Question

Your brother has just taken out a loan for $75,000. The stated (simple) interest rate on this loan is 10 percent, and the bank requires him to maintain a compensating balance equal to 15 percent of the initial face amount of the loan. He currently has $20,000 in his checking account, and he plans to maintain this balance. The loan is an add-on installment loan which he will repay in 12 equal monthly installments, beginning at the end of the first month.

What is the annual percentage rate (APR) on this loan?

Answer 1

Compensating balance required= Loan*15%= 75,000*15%= $11,250

Since there is adequate amount in checking account, no separate amount is needed as compensating balance.

Since the loan is with add-on interest, monthly payments= (Loan + Interest)/Number of months

Interest= 75,000*10%= $7,500

Monthly payments= (75,000+7,500)/12= $6,875.

APR= 17.97% as follows: