Board Topic: Loan advice present value questions
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Loan advice

Posted by: goldbyrd Nov 23 2004, 11:17 PM
Hi I have a couple of questions
1. if someone can help me out. Which is preferable, a loan with a lower present value or a loan with a lower periodic installment and why?

2. if a loan has a pre-payment penalty attached to it, would it still viable to retire it? Why or why not? Thanks

Posted by: loanuniverse Nov 24 2004, 12:52 PM

Goldbyrd:

Are these questions for an exam or school homework? smile.gif

1. if someone can help me out. Which is preferable, a loan with a lower present value or a loan with a lower periodic installment and why?

The answer is it depends. Assuming that the way that you get the present value of the loan is by applying a discount rate to the payment stream to both loans, the obvious answer would be that the desirable one is the one with the lowest present value. However, things are not so simple. You also have to take into consideration the impact on your cash flow. The following thoughts will give you an idea of where I am coming from.

- By paying a lower payment, you will have extra cash available to invest.
- What kind of return can you make on this extra cash?
- This is the main reason why borrowers want longer maturities.

2. if a loan has a pre-payment penalty attached to it, would it still viable to retire it? Why or why not?

The answer is in the rate differential and the impact of that rate in the payment streams. Deduct the new payment from the old payment and that is the additional cash flow. Discount it back to the present, and if the number is higher than the prepayment penalty, the refinancing is a go

Good luck on your class



Posted by: Goldbyrd Nov 24 2004, 05:59 PM
Thanks for the help.
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