Question

5. Assume that Jocelyn is comparing two fixed-rate loan options, a 15 year and a 30 year mortgage. Both options have the same interest rate and amount borrowed. The 30 year, when compared to the 15 year loan will have a 1)_____________ monthly payment and a 2)___________ total cost when repayment is completed.

Answer 1

The correct answers are:

1. LOWER
2. HIGHER

When the repayment schedule of the mortgage is calculated, the total amount of the loan (called principal) is divided in a number of identical monthly instalments. In the 30 year mortgage, as the principal is divided into a larger number of months, the amount due on each of them is lower.

The interest is accrued when a payment is made every month. As in the 30-year loan there is a larger number of repayments the aggregate amount repaid in terms of interest in much larger than in the 15-year one. As in both the repayment of the principal is exactly the same, the cost of the 30 year mortgage is larger.

Answer 2

1. LOWER
2. HIGHER

The 30 year loan has a lower monthly payment since the payment is spread over a longer duration.

The 30 year loan will have a higher total cost because the interest (although same rate with the 15 year loan) would be paid for a longer duration.