Rick and Stacy Stark, a married couple, are interested in purchasing their first boat. They have decided to borrow the boat's purchase price of $100,000. The family is in the 28% federal income tax bracket. There are two choices for the Stark family: They can borrow the money from the boat dealer at an annual interest rate of 8%, or they could take out a $100,000 second mortgage on their home.
Currently, home equity loans are at rates of 9.2%. There is no problem securing either of these two alternative financing choices.
Rick and Stacy learn that if they borrow from the boat dealership, the interest will not be tax deductible. However, the interest on the second mortgage will qualify as being tax deductible on their federal income tax return.
a. Calculate the after-tax cost of borrowing from the boat dealership.
b. Calculate the after-tax cost of borrowing through a second mortgage on their home.
c. Which source of borrowing is less costly for the Stark family?