Jazmyn Wise SACE ID- 464588T

Interest Minimization on a Loan

Introduction-

Josh and Emma are buying a house that costs $625,000. They put a $125,000 deposit on the house and took
out a $500,000 loan. They have agreed to pay the loan in 25 years. They have 3 loan options to decide on
which will be compare by analyzing the comparison rates. Various strategies will also be investigated such
as, increasing the size of regular repayments, changing monthly repayments to fortnightly or weekly, making
lump sum payments, using an offset account and combining some of these strategies to reduce the term of
the loan and therefore the amount of interest that they pay.

Mathematical Investigation-

Initial Choice of Loan

Josh and Emma have 3 loan options.

Loan A- No setup/ establishment fee or ongoing fee.

Interest Rate= 4.51%

Loan B- Setup/ establishment fee of $300 and ongoing fee of $15

Interest Rate= 4.47%

Loan C- Ongoing fee of $20

Interest Rate= 4.49%

The loan with the lowest interest rate is loan B, this appears to be the cheapest option, however a
comparison rate needs to be calculated before making a final decision.

Calculations for Comparison Rate

Loan A

Comparison rate= 4.51%

Loan B

Establishment fee added to principal= 300+500,000= $500,300

Calculating Repayments
N= 25 x 12 PMT= -2772.32
I%= 4.47
PV= 500,300
PMT=?
FV= 0
P/Y= 12
C/Y= 12

Monthly Fee is added to repayments= 15+2772.32= $2787.32

Calculating Comparison Rate

N= 25 x 12 I%= 4.52
I%= ?
PV= 500,300
PMT= 2787.32
FV= 0
P/Y= 12
C/Y= 12

1|Page
Loan C

Calculating Repayments
N= 25 x 12 PMT= -2776.33
I%= 4.49
PV= 500,000
PMT=?
FV= 0
P/Y= 12
C/Y= 12

Monthly Fee is added to repayments= 20+2776.33= $2796.33

Calculating Comparison Rate

N= 25 x 12 I%= 4.56
I%= ?
PV= 500,300
PMT= 2796.33
FV= 0
P/Y= 12
C/Y= 12

Loan A had the highest interest rate but after calculated the comparison rate, Loan A has the lowest. Josh
and Emma should choose Loan A.

Monthly repayments of Loan A

The monthly repayments of the loan need to be calculated and then used to calculate the interest that
Emma and Josh will be paying on the loan. These values can then be used in future calculations.

Calculating Repayments Calculating interest

N= 25 x 12 PMT= -2782.00 Interest= PMT x N – PV
I%= 4.51 = 2782 x 300 – 500,000
PV= 500,000 = 334,600
PMT=?
FV= 0
P/Y= 12
C/Y= 12

Increasing Size of Regular Repayments

This section will investigate the effect of increasing the regular repayments by $100 and $200 for the length
of the loan to determine how much interest can be saved.

New Repayment One = $100 New Repayment Two = $200

New Repayments= 100 + 2782 New Repayments= 200 + 2782

= $2882 = $2982

Calculating Time Calculating Time

N= ? N= 281.41 N= ? N= 265.17
I%= 4.51 N= 282 Months I%= 4.51 N= 266 Months
PV= 500,000 PV= 500,000
PMT= -2882 PMT= -2982
FV= 0 FV= 0
P/Y= 12 P/Y= 12
C/Y= 12 C/Y= 12

Time Saved= 300 - 282 Time Saved= 300 - 266

2|Page
 = 18 Months = 34 Months

Calculating interest Calculating interest

Interest= PMT x N – PV Interest= PMT x N – PV
= 2882 x 282 – 500,000 = 2982 x 266 – 500,000
= $312,724 = $293,212

Interest saved= 334,600 – 312,724 Interest saved= 334,600 – 293,212

= $21,876 = $41,388

As the calculations above show, when $100 is added on to the monthly repayments the loan is able to be
paid off 18 months quicker than the previous repayments of $2782. However, when this amount is doubled
to $200 on top of the monthly repayment, the loan is paid off in almost double the amount of time that is
saved when $100 is added to the repayments. In total, the larger repayment saves 16 months more than the
smaller repayment option. The same can also be said for the amount of interest saved. When the amount
added onto the repayment is doubled from $100 to $200, the interest saved is also nearly doubled from
$21,876 to $41,388. According to the calculations, the more the couple increases the repayment, the more
time and interest will be saved. Therefore, the couple should opt for as large of repayments that they can
afford.

These calculations assume that Josh and Emma can afford to increase the size of their regular repayments,
since their financial status is unknown. Although the calculations may not resemble true values that Josh
and Emma maybe able to afford, the calculations are still reasonable as they provide a general trend that
demonstrates that as the monthly repayment is increased, the amount of interest and time saved is also
increased.

Changing the Time of Regular Repayments

This section will investigate how changing the time of regular repayments from monthly to fortnightly or
weekly will affect the length of the loan and interest saved.

Fortnightly Weekly

Fortnightly Repayments = 2782/2 = $1,391 Weekly Repayments = 2782/4 = $695.5

Calculating Time Calculating Time
N= ? N= 563.26 N= ? N= 1125.69
I%= 4.51 N= 564 Fortnights I%= 4.51 N= 1126 Weeks
PV= 500,000 PV= 500,000
PMT= -1,391 PMT= -695.5
FV= 0 FV= 0
P/Y= 26 P/Y= 52
C/Y= 12 C/Y= 12

Time Saved= 25x26 - 564 Time Saved= 1300 - 1126

= 86 Fortnights = 174 Weeks

Calculating interest Calculating interest

Interest= PMT x N – PV Interest= PMT x N – PV
= 1,391 x 564 – 500,000 = 695.5 x 1126 – 500,000
= $284,524 = $283,133

Interest saved= 334,600 – 284,524 Interest saved= 334,600 – 283,133

= $50,076 = $51,467

As the calculations show, weekly repayments save more interest than fortnightly repayments. However, if
the time of weeks saved is converted to fortnights by dividing it by 2, it saves 174 weeks which is only one
week more than fortnightly repayments. The weekly repayments save $51,467 which is $1,391 more than the

3|Page
fortnightly repayments which saved $50,076. These calculations suggest that the couple should opt for
weekly repayments rather than fortnightly repayments.

To convert the monthly repayments to fortnightly repayments, the repayments were divided by 2 and to
convert them to weekly, the repayments were divided by 4. It was assumed that 1 month equals 2 fortnights
and 1 month equals 4 weeks. Since there are 52 weeks in a year and to convert the repayments made in
weeks back to months, 52 is divided by 4 which gives a value of 13 months. Using this method results in Josh
and Emma paying an extra monthly repayment in a year for both calculations. Because of this assumption,
it is reasonable to compare these calculations to one another but is unreasonable to compare them to
other strategies. A limitation to the calculation is that it is unknown how often the couple are paid. If they
are paid fortnightly, weekly repayments may not be the best option for them.

Making Lump Sum Payments

This section will investigate how making lump sum payments may benefit the interest and time that Josh and
Emma can save on the loan. A lump sum of $10,000 after 5 years, a lump sum of $20,000 after 5 years and a
lump sum of $20,000 after 10 years will be looked at.

A lump sum of $10,000 after 5 years

Calculating Future value

N= 5 x 12 FV= 439363.34
I%= 4.51
PV= 500,000
PMT= -2782
FV= ?
P/Y= 12
C/Y= 12

Outstanding debt after lump sum = 439,363.34 – 10,000

= $429,363.34

Calculating Time
N= ? N= 231.28
I%= 4.51 N= 232
PV= 429,363.34
PMT= -2782
FV= 0
P/Y= 12
C/Y= 12

Time of Loan = 60 + 232

= 292 Months

Time saved= 300 - 292

= 8 Months

Calculating interest
Interest= PMT x N + Lump sum – PV
= 2782 x 292 + 10,000 – 500,000
= $322,344

Interest saved= 334,600 - 322,344

= $12,256

4|Page
A lump sum of $20,000 after 5 years

Calculating Future value

N= 5 x 12 FV= 439363.34
I%= 4.51
PV= 500,000
PMT= -2782
FV= ?
P/Y= 12
C/Y= 12

Outstanding debt after lump sum = 439,363.34 – 20,000

= $419,363.34

Calculating Time
N= ? N= 222.84
I%= 4.51 N= 223
PV= 419,363.34
PMT= -2782
FV= 0
P/Y= 12
C/Y= 12

Time of Loan = 60 + 223

= 283 Months

Time saved= 300 - 283

= 17 Months

Calculating interest
Interest= PMT x N + Lump sum – PV
= 2782 x 283 + 20,000 – 500,000
= $307,306

Interest saved= 334,600 - 307,306

= $27,294

The first two calculations compare different sized lump sums after 5 years. The smaller lump sum of $10,000,
saved $12,256 whereas the lump sum which is double the size at $20,000, saved more than double the
amount of interest with $27,294 saved. The larger lump sum also saved more time than the smaller one. This
indicates that a larger sized lump sum is more efficient at reducing the interest paid and increasing the time
saved.

5|Page
A lump sum of $20,000 after 10 years

Calculating Future value

N= 10 x 12 FV= 363,420.81
I%= 4.51
PV= 500,000
PMT= -2782
FV= ?
P/Y= 12
C/Y= 12

Outstanding debt after lump sum = 363,420.81 – 20,000

= $343,420.81

Calculating Time
N= ? N= 166.21
I%= 4.51 N= 167 Months
PV= 343,420.81
PMT= -2782
FV= 0
P/Y= 12
C/Y= 12

Time of Loan = 120 + 167

= 287 Months

Time saved= 300 - 287

= 13 Months

Calculating interest
Interest= PMT x N + Lump sum – PV
= 2782 x 287 + 20,000 – 500,000
= $318,434

Interest saved= 334,600 – 318,434

= $16,166

A $20,000 lump sum after 10 years was calculated to identify how the timing of the lump sum effects the
interest and time saved. It saved only $16,166 which is $11,128 less than when the same sized lump sum was
paid after 5 years. The lump sum paid after 5 years also saved more time compared to the lump sum paid
after 10 years. This identified that it was better to pay the lump sum earlier in the term of the loan. If the lump
sum is paid earlier, it is able to reduce more interest. The calculations suggest that the couple should pay a
larger sized lump sum earlier in the length of their loan.

6|Page
The calculation assumes that the couple will be able to afford such a significant amount of money which
may not be practical due to their financial state. If they were given an inheritance or won a large sum of
money, they could be able to afford the lump sum. The calculations provide a reasonable trend that shows
that as the size of the lump sum is increased and is paid earlier in the term of the loan, more time and
interest will be saved.

Using an Offset Account

This section will look at the effect to the time and interest saved on the loan if the couple were to utilize an
offset account of either $10,000 or $20,000.

Size of offset account= $10,000 Size of offset account= $20,000

Principal= 500,000 – 10,000 Principal= 500,000 – 20,000

= $ 490,000 = $ 480,000

Calculating Time Calculating Time

N= ? N= 289.13 N= ? N= 278.90
I%= 4.51 N= 290 Months I%= 4.51 N= 279 Months
PV= 490,000 PV= 480,000
PMT= -2782 PMT= -2782
FV= 0 FV= 0
P/Y= 12 P/Y= 12
C/Y= 12 C/Y= 12

Time saved= 300 - 290 Time saved= 300 - 279

= 10 Months = 21 Months

Calculating interest Calculating interest

Interest= PMT x N + Offset account – PV Interest= PMT x N + Offset account – PV
= 2782 x 290 + 10,000 – 500,000 = 2782 x 279 + 20,000 – 500,000
= $316,780 = $296,178

Interest saved= 334,600 – 316,780 Interest saved= 334,600 – 296,178

= $17,820 = $38,422

The offset account of $10,000 saved 10 months and $17,820. The offset was doubled to a value of $20,000
where it saved 21 months and $38,422. This means that the larger offset size resulted in more than doubled
the time and interest saved suggesting that the couple should opt for a larger offset.

It is assumed that Emma and Josh will be able to afford an offset and that their offset will start at exactly
$10,000 or $20,000. Offsets do not usually start at a high value, instead they build up as more money is paid
into the offset account. Offset accounts can also decrease as the borrower may take out money when
they need it. Therefore, offsets fluctuate over the length of the loan. When the offset is increased, the
principal is decreased, and therefore the interest is decreased. But when the offset is decreased, the
principal increases and therefore causing the interest to increase.

7|Page
Combination of Strategies

This section will utilise strategies that have been previously investigated to see how they can combine to
better impact the interest and time saved. The strategies that the couple will combine are, a $10,000 offset
with fortnightly repayments. After 5 years, a lump sum payment of $20,000 is made and the fortnightly
repayments are increased by $50.

Principal with offset = 500,000 – 10,000 Fortnightly Repayments = 2782/2

= $ 490,000 = $1,391

Calculating Future Value after 5 years

N= 5 x 26 FV= $411,063.98
I%= 4.51
PV= 490,000
PMT= -1391
FV= ?
P/Y= 26
C/Y= 12

New principal with lump sum = 411,063.98 – 20,000 Increasing Fortnightly Repayments = 1391 + 50
= $391,063.98 = $1,441

Calculating Time
N= ? N= 366.99
I%= 4.51 N= 367 Fortnights
PV= 391,063.98
PMT= -1441
FV= ?
P/Y= 26
C/Y= 12

Overall Time= 5 x 26 + 367

= 497 Fortnights

Time Saved= 25 x 26 – 497

= 153 Fortnights

Calculating interest
Interest= Offset + N1 x pmt1 + lump sum + N2 x pmt2 – original amount borrowed
= 10,000 +((5 x 26) x 1391) + 20,000 + (367 x 1441)- 500,000
= $239,677

Interest saved= 334,600 – 239,667

8|Page
 = $94,923

By combining a few strategies together, the couple is able to significantly impact the overall time saved by
76 and a half months and save $93,923 in interest. This strategy is more efficient than other methods.
However, it also has the same assumption as seen when changing the time of repayments, limiting the
accuracy of this calculation. Because of this, it would be unreasonable to outright compare this calculation
to others.

Analysis and Discussion-

Each strategy calculated saved over $10,000 in interest. This is because the strategies allow the loan to be
paid off quicker by reducing how many compounding periods there are. For example, when the size of
regular repayments is increased, the principle drops faster, therefore reducing the amount of interest paid
each compound period. The same can be said for the other strategies, changing the time of regular
repayments reduces the principal faster as more is essentially paid by each compounding period, an offset
account reduces the starting principal, meaning less interest is paid, a lump sum also reduces the interest
charged on the loan by reducing the principal and a combination of these strategies results in an even
larger amount of interest and time saved.

All strategies make the assumption that the interest rate will not change over the length of the loan. It is
common in real life situations that the interest rate increases and decreases during the term of the loan and
therefore the size of repayments either increase or decrease. This was not included in the calculations,
limiting the data to one interest rate. Despite this assumption, the calculations are reasonable as all
calculations are affected and therefore does not change the overall comparison of each strategy or affect
the outcome of the answers

A limitation to all strategies is that the term of the loan was always rounded up to the nearest month. This
impacts the calculations as more time could have been added to one calculation compared to another.
For example, if the answer was 281.4 months, it was rounded to 282 months and if the answer was 265.17
months, it was rounded to 266 months. More time was added to the answer of 265.17 than 281.4, resulting in
inaccurate answers for the amount interest and therefore the interest saved. However, while this limitation
lessens the accuracy of the calculations, they are still reasonable as it is clear that 282 months is larger than
266 months.

Another limitation that effects all strategies investigated is, the calculator compounds the interest at the end
of every month and then adds it to the principal. In real life, the interest is calculated daily and then added
at the end of the month for total interest. This means that the calculations do not reasonably represent real
life situations.

Due to assumptions and limitations encountered in this investigation, the general trend of the strategies can
be compared however the actual amount of interest and time saved cannot be accurately compared to
real world situations.

Conclusion-

Despite assumptions and limitations to the strategies, the calculations still identify a general trend as
discussed previously. Josh and Emma should opt to use a combination of strategies to reduce the term of
the loan and therefore the amount of interest that they pay. The calculations suggest that Josh and Emma
should change their repayments from monthly to weekly in order to decrease the principal quicker. This
strategy does not require the couple to pay any extra money and therefore they should definitely be
paying weekly. The couple should also use an offset account. They can use an offset as another bank
account such as an emergency funds account, that would instead of just having money sitting in the bank,
they can use it towards paying off their loan faster and saving more interest. This strategy also does not

9|Page
require the couple to pay any extra money if they already have an emergency fund or any other fund that
they can transfer to the offset account instead. If the couple was to acquire a large sum of money through
either inheritance or by winning some, they can either increase their offset or they can pay a lump sum.
While both strategies will save the same amount of interest, offsets enable the couple to access the money
whereas with a lump sum they cannot use the money. If Josh and Emma have disposable income, the
calculations suggest they should increase their repayments. Larger repayments save more interest and
reduce the term of the loan. They do not have to do this for every repayment, just when they can afford it.

10 | P a g e