An individual took out a loan of dollar 100,000 to purchase a house on 1 January 1980. The loan is due to be repaid on 1 January 2010 but the borrower can repay the loan early if he wishes.
The borrower pays interest on the loan at a rate of 6 percentage per annum compounded monthly paid in arrears.
The loan installments only cover the interest on the loan. At the same time, the borrower took out a 30 year investment policy, which was expected to repay the loan, and into which monthly premiums were paid in advance, at a rate of dollar 1, 060 per annum.
The individual was told that premiums in the investment policy were expected to earn a rate of return of 7 percentage per annum effective.
After 20 years, the individual was informed that the premiums had only earned a rate of return of 4 percentage per annum effective and that they would continue to do so for the final 10 years of the policy.
The borrower agrees to increase his monthly payments into the investment policy to dollar 5,000 per annum for the final 10 years.
Calculate the amount to which the investment policy was expected to accumulate at the time it was taken out.
Calculate the amount by which the investment policy would have fallen short of repaying the loan had extra premiums not been paid for the final 10 years.
Calculate the amount of money the individual will have, after using the proceeds of the investment policy to repay the loan, after allowing for the increase in premiums.
Suggest another course of action the borrower could have taken which would have been of higher value to him, explaining why this higher value arises.
Calculate the level annual installment that the investor would have had to pay from outset if he had repaid the loan in equal installments of interest and capital.