11. Finance charge calculation – The discount method
The discount method is a method for computing interest on an installment loan. With the discount method, you calculate the interest based on a discount rate that is multiplied times the amount borrowed and by the number of years to repay the loan. The interest is then subtracted from the amount of the loan, and only the difference is given to the borrower. Thus, the interest is paid up front. For loans using the discount method, the monthly payment amount is calculated based on the entire loan amount, including the discounted interest.
Consider the following example:
Carlos Alvarez from Columbus, Ohio, borrows $1,500 (including interest) for four years (48 months) at an interest rate of 7% per year. The loan uses the discount method for determining the amount of interest.
How much of the loan amount ($1,500) consists of interest? $
How much of the loan is actually given directly to Carlos? $
What is the monthly payment (rounded to the nearest penny), assuming 48 monthly payments? $