monthly). 13 A loan of $60 000 is to be repaid by quarterly instalments of: a $1292.90 over 20 years at 1.5% per quarter (debited quarterly) b $1421.02 over 20 years at 1.8% per quarter (debited quarterly) c $1554.87 over 20 years at 2.1% per quarter (debited quarterly) d $1694.06 over 20 years at 2.4% per quarter (debited quarterly) e $1911.89 over 20 years at 2.85% per quarter (debited quarterly) f $2062.53 over 20 years at 3.15% per quarter (debited quarterly).

Chapter 15

Reducing balance loans

721

14 The loan accounts outlined in question 12 are the same except for the interest rate. The same applies to question 13. In these cases, as the interest rate increases, what happens to: a the repayment? b the amount still owing after the 4th repayment? c the amount of interest paid during the 4 repayments?
WORKED

Example

15 a Madakos loan of $50 000 has interest charged at a rate of 9% p.a. (debited monthly) and it is repaid over 10 years by monthly instalments of $633.38. For the 3 3rd repayment nd: i the principal repaid ii the interest paid. b After 8 years the amount still owing is $13 863.96. Assuming the same conditions apply as in part a, for the 97th repayment nd: i the principal repaid ii the interest paid. 16 a Pinas loan of $60 000 has interest charged at a rate of 8% p.a. (debited monthly) and it is repaid over 20 years by monthly instalments of $501.86. For the 3rd repayment nd: i the principal repaid ii the interest paid. b After 18 years the amount still owing is $11 098.43. Assuming the same conditions apply as in part a, for the 217th repayment nd: i the principal repaid ii the interest paid. 17 a Katharines loan of $80 000 has interest charged at a rate of 12% p.a. (debited quarterly) and it is repaid over 20 years by quarterly instalments of $2648.94. For the 3rd repayment nd: i the principal repaid ii the interest paid. b After 18 years the amount still owing is $18 594.66. Assuming the same conditions apply as in part a, for the 73rd repayment nd: i the principal repaid ii the interest paid. 18 a Tony and Marietta take out a loan of $90 000 as part payment on their new house. The loan is to be repaid over 25 years at 13% p.a. (debited fortnightly) and with fortnightly instalments of $468.31. For the 3rd repayment nd: i the principal repaid ii the interest paid. b If the principal is reduced to $80 268.49 after 10 years (use the same conditions as in part a), for the 261st repayment nd: i the principal repaid ii the interest paid. c If the principal is reduced to $44 676.17 after 20 years (use the same conditions as in part a), for the 521st repayment nd: i the principal repaid ii the interest paid.

722

Further Mathematics

19 multiple choice If the quarterly instalments for a $15 000 loan, which is to be repaid over 4 years, are $1148.98 and interest is debited quarterly at 2.5% per quarter, the decrease in the principal in the rst year would be (to the nearest dollar): A $11 786 B $3214 C $1382 D $774 E $375 20 multiple choice Johns $23 000 loan has interest charged at 9% p.a., debited fortnightly, and is repaid over 8 years by fortnightly instalments of $155.30. For the 3rd repayment the amount of interest paid is: A $13.98 B $75.95 C $76.21 D $79.09 E $155.30 21 multiple choice The term of a loan is 120 monthly instalments. Which of the following repayments will reduce the principal by the greatest amount? A 10th B 20th C 30th D 100th E 110th 22 multiple choice Which of the following loan terms would have the greatest amount of interest debited? (Assume other conditions are the same.) A 20 years B 22 years C 14 years D 12 years E 10 years 23 Voulas loan of $55 000 starts with quarterly repayments of $1396.64 and is due to run for 15 years at 6% p.a., interest debited quarterly. However, after 1 year the interest rate rises to 7% p.a. and consequently the quarterly repayments rise to $1482.84 to maintain the 15 year term. a What amount is still owing after 2 years? b What amount would have still been owing after 2 years if the rate had remained at 6% p.a.? c What would be the difference in interest charged between the two scenarios? 24 Cynthia takes out a loan of $85 000 to set up an outdoors adventure business. She starts with quarterly repayments of $2300.42 and the loan is due to run for 20 years at 9% p.a., interest debited quarterly. However, after 1 year the interest rate falls to 8% p.a. and consequently the quarterly repayments fall to $2143.88 to maintain the 20 year term. a What amount is still owing after 2 years? b What amount would have still been owing after 2 years if the rate had remained at 9% p.a.? c What would be the difference in interest charged between the two scenarios?

Chapter 15

Reducing balance loans

723

The annuities formula

In the previous section step-by-step calculations were made to determine the amount still owing. The process was restrictive in that the previous balance was needed to calculate subsequent balances. A method is needed to enable calculation of the amount still owing at any point in time during the term of the loan. An annuities formula can be used to enable such calculations to be made. An annuity is a regular payment. When a consumer borrows money from a nancial institution that person contracts to make regular payments or annuities in order to repay the sum borrowed over time. Let us now use, in general terms, the process adopted in the previous section to develop this annuities formula. Let P = amount borrowed (principal) R = growth factor for amount borrowed r = 1 + -------(r = interest rate period) 100 n = number of repayments Q = amount of regular repayments made per period An = amount owing after n repayments Assuming interest is debited to the account before a repayment is credited, then: A0 = P A1 = A0R Q A2 = A1R Q = (PR Q)R Q = PR2 QR Q A3 = A2R Q = (PR2 QR Q)R Q = PR3 QR2 QR Q A4 = A3R Q = (PR3 QR2 QR Q)R Q = PR4 QR3 QR2 QR Q In general, = PR4 Q(R3 + R2 + R + 1) = PR3 Q(R2 + R + 1) = PR2 Q(R + 1) = PR Q

An = PRn Q(Rn 1 + . . . + R2 + R + 1) The term in the bracket (Rn 1 + . . . + R2 + R + 1) is the sum of n terms of a geometric progression (GP) (refer to chapter 6: Arithmetic and geometric sequences). First term, a = 1 Common ratio, r = R Now, the sum of n terms of a geometric progression is: a(rn 1) Sn = --------------------r1 Hence, in this case, 1( Rn 1 ) 1 + R + R2 + . . . + Rn 1 = ---------------------R1 Q( Rn 1 ) An = PR n ----------------------R1

724

Further Mathematics

So, in general, the amount owing in a loan account for n repayments is given by the annuities formula:
Number of repayments made Amount still owing Repayment value Interest rate per period

Q( Rn 1 ) A = PR n ----------------------R1

r where R = 1 + -------100

Amount borrowed

Growth factor

WORKED Example 4
A loan of $50 000 is taken out over 20 years at a rate of 6% p.a. (interest debited monthly) and is to be repaid with monthly instalments of $358.22. Find the amount still owing after 10 years. THINK
1

WRITE P = 50 000 Q = 358.22 n = 10 12 = 120 6 r = ----12 = 0.5 r R = 1 + -------100 0.5 = 1 + -------100 = 1.005 Q( Rn 1 ) A = PRn ----------------------R1 358.22 ( 1.005 120 1 ) = 50 000(1.005)120 -------------------------------------------------1.005 1 A = $32 264.98 The amount still owing after 10 years will be $32 264.98.

State the loan amount, P, and regular repayment, Q. Find the number of payments, n, interest rate per month, r, and growth factor, R.

Substitute into the annuities formula.

4 5

Evaluate A. Write a statement.

Note: If R is a recurring decimal, place the value in the calculator memory and bracket R if needed when evaluating A.

Chapter 15

Reducing balance loans

725

Note that, even though 10 years is the halfway point of the term of the loan, more than half of the original $50 000 is still owing. When we consider borrowing money we usually know how much is needed and we choose a term which requires a repayment that we can afford. To nd the repayment value, Q, the annuities formula is used where A is zero, that is, the loan is fully repaid. Q is then isolated. Q( Rn 1 ) A = PRn ----------------------R1 When A = 0, Q( Rn 1 ) 0 = PRn ----------------------R1

Q( Rn 1 ) ----------------------- = PRn R1 PR n ( R 1 ) Q = --------------------------Rn 1

WORKED Example 5
Rob wants to borrow $2800 for a new hi- system from a building society at 7.5% p.a., interest adjusted monthly. -- years? a What would be Robs monthly repayment if the loan is fully repaid in 1 1 2 b What would be the total interest charged? THINK a
1

WRITE a P = 2800 n = 18 7.5 r = -----12 = 0.625 0.625 R = 1 + -----------100 = 1.00625 PR n ( R 1 ) Q = --------------------------Rn 1 2800 ( 1.00625 ) 18 ( 1.00625 1 ) = -------------------------------------------------------------------------1.00625 18 1 Q = $164.95 The monthly regular payment is $164.93 over 18 months. b Total interest = 164.95 18 2800 = 2969.10 2800 = $169.10 The total interest on a $2800 loan over 18 months is $169.10.

(a) Find P, n, r and R. (b) Store in your calculator memory the growth factor, R.

Substitute into the annuities formula to nd the regular monthly repayment, Q.

3 4

Evaluate Q. Write a statement. Total interest = Total repayments Amount borrowed Write a statement.

726

Further Mathematics

Alternative method using a graphics calculator

The Texas Instrument graphics calculators TI83 and TI86 have a FINANCE function: TVM Solver. This allows quick analysis of reducing balance loans using the annuities formula. To use the TVM Solver, press 2nd [FINANCE] and select 1:TVM Solver. From this screen we dene the following: where N = the number of repayments I% = the nominal interest rate (must enter as % per annum) PV = the amount borrowed or the current amount owed (enter as a positive number as cash is owing to you from the bank; a positive cashow) PMT = regular payment amount (enter as a negative number as the cash is owing from you to the bank; a negative cashow) FV = the nal amount owing (enter as 0 if the loan is fully repaid or enter the amount still owing as a negative number) P/Y = number of payments per year, for example quarterly; P/Y = 4. C/Y = number of compounds per year, for example monthly adjusted C/Y = 12 (Note: In this chapter, P/Y and C/Y are to be of the same frequency.) PMT:END BEGIN Leave END highlighted as normally interest is charged at the end of the month.

WORKED Example 6
Josh borrows $12 000 for some home ofce equipment. He agrees to repay the loan over 4 years with monthly instalments at 7.8% p.a. (adjusted monthly). Find: a the instalment value b the principal repaid and interest paid during the: i 10th repayment ii 40th repayment. THINK a
1

WRITE a P = 12 000 n = 4 12 = 48 7.8 r = -----12 = 0.65 0.65 R = 1 + --------100 = 1.0065 PR n ( R 1 ) Q = --------------------------Rn 1 12 000 ( 1.0065 ) 48 ( 1.0065 1 ) = ------------------------------------------------------------------------1.0065 48 1 Q = $291.83

(a) Find P, n, r and R.

(b) Store R in your calculator memory.

2

Substitute into the annuities formula to nd the monthly repayment, Q.

Evaluate Q.

Chapter 15

Reducing balance loans

727

THINK If using the TVM Solver on the TI83, enter the appropriate values. Identify A, P, r and R. N = 48 r (= I%) = 7.8 P(= PV) = 1200 Q(= PMT) = unknown A(= FV) = 0 P/Y = 12 C/Y = 12 Place cursor on PMT =. Press ALPHA [SOLVE] to solve.
4

WRITE/DISPLAY

Write a statement. Find the amount owing after 9 months. (a) State P, n, R. (b) Substitute into the annuities formula.

The monthly repayment over a 4-year period is $291.83. b i P = 12 000, n = 9, R = 1.0065 Q( Rn 1 ) A = PRn ----------------------R1 291.83 ( 1.0065 9 1 ) = 12 000(1.0065)9 -----------------------------------------------1.0065 1 A9 = $10 024.73

b i

Evaluate A9. If using the TVM Solver on the TI83, enter the appropriate values. Place cursor on FV =. Press ALPHA [SOLVE] to solve.

Find the amount owing after 10 months. Substitute (change n = 9 to n = 10) and evaluate.

A10 = 12 000(1.0065)10 291.83 ( 1.0065 10 1 ) --------------------------------------------------A10 = 1.0065 1 A10 = $9798.06

Continued over page

728
THINK

Further Mathematics

WRITE/DISPLAY If using the TVM Solver on the TI83, enter the appropriate values. Place cursor on FV =. Press ALPHA [SOLVE] to solve.

4 5 6

Principal repaid = A9 A10 Interest paid = Total repayments Principal repaid Write a statement. Repeat steps 16 for A39 and A40.

b ii

Write a statement.

Principal repaid = 10 024.73 9798.06 = $226.67 Total interest = $291.83 226.67 = $65.16 In the 10th repayment $226.67 principal is repaid and $65.16 interest is paid. b ii A39 = 12 000(1.0065)39 291.83 ( 1.0065 39 1 ) --------------------------------------------------A39 = 1.0065 1 A39 = $2543.10 A40 = $2267.80 Principal repaid = A39 A40 = 2543.10 2267.80 = $275.30 Interest = 291.83 275.30 = $16.53 In the 40th repayment $275.30 principal is repaid and $16.53 interest is paid.

remember remember
1. To calculate the amount in a loan account use the formula: Q( Rn 1 ) A = PR n ----------------------R1 2. To calculate the repayment value use the formula: PR n ( R 1 ) Q = --------------------------Rn 1 where P = amount borrowed (principal) ($) R = growth factor for amount borrowed r = 1 + -------(r = interest rate per period) 100 n = number of repayments Q = amount of regular repayments made per period ($) An = amount owing after n repayments ($)

Chapter 15

Reducing balance loans

729

15B

The annuities formula

EXCE

1 Use the annuities formula to nd A, given: a P = $50 000, n = 100, Q = $550, r = 1 b P = $50 000, n = 200, Q = $550, r = 1 c P = $60 000, n = 100, Q = $650, r = 1 d P = $60 000, n = 200, Q = $650, r = 1 e P = $20 000, n = 50, Q = $300, r = 0.5 f P = $40 000, n = 100, Q = $400, r = 0.8 g P = $80 000, n = 150, Q = $700, r = 0.75 h P = $100 000, n = 200, Q = $720, r = 0.65.
WORKED

Reducing balance loans

Example

2 A loan of $65 000 is taken out over 20 years at a rate of 12% p.a. (interest debited monthly) and is to be repaid with monthly instalments of $715.71. Find the amount still owing after: a 5 years b 10 years c 15 years d 18 years. 3 Matthew takes out a reducing balance loan of $75 000 over 25 years at a rate of 10% p.a. (interest debited quarterly) and is to be repaid with quarterly instalments of $2048.39. Find the amount still owing after: a 5 years b 10 years c 15 years d 20 years. 4 A loan of $52 000 is taken out over 15 years at a rate of 13% p.a. (interest debited fortnightly) and is to be repaid with fortnightly instalments of $303.37. Find the amount still owing after: a 4 years b 8 years c 12 years d 14 years. 5 Link borrows $48 000, taken out over 10 years and to be repaid in monthly instalments. (Note: As the interest rate increases, the monthly repayment increases if the loan period is to remain the same.) Find the amount still owing after 5 years if interest is debited monthly at a rate of: a 6% p.a. and the repayment is $532.90 b 9% p.a. and the repayment is $608.04 c 12% p.a. and the repayment is $688.66 d 15% p.a. and the repayment is $774.41. 6 A loan of $20 000 has interest charged monthly at a rate of 9% p.a. What will be the amount still owing after 3 years if the term of the loan is: a 4 years and monthly repayments of $497.70 are made? b 5 years and monthly repayments of $415.17 are made? c 6 years and monthly repayments of $360.51 are made? d 7 years and monthly repayments of $321.78 are made? e 8 years and monthly repayments of $293 are made? 7 Pablos loan of 30 000 has interest charged quarterly at a rate of 10% p.a. What will be the amount still owing after 5 years if the term of the loan is: a 6 years and quarterly repayments of $1677.38 are made? b 7 years and quarterly repayments of $1502.64 are made? c 8 years and quarterly repayments of $1373.05 are made? d 9 years and quarterly repayments of $1273.55 are made? e 10 years and quarterly repayments of $1195.09 are made?

Mat

reads L Sp he

d hca

et

730

Further Mathematics

8 multiple choice Peter wants to borrow $8000 for a second-hand car and his bank offers him a personal loan for that amount at an interest rate of 13% p.a., interest debited fortnightly, with fortnightly repayments of $124.11 over 3 years. After 2 years he wants to calculate how much he still owes by using the annuities formula. a Which of the following equations should he use? 124.11 ( 1.005 78 1 ) A A = 8000 ( 1.005 ) 78 -----------------------------------------------1.005 1 124.11 ( 1.05 52 1 ) B A = 8000 ( 1.05 ) 52 --------------------------------------------1.05 1 124.11 ( 1.005 52 1 ) C A = 8000 ( 1.005 ) 52 -----------------------------------------------1.005 1 124.11 ( 1.05 78 1 ) D A = 8000 ( 1.05 ) 78 --------------------------------------------1.05 1 124.11 ( 0.005 52 1 ) E A = 8000 ( 0.005 ) 52 -----------------------------------------------0.005 1 b The actual amount that Peter still owes after 2 years is closest to: A $2500 B $3000 C $3500 D $4000 E $4500

Chapter 15

Reducing balance loans

731

9 multiple choice Gwendoline has borrowed $14 000 for renovations to her house. The terms of this loan are monthly instalments of $297.46 over 5 years with interest debited monthly at 10% p.a. of the outstanding balance. a The amount still owing after 3 years is given by: 297.46 ( 1.008 333 3 36 1 ) A A = 14 000 ( 1.008 333 3 ) 36 -------------------------------------------------------------1.008 333 3 1 297.46 ( 1.008 333 3 60 1 ) B A = 14 000 ( 1.008 333 3 ) 60 -------------------------------------------------------------1.008 333 3 1 297.46 ( 1.1 60 1 ) C A = 14 000 ( 1.1 ) 60 -----------------------------------------1.1 1 297.46 ( 0.083 333 36 1 ) D A = 14 000 ( 1.083 333 ) 36 ---------------------------------------------------------0.083 333 1 297.46 ( 1.083 333 36 1 ) E A = 14 000 ( 0.083 333 ) 36 ---------------------------------------------------------1.083 333 1 b The actual amount that Gwendoline still owes after 3 years is closest to: A $5000 B $5500 C $6000 D $6500 E $7000 10 multiple choice Ben took out a loan for $20 000 to buy a new car. The contract required that he repay -- years Ben used the loan over 5 years with monthly instalments of $421.02. After 2 1 2 the annuities formula to obtain the expression below to calculate the amount he still owed. 421.02 ( 1.008 30 1 ) A = 20 000 ( 1.008 ) 30 -----------------------------------------------0.008 The interest rate per annum charged by the bank for this reducing balance loan is: A 1.008% B 0.008% C 0.096% D 9.6% E 12.096%
WORKED

Example

11 Use the annuities formula to nd the repayment value, Q, given: a P = $5000, r = 1, n = 12 5 b P = $3000, r = 2, n = 8 c P = $1500, r = 3, n = 4 d P = $9000, r = 0.5, n = 30 e P = $14 000, r = 0.8, n = 24 f P = $120 000, r = 0.6, n = 240 g P = $95 000, r = 2.5, n = 100 h P = $64 000, r = 0.5, n = 520. 12 Sergios reducing balance loan of $12 000 has interest charged at 9% p.a., interest adjusted monthly. Find: 5 i the monthly repayment ii the total interest charged if the loan is fully repaid in: -- years -- years. a 2 years b 3 years c 4 years d 41 e 51 2 2 13 Conchitas loan of $85 000 is charged interest at 7% p.a., interest adjusted monthly. Find: i the monthly repayment ii the total interest charged if the loan is fully repaid in: a 10 years b 12 years c 15 years d 18 years e 20 years f 25 years.

WORKED

Example

732

Further Mathematics

14 In each of questions 12 and 13 the only quantity which varied was the term of the loan. As the term of the loan increases, what happens to: a the repayment value? b the amount of interest paid? 15 Declan borrows $32 000 and contracts to repay the loan over 10 years. Find: i the repayment value ii the total interest charged if the loan is repaid quarterly at: a 6% p.a., interest charged quarterly b 8% p.a., interest charged quarterly c 10% p.a., interest charged quarterly d 10.5% p.a., interest charged quarterly e 11% p.a., interest debited quarterly f 12.5% p.a., interest debited quarterly. 16 Felice borrows $46 500 and contracts to repay the loan over 15 years. Find: i the repayment value ii the total interest charged if the loan is repaid fortnightly, with interest adjusted fortnightly at: a 6% p.a. b 8% p.a. c 10% p.a. d 10.5% p.a. e 11% p.a. f 12.5% p.a. 17 A loan of $94 000 is to be repaid over 20 years. Find: i the repayment value ii the total interest charged if the loan is repaid: a weekly at 13% p.a., interest adjusted weekly b fortnightly at 13% p.a., interest adjusted fortnightly c monthly at 13% p.a., interest adjusted monthly d quarterly at 13% p.a., interest adjusted quarterly e weekly at 6.5% p.a., interest adjusted weekly f fortnightly at 6.5% p.a., interest adjusted fortnightly. 18 Based on your answers to question 17 ad when the frequency of repayments (and interest charged) decreases, how does this affect: a the repayment value? b the total interest paid? 19 multiple choice Which of the following would decrease the total amount of interest paid during the life of a loan? (There may be more than one answer.) A A fall in the interest rate B A decrease in the frequency of repayment (repay less often) C A greater amount borrowed D A decrease in the term of the loan E A rise in the interest rate 20 multiple choice Which of the equations below would enable the quarterly repayment value, Q, to be determined for a loan of $16 000 to be repaid over 5 years at 7.8% p.a., interest debited quarterly? Q ( 0.0195 20 1 ) A 0 = 16 000 ( 0.0195 ) 20 -------------------------------------0.0195 1

Chapter 15

Reducing balance loans

733

Q ( 1.078 5 1 ) B 0 = 16 000 ( 1.078 ) 5 --------------------------------1.078 1 Q ( 1.0195 5 1 ) C 0 = 16 000 ( 1.0195 ) 5 -----------------------------------1.0195 1 Q ( 1.0195 20 1 ) D 0 = 16 000 ( 1.0195 ) 20 -------------------------------------1.0195 1 Q ( 1.078 20 1 ) E 0 = 16 000 ( 1.078 ) 20 ----------------------------------1.078 1
WORKED

Example

21 Grace has borrowed $18 000 to buy a car. She agrees to repay the reducing balance loan over 5 years with monthly instalments at 8.1% p.a. (adjusted monthly). Find: 6 a the instalment value b the principal repaid and the interest paid during: i the 10th repayment ii the 50th repayment. 22 Tim has borrowed $45 000 to buy a house. He agrees to repay the reducing balance loan over 15 years with monthly instalments at 9.3% p.a. (adjusted monthly). Find: a the instalment value b the principal repaid and the interest paid during: i the 20th repayment ii the 150th repayment. 23 Gail has agreed to repay a $74 000 reducing balance loan with fortnightly instalments over 20 years at 9.75% p.a. (adjusted fortnightly). Find: a the instalment value b the principal repaid and the interest paid during: i the 1st repayment ii the 500th repayment. 24 Terry is repaying a $52 000 loan over 15 years with quarterly instalments at 6.25% p.a. -- years have passed since the loan was drawn down (adjusted quarterly). Currently, 5 1 2 (money borrowed). How much does Terry still owe?
-- years ago. The reducing balance loan was for a 25 Stefanie borrowed $18 000 exactly 3 1 2 term of 5 years and was to be repaid in monthly instalments of 10.2% p.a. (adjusted monthly). How much does Stefanie still owe?

Questions 26 and 27 refer to the following information. The interest charged to a housing loan account during a nancial year (1 July30 June) is a tax deduction against income if the house is rented to tenants. 26 Bruce borrowed $80 000 to nance the purchase of a rental property and he is repaying the loan over 20 years by quarterly instalments at 8.6% p.a. (adjusted quarterly). By 1 July last year he had made 24 repayments. Find: a the amount Bruce owed after 24 repayments b the amount he owes by 30 June this year c the total interest that Bruce can claim as a tax deduction for this particular nancial year. 27 Lyn is repaying a $55 000 housing loan over 15 years by monthly instalments at 9.9% p.a. (adjusted monthly). By 1 July last year she had made 42 repayments. If Lyn rented the house to tenants, nd: a the amount she owed after 42 repayments b the amount she owes by 30 June this year c the total interest that Lyn can claim as a tax deduction for this particular nancial year.

Work

ET SHE

15.1