Shannon and Duncan Fisher were concerned about their level of debt. They had borrowed from their bank to purchase their house, car, and computer. For these three loans, the Fishers must make regular monthly payments. The couple also owes $6000 to MasterCard and $2500 to Visa. Shannon and Duncan decided to meet with a consumer credit counsellor to gain control of their debts.
The counsellor explained to them the details of their loans and credit card debts. Shannon and Duncan were shocked to discover that whereas their computer and car loans had an interest rate of 10.5% p.a., their credit cards had an interest rate of 19.5% p.a. The counsellor pointed out that the interest rate on their three loans was reasonable. However, because the interest rate on the credit cards was so high, she advised Shannon and Duncan to borrow money at a lower interest rate and pay off the credit card debts.
The credit counsellor suggested that they should consider obtaining a home equity line of credit (HELOC). She explained that the rate of interest on the line of credit would likely be a few percentage points higher than the prime rate, but much lower than the rate of interest charged on credit card balances. Shannon and Duncan would have to make a minimum payment every month, similar to that of a credit card. The payment would then be applied to pay all the interest and a portion of the principal balance owing on the line of credit. The line of credit would allow them to make monthly payments higher than the minimum so that they could pay as much toward the principal balance as they could afford. Due to the much lower interest rate on a line of credit as compared to a typical credit card, the money they would save on interest each month could be paid toward the principal. A line of credit appealed to Shannon and Duncan, as it helped them feel more in control of their finances and gave them the resolve to pay off their credit card debts.
Shannon and Duncan then met with their bank manager and were approved for a $15 000 line of credit. Immediately, they paid off the $6000 owed to MasterCard and the $2500 owed to Visa with money from the line of credit. They then decided to pay off the line of credit over the next ten months by making monthly payments equal to one-tenth of the original line of credit balance plus the simple interest owed on the remaining line of credit balance. The simple interest rate on the line of credit is expected to be 6.25% over the next ten months. Shannon and Duncan agreed to cut up their credit cards and not charge any more purchases until they had paid off their line of credit.
Questions
a. Suppose Shannon and Duncan pay off their credit cards with their line of credit on April 20. They will make their monthly payments on the 20th of each month, beginning in May. Create a schedule showing their monthly payments for the next ten months. How much interest will they pay using this repayment plan?
b. Suppose Shannon and Duncan had not gotten a line of credit but kept their credit cards. They decided not to make any more credit card purchases. Instead, they made monthly payments equal to one-tenth of the original credit card balance plus the simple interest owed on the remaining credit card balance. They will make their monthly payments on the 20th of each month, beginning in May. Create a schedule showing their monthly payments for the next ten months. How much interest would they have paid using this repayment plan?
c. How much money did Shannon and Duncan save on interest by getting the line of credit?
d. What are the requirements for obtaining a line of credit from your financial institution?