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What are the payments for the interest-only loan?

05 / 03 / 2018 Assignment

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CHAPTER CASE
S&S AIRS MORTGAGE
Mark Sexton and Todd Story, the owners of S&S Air, Inc., were impressed by the work Chris had
done on financial planning. Using Chriss analysis, and looking at the demand for light aircraft,
they have decided that their existing fabrication equipment is sufficient, but it is time to acquire a
bigger manufacturing facility. Mark and Todd have identified a suitable structure that is currently
for sale, and they believe they can buy and refurbish it for about $35 million. Mark, Todd, and
Chris are now ready to meet with Christie Vaughan, the loan officer for First United National
Bank. The meeting is to discuss the mortgage options available to the company to finance the
new facility.
Christie begins the meeting by discussing a 30-year mortgage. The loan would be repaid in equal
monthly installments. Because of the previous relationship between S&S Air and the bank, there
would be no closing costs for the loan. Christie states that the APR of the loan would be 6.1
percent. Todd asks if a shorter mortgage loan is available. Christie says that the bank does have a
20-year mortgage available at the same APR.
Mark decides to ask Christie about a smart loan he discussed with a mortgage broker when he
was refinancing his home loan. A smart loan works as follows: Every two weeks a mortgage
payment is made that is exactly one-half of the traditional monthly mortgage payment. Christie
informs him that the bank does have smart loans. The APR of the smart loan would be the same
as the APR of the traditional loan. Mark nods his head. He then states this is the best mortgage
option available to the company since it saves interest payments.
Christie agrees with Mark, but then suggests that a bullet loan, or balloon payment, would result
in the greatest interest savings. At Todds prompting, she goes on to explain a bullet loan. The
monthly payments of a bullet loan would be calculated using a 30-year traditional mortgage. In
this case, there would be a 5-year bullet. This would mean that the company would make the
mortgage payments for the traditional 30-year mortgage for the first five years, but immediately
after the company makes the 60th payment, the bullet payment would be due. The bullet
payment is the remaining principal of the loan. Chris then asks how the bullet payment is
calculated. Christie tells him that the remaining principal can be calculated using an amortization
table, but it is also the present value of the remaining 25 years of mortgage payments for the 30year mortgage.
Todd has also heard of an interest-only loan and asks if this loan is available and what the terms
would be. Christie says that the bank offers an interest-only loan with a term of 10 years and an
APR of 3.5 percent. She goes on to further explain the terms. The company would be responsible

for making interest payments each month on the amount borrowed. No principal payments are
required. At the end of the 10-year term, the company would repay the $35 million. However, the
company can make principal payments at any time. The principal payments would work just like
those on a traditional mortgage. Principal payments would reduce the principal of the loan and
reduce the interest due on the next payment.
Mark and Todd are satisfied with Christies answers, but they are still unsure of which loan they
should choose. They have asked Chris to answer the following questions to help them choose the
correct mortgage.
QUESTIONS
1. What are the monthly payments for a 30-year traditional mortgage? What are the payments for
a 20-year traditional mortgage?
2. Prepare an amortization table for the first six months of the traditional 30-year mortgage. How
much of the first payment goes toward principal?
3. How long would it take for S&S Air to pay off the smart loan assuming 30-year traditional
mortgage payments? Why is this shorter than the time needed to pay off the traditional
mortgage? How much interest would the company save?
4. Assume S&S Air takes out a bullet loan under the terms described. What are the payments on
the loan?
5. What are the payments for the interest-only loan?
6. Which mortgage is the best for the company? Are there any potential risks in this action?


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