Ed needs to take out a loan for $7,000 to purchase a car. his bank has offered him a loan at 10.0% interest, compounded monthly, for 36 months or 10.5% interest, compounded monthly, for 24 months. ed’s goal is to save as much money as possible by the time he pays off the loan. which of the following statements best describes what ed should be thinking?
a. since the monthly payment for the 36 month loan is lower, this loan will save more.
b. since the monthly payment for the 24 month loan is lower, this loan will save more.
c. since the finance charge for the 36 month loan is lower, this loan will save more.
d. since the finance charge for the 24 month loan is lower, this loan will save more.

d. Since the finance charge for the 24 month loan is lower, this loan will save more.

Explanation:

The longer your repayment term of a loan, the more you finance charges you will pay even though the monthly repayment amount will be less each month. You will inevitably be paying more over the 36 month term.

Calculations:

1. $7000 @ 10% interest for 36 months compounded monthly.

= $7000 (1 + i)ⁿ

= $7000 (1 + 0.10)³

= $9317.00 over 3 years whereas:

2. $7000 @ 10.5% interest rate over 24 months compounded monthly:

= $7000 (1 + 0.105)²

= $ 8547.18 over 2 years.

To conclude, you would end up saving $769.82 by paying off your $7000.00 loan in a 24 month period at a higher interest rate than opting for a longer repayment term of 36 months with a lower interest rate.

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