SHOW YOUR WORK (EQUATIONS)

Suppose that you are given the option to borrow a fixed rate US mortgage of $80,000 at 12% for 25 years with monthly payments. Alternatively, you may borrow another fixed rate US mortgage of $90,000 for 25 years with monthly payments at a contract interest rate to be determined. The lender would like to have an effective annual yield of 25% on the incremental cost of borrowing (i.e., on the $10,000), reflecting the borrower's increased default risk. Formulate how you would compute the contract interest rate on the entire $90,000 loan.