Sharp EL733A EL-733A Operation Manual - Page 39

Then compute your payment on the loan. Press: Imo] l TI Result: -12'777.81 Along these same lines, an example of quoting an effective rate that includes all finance charges is shown on page 79 in the section More TVM Examples. VARIABLE RA lh LOANS Variable rate loans started becoming more and more common during the skyrocketing interest rates of the early 1980's. If the economy is unstable or interest rates are wildly going up and down, it usually makes sense for both parties to allow the interest rate on a loan to vary. This practice can be beneficial to both parties in the loan because lenders feel more comfortable lowering their rates when times are good, if they know they have a safety valve written into the contract to use in case the market rates increase. Variable rates complicate a TVM problem, because the TVM functions depend on an even payment calculated at a single interest rate. However, all is not lost. By breaking variable rate problems into separate problems, each corresponding to an adjustment in the interest rate, the solution becomes a series of simple TVM problems. Some of the fairest variable rate loans are those written so that the interest rate is tied to some economic indicator (for example, the prime lending rate, or the rates on government bonds or treasury bills) that can not be controlled by either the lender or the borrower. In the U. S., the most interesting value in a variable rate loan calculation is the payment, because the payment is the value that has to compensate for the fluctuating interest rate. Most variable rate loans are written so that the rates can go up or down, which means the payment can go up or down. And there are usually limits on how much the interest rate can increase in one year and on the maximum interest rate. Often with variable rate loans, an infinite number of possiblities exist for interest rate and, thus, payment amount. At the onset of the loan, a borrower or lender could spend many long nights in front of a calculator speculating on variations of the loan payment, but the only variation that is worthwhile looking at ahead of time is the (dreaded for the borrower) "worst case scenario," which is dictated by the limits of the contract, The borrower has to be able to handle the payments that result from the "worst case scenario." That is, if everything falls apart and the interest rates in the loan head toward the ceiling as rapidly as the contract allows, will the payments still be affordable? If not, somebody is taking a gamble. Solving for the payment schedule on a variable rate loan goes something like this: 1. Solve for the payment (amortize the loan) using the first interest rate in the contract. 2. Calculate the remaining loan balance (FV) at the first time the interest can increase, assuming the maximum increase. 3. Re-amortize the loan for the remaining term, using the balance calculated in step 2 as the present value (PV) and using the increased interest rate. 74 75