In This World - Problem of the Day

CNN News Clip

It seems as if some people have an unlimited supply of money... million dollar homes, paid for in cash, expensive art, or tearing down one perfectly good house to build another, are some examples of spending money without regard. Sit back, relax, and inquire what you would do if you won the lottery. Some time ago, Ron and Lorraine purchased a home, and they still owe $200,000. Their payments are $1,450 per month, and they have 10 years left to pay. They just came into some money and want to free themselves of the monthly payments by paying off the loan. They go to the bank and are told that, to pay off the home loan, they must pay $200,000 plus a "prepayment penalty" of 3%. (Older home loans often had prepayment clauses ranging from 1% to 5% of the amount to be paid off. Today, most lenders will waive this penalty, if requested.) This means that, to own their home outright, Ron and Lorraine would have to pay $206,000 ($200,000 + 3% of $200,000). They want to know whether this is a wise financial move.

In this section, Ron and Lorraine will learn about the effects of compound interest, and they will see that with their $206,000 they could not only pay off the home loan but also end up with over a quarter of a million dollars in cash!