13.3. annual percentage rate (apr) and the rule of 78 annual interest rate (apr) table 13.3 annual...
TRANSCRIPT
A. Find the APR of a loan.
B. Use the rule of 78 to find the refund and payoff
of a loan.
C. Find the monthly payment for a loan using an
online calculator.
Objectives
Truth-in-Lending: APR to Z
We have studied several types of consumer credit: credit
cards, revolving charges, and add-on interest. Before 1969,
it was almost impossible to compare the different types of
credit accounts available to consumers.
In an effort to standardize the credit industry, the
government enacted the federal Truth-in-Lending Act of
1969.
A key feature of this law is the inclusion of the total
payment, the amount financed, and the finance charges
in credit contracts.
Annual Percentage Rate and the Rule of 78
How can we compare loans? To do so, two items are of
crucial importance: the finance charge and the annual
percentage rate (APR).
A look at annual percentage rates will enable us to
compare different credit options.
For example, suppose you can borrow $200 for a year at
8% add-on or get the same $200 by paying $17.95 each
month.
Which is the better deal? In the first instance, you borrow
$200 at 8% add-on, which means that you pay 8% of $200,
or $16, in finance charges.
Annual Percentage Rate and the Rule of 78
The charge you pay per $100 financed is .
On the other hand, if you pay $17.95 per month for 12
months, you pay a total of $215.40.
Here the finance charge per $100 financed is
. Obviously, the second loan is a better
deal.
Annual Percentage Rate and the Rule of 78
Can we find the APR for each loan? To help in doing so,
tables have been prepared so that we can translate the
finance charge per $100 to the APR (see Table 13.3).
True Annual Interest Rate (APR)
Table 13.3
Annual Percentage Rate and the Rule of 78
Note that the finance charge is the total dollar amount you
are charged for credit. It includes interest and other
charges such as service charges, loan and finder’s fees,
credit-related insurance, and appraisal fees.
The annual percentage rate (APR) is the charge for credit
stated as a percent.
In general, the lowest APR corresponds to the best credit
buy regardless of the amount borrowed or the period of
time for repayment.
For example, suppose you borrow $100 for a year and pay
a finance charge of $8.
APR
If you keep the entire $100 for the whole year and then pay
$108 all at one time, then you are paying an APR of 8%.
On the other hand, if you repay the $100 plus the $8
finance charge in 12 equal monthly payments (8% add-on),
you do not have use of the $100 for the whole year.
What, in this case, is your APR?
APR
The formulas needed to compute the APR are rather
complicated, and as a consequence, tables such as
Table 13.3 have been constructed to help you find the
APR.
True Annual Interest Rate (APR)
Table 13.3
APR
These tables are based on the cost per $100 of the amount
financed. To use Table 13.3, you must first find the finance
charge per $1 of the amount financed and then multiply by
100.
Thus, to find the APR on the $100 borrowed at 8% add-on
interest and repaid in 12 equal payments of $9, first find the
finance charge per $100 as follows:
1. The finance charge is $108 – $100 = $8.
2. The charge per $100 financed is
APR
Since there are 12 payments, look across the row labeled
12 in Table 13.3 until you find the number closest to $8.
True Annual Interest Rate (APR)
Table 13.3
APR
This number is $8.03. Then read the heading of the column
in which the $8.03 appears to obtain the APR. In this case,
the heading is .
Thus, the 8% add-on rate is equivalent to a APR. (Of
course, Table 13.3 gives the APR only to the nearest .)
APR
Example
Mary Lewis bought some furniture that cost $1400. She paid $200 down and agreed to pay the balance in 30 monthly installments of $48.80 each. What was the APR for her purchase?
SolutionWe now turn to Table 13.3 and read across the row labeled 30 (the number of payments) until we find the number closest to $22. This number is $21.99. We then read the column heading to obtain the APR, 16%.
The Rule of 78
In many cases you are entitled to a partial refund of the finance charge! The problem is to find how much you should get back. One way of calculating the refund is to use the rule of 78.
This rule assumes that the final payment includes a portion, say, $a, of the finance charge, the payment before that includes $2a of the finance charge, the second from the final payment includes $3a of the finance charge, and so on.
The Rule of 78
If the total number of payments is 12, then the finance charge is paid off by the sum of a + 2a + 3a + 4a + 5a + 6a+ 7a + 8a + 9a + 10a + 11a + 12a = 78a dollars.
If the finance charge is F dollars, then
78a = F
soa = .
This is the reason for the name “rule of 78.” Now suppose you borrow $1000 for 1 year at 8% add-on interest.
The Rule of 78
The interest is $80, and the monthly payment is one-twelfth of $1080, that is, $90.
If you wish to pay off the loan at the end of 6 months, are you entitled to a refund of half the $80 interest charge? Not according to the rule of 78.
Your remaining finance charge payments, according to this rule, are
The Rule of 78of 78
Since F = $80, you are entitled to a refund of , or
$21.54. There are six payments of $90 each for a total of
$540, so you would need to pay $540 – $21.54 = $518.46
to cover the balance of the loan.
Notice that to obtain the numerator of the fraction , we
had to add 1 + 2 + 3 + 4 + 5 + 6.
If there were n payments remaining, then to find the
numerator, we would have to add.
The Rule of 78
There is an easy way to do this. Let us call the sum S.
Then we can write the sum S twice, once forward and once
backward.
If we add these two lines, we get
and because there are n terms on the right,
The Rule of 78
Thus, for n = 6, we obtain
as before. For n = 12, we find S = (12 13)/2 = 78, which
again agrees with our previous result.
The Rule of 78
In general, if the loan calls for a total of n payments and the
loan is paid off with r payments remaining, then the
unearned interest is a fraction a/b of the total finance
charge, with the numerator
and the denominator
Actuary Formulas for the Refund u and the Payoff
There is another way of calculating refunds and payoffs: by
using a formula.
Example 3 – Refunds and Payoffs Using Formulas
Refer to Example 1, where Mary Lewis bought furniture
costing $1400 with $200 down and 30 payments of $48.80.
Assume that Mary wants to pay off the loan after 24
payments. Find
(a) the refund using the rule of 78.
(b) the refund using the formula.
(c) the payoff using the rule of 78.
(d) the payoff using the formula.
Example 3 – Solution
(a) Using the rule of 78, the refund is
where r = 30 – 24 = 6, n = 30, and
Thus, the refund using the rule of 78 is
(b) The refund using the formula is
where r = 6, PMT = $48.80, and V is the value from the
APR table corresponding to 6 and an APR of 16%
(note that the APR in Example 1 was 16%).
cont’dExample 3 – Solution
This value is $4.72.
Thus, the refund is
(c) The payoff using the rule of 78 is
cont’dExample 3 – Solution
Applications
Realistically, there are more factors associated with loans
than the APR and the rule of 78. In most cases you need a
calculator to do the work! We illustrate the use of such a
calculator in Example 4.
Example 4 the Net
Suppose that the purchase price of a car is $15,000.
There is no cash rebate, your trade-in is $4000, you do not
owe any money on your trade-in, the down payment is
$2000, and you want to finance the car at 10% for 36
months.
What is your monthly payment?
Example 4 – Solution
Steps 1 and 2 (see Figure 13.4) are to enter your zip code
and the vehicle sales price: ($15,000).
Figure 13.4
Skip the sales tax ($0) and the title and registration ($0) for
now.
Next enter the value of your trade-in ($4000), the amount
you owe on your trade-in ($0), and the cash down payment
($2000).
In step 4, enter the Loan Term in months (36) and the
Finance Rate (10%). Press
cont’dExample 4 – Solution