Question

You are purchasing a new car and plan to finance it through your employee credit union. The credit union has offered you two different promissory note plans, as follows:

Option 1: Three years at 6%, with interest payable annually.

Option 2: One year at 5%, renewable each year for up to three more years, at the then-current interest rate. Interest is payable at the end of each year.

Prepare a written report summarizing the advantages and disadvantages of each of these options.

Answer 1

Possible advantages and disadvantages include the following:

Three-year note

Advantages:

1. You can lock in the rate for three years. If interest rates increase, you will not be affected.

2. You pay off the note in three years, probably paying less total interest than with option 2.

Disadvantages:

1. If interest rates decrease, you cannot benefit.

2. You must pay off the note in three years, which gives you less flexibility than option 2.

One-year note

Advantages:

1. The initial rate is lower than on the three-year note.

2. You can stretch the payments up to four years.

3. If interest rates decrease, you could get an even lower rate.

Disadvantages:

1. The rate on the note could increase if interest rates increase. Further, no interest rate limit is indicated.

2. Total interest payments will be greater than under option 1, if the note is used for four years.