Tony is ready to meet with Austin Friend, the loan officer for Wells Fargo. She is asking to borrow $1 million. The meeting is to discuss the mortgage options available to the company to finance the new facility.
Austin begins the meeting by discussing a 30-year mortgage. The loan would be repaidin equal monthly installments. Because of the previous relationship between Organic Tea and the bank, there would be no closing costs for the loan. Austin states that the APR of the loan would be 6.5 percent. Tony asks if a shorter mortgage loan is available. Austin says that the bank does have a 20-year mortgage available at the same APR.
Tony decides to ask Austin about a "smart loan" she discussed with a mortgage broker when she was refinancing her home loan. A smart loan works as follows: every two week a mortgage payment is made that is exactly one-half of the traditional monthly mortgage payment. The APR of the smart loan would be the same as the APR of the traditional loan.
Austin also suggests a bullet loan, or balloon payment, which would result in the greatest interest savings. At Tony's prompting, he goes on to explain a bullet loan. The monthly payments of a bullet loan would be calculated using a 30-year traditional mortgage. In this case, there would be a 5-year bullet. This would mean that the company would make the mortgage payments for the traditional 30-year mortgage for the first five years, but immediately after the company makes the 60th payment, the bullet payment would be due. The bullet payment is remaining principal of the loan. Tony then asks how the bullet payment is calculated. Austin tells her that the remaining principal can be calculated using an amortization table, but it is also the present value of the remaining 25 years of mortgage payments for the 30-year mortgage.
Tony has also heard of an interest-only loan and asks if this loan is available and what the terms would be. Austin says that the bank offers an interest-only loan with a term of 10 years and an APR of 4.8 percent. He goes on to further explain the terms. The company would be responsible for making interest payments each month on the amount borrowed. No principal payments are required. At the end of the 10-year term, the company would repay the $1 million. However, the company can make principal payments at any time. The principal payments would work just like those on a traditional mortgage. Principal payments would reduce the principal of the loan and reduce the interest due on the next payment.
Tony isstill unsure of which loan she should choose. She has asked you to answer the following questions to help her choose the correct mortgage.
1. What are the monthly payments for a 30-year traditional mortgage?
What are the payments for a 20-year tradition mortgage?
2. Prepare an amortization table for the first six months of the traditional 30-year loan .How much of the first payment goes toward principal?
3. How long would it take for Organic Tea to pay off the smart loan assuming 30-year traditional mortgage payment?
Why is this shorter than the time needed to pay off the traditional mortgage? How much interest would the company save?
4. Assume Organic Tea takes out a bullet loan under the terms described. What are the payments on the loan?
What is the amount of the last payment of the loan?
5. What are the payments for the interest-only loan?
6. Which mortgage is the best for the company? Are there any potential risks in this action?