Problems in Compound Interest

This article from The Star interests me from the point of view of students at USIM who are taking The Actuarial Science & Risk Management Program and The Financial Mathematics Program. It involves practical problems in compound interest. Students can prepare spreadsheets showing the numerical computations involved and provide arguments to support or disagree with the proposal. They can even provide mathematical solutions.

Sunday March 1, 2009
It pays to continue paying the same amount

PETALING JAYA: Should houseowners take advantage of the lower base lending rate (BLR) and enjoy more disposal income with lower monthly home loan repayments? Or should they pay the same amount and complete their loan repayments faster?

Financial planners urge homeowners to opt for the second option if their income level has not been affected by economic downturn.

By shortening the tenure of their loan repayment period, they pay significantly less interest in the long run.

Based on the expected reduced BLR of 0.4% which comes into effect next week, a borrower with a RM200,000 home loan over a tenure of 20 years stands to save more than RM19,000 if he continues to pay the same amount.

On the other hand, he will save only close to RM11,000 if he reduces his monthly payment in keeping with the lower BLR (see chart).

Bank Negara Malaysia reduced the Overnight Policy Rate (OPR) from 2.5% to 2% on Tuesday to allow for more disposable income in the hands of the public, which translates into a lower BLR. This follows a cut in OPR by 75 basis points to 2.5% last month.

Financial planner with MAAKL Mutual Rajen Devadason says individuals who still have their jobs and normal income levels should maintain their monthly repayment sum as each ringgit channelled towards the home mortgage will reduce the interest component.

“However, for those in dire straits, maintaining the loan tenure while reducing the monthly payments will help them reduce their monthly outflow of cash. So, what to do depends upon the current circumstances of the individual,” he adds.