Question

. Mr. Tramp made a mortgage 5 years ago for $85,000 at 8.25% interest and a 15 year term. Rates have now risen to 10% for an equivalent loan. Mr. Tramp’s lender is willing to discount the loan by $2,000 if he will prepay the loan. What rate of return would Mr. Tramp receive by prepaying the loan?

(A) 10.24% (B) 8.95% (C) 14.32% (D) 9.14%

Answer 1

Correct ANswer is (B) 8.95%

As per the above given data we are considering the loan is paid off annually,

loan amount $ 85000 @ 8.25% interest for a 15 year tenure will create an installment of $10082.61

Here, total amount to be paid by Mr. Tramp will be $151,239.31 with total interest payments of $66239.31 and annual interest payment of $4415.954.

If Mr. Tramp prepay's the loan after 5 years interest amount saved by him equals ( 4415.954 x 10) = $44159.54 and the loan is discounted by $2000.

So, loan balance of Mr. Tramp after 5 years equals $ 51340.268 but since $ 2000 is discount so he needs to pay only $ 49340.268 and will gains $ 4415.954 per year.

Therefore, the rate of return received by him by prepaying the loan = Annual Gain/ Prepaid Amt. = 4415.954/ 49340.268 = 8.95% is the rate of return

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