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    Argosy University/ Phoniex University/
    Nov-2005 - Oct-2011

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    Phoniex University
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Category > Management Posted 04 Feb 2018 My Price 6.00

home equity loan

Your uncle Fred just purchased a new boat. He brags to you about the low X%    
interest rate (APR, monthly compounding) he obtained from the dealer. The    
rate is even lower than the rate he could have obtained on his home equity loan    
(Y% APR, monthly compounding). But if his tax rate isZ% and the interest on    
the home equity loan is tax deductible, which loan is truly cheaper?      
                 
X% interest rate = 6.9%            
Y% equity loan rate= 7.9%            
tax rate Z = 28.0%            
                 
Solution                
Because taxes are typically paid annually, we first convert the home equity    
loan to an EAR to determine the actual amount of interest during the year.    
                 
The after tax cost of the home equity loan, which is tax-deductible is:      
                 
After-tax cost= [(1+APR/12)^12 -1]*(1-t)          
                 
After-tax cost = 5.90%            
                 
Since the dealer's boat loan is not tax-deductible, we only need to calculate the EAR    
of the loan and compare them.            
                 
Dealer's boat loan= 7.12%            
                 
The home equity loan at rate 5.90% is cheaper than the boat loan at 7.12%  
Thus Uncle Fred should choose the home equity loan.

 

Answers

Maurice Tutor
(5)
Status NEW Posted 04 Feb 2018 07:02 PM My Price 6.00

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