Ricky is taking out a personal loan for $12,000 to remodel his kitchen. He would like the lowest monthly payment possible, even if it means a bigger finance charge in the end. His bank has offered him a loan at 13% interest for 36 months or 12% interest for 60 months, both of which are compounded monthly. Which of the following statements most accurately describes what Ricky should be thinking?
Answer
A
More payments with the 60 month loan will give him the lowest monthly payment.
B
Fewer payments with the 36 month loan will give him the lowest monthly payment.
C
The 60 month loan comes with a bigger finance charge and, thus, a bigger monthly payment.
D
The 36 month loan comes with a bigger finance charge and, thus, a bigger monthly payment.
Explanation
The 60-month loan spreads repayment over more months, so Ricky’s monthly payment is lower. Using monthly compounding and equal monthly payments, the 36-month loan is about $404 per month, while the 60-month loan is about $267 per month. The longer loan would likely have a larger total finance charge, but that does not make its monthly payment larger; choice A best describes the trade-off Ricky prefers.
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