Use the information below to answer the following question. You have cash on han

Question

Use the information below to answer the following question. You have cash on hand Property value $400,000 Down payment is $120.000 (i.c. LVR is 70%) Loan #1 - $200,000 Loan #2 - $80,000 Interest rate (nominal) for Loan #1 is 8.40% per annum compounded semi-annually Interest rate for Loan #2 is 9% per annum compounded semi-annually Processing fees is $2,500 No cancellation penalty Mortgage payment paid annually Term of loan 12 years What is the effective cost of borrowing (ECB)? 8.89% 8.93% 8.70% 8.78% None of the above

Explanation / Answer

Loan 1

Loan Amount = 200000

Apportioned Processing Fee = 2500*200000/280000 = 1786

Loan amount outstanding = 201786

Effective Annual Interest Rate = (1+8.4%/2)^2 -1 = 8.576%

Using Excel formula or financial calculator

Annual Payment of Mortgage = pmt(rate,nper,pv,fv)

Annual Payment of Mortgage = pmt(8.576%,12,-201786,0)

Annual Payment of Mortgage = $ 27,580.51

Loan 2

Loan Amount = 80000

Apportioned Processing Fee = 2500*80000/280000 = 714

Loan amount outstanding = 80714

Effective Annual Interest Rate = (1+9%/2)^2 -1 = 9.2025%

Using Excel formula or financial calculator

Annual Payment of Mortgage = pmt(rate,nper,pv,fv)

Annual Payment of Mortgage = pmt(9.2025%,12,-80714,0)

Annual Payment of Mortgage = $ 11387

Total Annual Payment of both mortgage = 27580.51+11387.01

Total Annual Payment of both mortgage = $ 38,967.52

Effective anuual cost of borrowing = rate(nper,pmt,pv,fv)

nper = 12

pmt = 38967.52

pv = -280000

fv = 0

Effective anuual cost of borrowing = rate(12,38967.52,-280000,0)

Effective anuual cost of borrowing = 8.93%

Answer

b) 8.93%

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