A borrower can obtain an 85 percent loan with an 8 percent interest rate and monthly payments. The loan is to be fully amortized over 25 years. Alternatively, he could obtain a 95 percent loan at an 8.5 percent rate with the same loan term. The borrower plans to own the property for the entire loan term.

Required:

a. What is the incremental cost of borrowing the additional funds? (Hint: The dollar amount of the loan does not affect the answer.)

b. What is the incremental cost of borrowing the additional funds if 2 points were charged on the 95 percent loan?

c. What is the incremental cost of borrowing the additional funds if the borrower planned to own the property for only five years?

*****************They gave this solution for part C, but it is still coming up as the incorrect answer when I plug their variable into my calculator. How should this question be solved to get the same answer?**************

Note that the net proceeds of the loan is still $8,100 as in Part b. Thus we have:

i(n,PV,PMT,FV)

n = 25 12 or 300

PMT = $656.04

PV = $8,100

FV = $9,714.20

Solve for the annual interest rate:

i = 18.58%

Solving for the interest rate with a financial calculator we now obtain an incremental borrowing cost of 18.58 percent.