Utilize the information from this unit, Part A of this lab, and the information below to answer the following questions in paragraph form:
1. Explain what occurs over the course of the loan with the amount of interest and principal that makes up each monthly payment.
2. Molly takes a second job and begins paying an additional $100 per month, starting with her very first payment. Using the second amortization first amortization table, why would Molly choose to pay an extra $100 per month?
Information:
Molly wants to take the 60 month, $6.6 \% loan, with $400 Cash Allowance, and a $2,500 down payment.
Remember: We are assuming that Molly's car costs $24,790.
This makes her total loan amount $21,890.
Use this amortization table to answer question 1.
Payment Date
Apr 2024
May 2024
Jun 2024
Jul 2024
Aug 2024
Sep 2024
Payment
$486.21
$486.21
$486.21
$486.21
$486.21
$486.21
Principal
$349.86
$351.79
$353.72
$355.67
$357.62
$359.59
Interest
$136.34
$134.42
$132.49
$130.54
$128.58
$126.62
Total Interest
$136.34
$270.77
$403.25
$533.79
$662.38
$788.99
Balance
$24,440.14
$24,088.35
$23,734.63
$23,378.96
$23,021.34
Answer (2)
Molly's loan payments begin with a larger portion going toward interest, which shifts to primarily reducing the principal over time. By paying an extra $100 each month, she accelerates the reduction of her principal amount, saving money on interest and potentially paying off the loan sooner. This strategy ultimately benefits her financially by lowering total interest paid and shortening her loan term.
;
Initially, a larger portion of the monthly payment covers interest, while a smaller portion reduces the principal.
As the loan progresses, the principal portion increases, and the interest portion decreases.
Paying an extra $100 per month reduces the principal faster, leading to less interest paid overall. - Molly would choose to pay an extra $100 per month to save money on interest and shorten the loan term.
Explanation
Understanding the Loan Amortization Let's analyze the loan amortization table provided for Molly's car loan. The loan is for $21,890 at a 6.6% interest rate over 60 months. The table shows the breakdown of each monthly payment into principal and interest for the first six months. We need to explain how the interest and principal portions of the monthly payment change over the course of the loan and why Molly might choose to pay an extra $100 per month.
Analyzing the Principal and Interest Payments Looking at the amortization table, we can see that in April 2024, Molly's payment of $486.21 consists of $349.86 towards the principal and $136.34 towards interest. By September 2024, the payment is still $486.21, but the principal portion has increased to $359.59, while the interest portion has decreased to $126.62. This trend continues throughout the life of the loan: as time passes, a larger portion of each payment goes towards paying off the principal, and a smaller portion goes towards interest.
The Trend of Principal vs. Interest In the early months, a significant portion of the payment is used to cover the interest charges. As Molly makes payments and reduces the outstanding balance, the amount of interest accrued each month decreases. Consequently, a larger portion of each subsequent payment goes towards reducing the principal balance.
Benefits of Paying an Extra $100 per Month Molly is considering paying an extra $100 per month. By paying an additional $100 each month, Molly will reduce the principal balance more quickly. This has two main benefits: First, because the principal is decreasing faster, Molly will accrue less interest over the life of the loan, saving her money. Second, by paying down the principal faster, Molly will pay off the loan in less than 60 months.
Conclusion Therefore, Molly would choose to pay an extra $100 per month to reduce the total interest paid over the life of the loan and to shorten the loan term. This strategy allows her to save money and own her car outright sooner.
Examples
Understanding loan amortization is crucial in personal finance. For instance, when buying a home, the same principle applies. Initially, most of your mortgage payment covers interest, but over time, more goes towards the principal. By making extra payments, you can significantly reduce the total interest paid and shorten the life of the loan. This knowledge empowers you to make informed financial decisions and save money in the long run.
