Loan OptionsWhich loan is best for you?

Fixed vs. Variable

Team 7: Guy Canedo, Nathan

Sheagley, Thomas Nashed

What are we doing?

When purchasing a home, and requiring a loan there are many options to consider. We will analyze and compare the main two types of loans using Future Worth Analysis.

Some Loan BackgroundFixed vs. Variable

Fixed Rate

Mortgage (FRM)

• Constant interest rate throughout the life of the loan, which produces constant payments

Adjustable Rate

Mortgage (1 ARM)

• First year fixed interest rate

• Rates change monthly after fixed period

• Payment amount is not fixed.

Scenario• We want a 30-year loan of $500,000 to buy a

house. Assuming No down payment & no PMI.• When we compare the 2 loan types over a 10

year period. We assume:- a Fixed Rate Loan of 6.75%- a 1 ARM Loan: first year fixed at 6.45%; and different avg. interest

rates for the remaining 9 years. • We also assume that the house appreciation is

equal to 3%, which is the national average.

Future Worth Analysis

• For both cases we looked at the Future Worth as:– The Future value of the house– Less how much will still be

owed on the principal– Less our total out of pocket

expense (sum of monthly payments)

Fixed Interest Rate Flow• A=$500,000(A/P, 6.75/12%, 360)

A= $3,242.99

...

At 10 years: • House value = $674,676.77 (w/ 3%

appreciation)• Paid $315,663.85 in interest• Still owe $427,344.17 on the principal• Paid a total of $388,319.68• Profit = -$140,987.08

Variable Interest Rate Flow• A= $3,143.92 for the life of the loan assuming

the variable stays at 6.45%

. . .

At 10 years:• House value = $674,676.77• Paid $300,617.66 in interest• Still owe $424,211.42 on principal• Paid a total of $376,406.24• Net Profit = -$125,940.89

Sensitivity AnalysisVariable vs. Fixed @ 10 Years @ 3% Inflation

-142,000.00

-141,500.00

-141,000.00

-140,500.00

-140,000.00

0.0

65

0

Interest Rate

Pro

fit

Variable RateInterest

Fixed RateInterest at 6.75%

Intercepting at 6.765%Therefore, a variable rate loan that averages 6.765% over the next 9 years would be equal to a fixed rate 6.75 loan, therefore it is probably safer to go with the fixed loan from the beginning.

More Sensitivity AnalysisAnalysis for the fixed loan on # of years

Net Profit Over Life of Property

-200000

-150000

-100000

-50000

0

50000

100000

0 10 20 30

Years

Pro

fit

15 years = turning point 27 years = lived there for free

A Little More Sensitivity AnalysisWe Also performed Sensitivity Analysis on the inflation rates of the fixed and variable loans.

- As inflation went up, we saw quicker profit. (trough moved to the left)

- As inflation went down, took longer to see profit. (trough moved to the right

Net Profit Over Life of Property

-200000

-150000

-100000

-50000

0

50000

100000

0 10 20 30

Years

Pro

fit

ConclusionBecause of the nature of our projectthere is no definite answer only suggestions:

1. If in rising market – Fixed rateIf in declining market – Variable

2. If more than 10 years – Fixedbecause in past 20 years rates went up to 20%

3. If short term, and can get much lower rate than fixed - Variable

Resources

• BankOfAmerica.com• QuotingLoans.com• LendingTree.com