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									                                                                           Marchant/Fall 2008

                                  DEBT SERVICE EXERCISE

This exercise covers the basics of calculating debt service payments. Answers are
provided on the following pages. Proficiency in doing these calculations and an
understanding of the underlying concepts will be assumed in future classes.
Based upon the following assumptions:

         Initial mortgage loan balance = $100,000
         Interest rate = 10%
         Loan term = 25 years
         Fully-amortized, level monthly debt service payments consisting of interest and
          principal payments payable at the end of each month
         Annual Constant to be calculated using your financial calculator (or your computer)

Answer the following questions:
1.        What is the dollar amount of your constant monthly debt service payment?

2.        What is your interest payment at the end of the first month of the loan?

3.        What is your principal payment at the end of the first month of the loan?

4.        What is your total loan amortization after the third month’s debt service payment
          has been made?

5.        Do interest payments increase or decrease over the term of the loan? Why?

6.        Do principal payments increase or decrease over the term of the loan? Why?

7.        What is the dollar amount of your annual debt service payments (sum of your 12
          monthly payments)? What percent of the initial mortgage loan balance does this
          annual payment represent? (Note: This percentage is known as the "Annual
          Constant.")

8.        What will your debt service payments total over the 25-year life of the loan? How
          much of the total debt service payments represents interest payments?

9.        What would the outstanding loan balance be after only 10 years of payments?

10.       What would your annual constant be if the loan term were 30 years instead of 25
          years?
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                       DEBT SERVICE EXERCISE (ANSWERS)
1.   Monthly Debt Service Payment

     Use your financial calculator or computer to calculate the Annual Constant and/or
     monthly payment. The Annual Constant is 10.9044 (rounded), resulting in the following
     Monthly Debt Service Payment:

            $100,000*10.9044% = $10,904.44 = Annual Debt Service Payment
            $10,904.44/12 months = $908.70 = Monthly Debt Service Payment

2.   Interest Payment at End of First Month

            $100,000 (original total principal)* 10% (interest rate per year)
                                                     12 (months per year)
            = $100,000*.008333 = $833.30

3.   Principal Payment at End of First Month

     $908.70 (total monthly payment) - $833.30 (interest payment at end of first month)
      = $75.40 (principal payment at end of first month)


4.   Total Loan Amortization after 3 Months:
     Second Month Payment

     $100,000 (initial principal balance) - $75.40 (principal paid off at end of first month) =
     $99,924.60 (principal balance at beginning of second month)

     $99,924.60*.008333 = $832.67 interest payment

     $908.70 (total monthly payment) - $832.67 (interest payment at end of second month)
     = $76.03 (principal payment at end of second month)

     Third Month Payment

     $99,924.33 (principal balance remaining at beginning of second month) - $76.03
     (principal paid off at end of second month) = $99,848.60 (principal balance at
     beginning of third month)

     $99,848.60*.008333 = $832.07 interest payment

     $908.70 (total monthly payment) - $832.04 (interest payment at end of third month)
      = $76.66 (principal payment at end of third month)

     Total Amortization after Three Months

     $75.40 (1st month) + $76.03 (2nd month) + $76.66 (3rd month) = $228.09
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5.    Interest payments DECREASE over the life of the loan because the fixed monthly
      interest rate (10% divided by 12 months = .008333) is constantly applied to a
      decreasing outstanding loan balance, resulting in a decreasing interest payment
      over the life of the loan.


6.    Principal payments INCREASE over the life of a constant monthly payment loan
      because decreasing interest payments allow a higher amount of the total monthly
      debt service payment to go toward amortization of the outstanding principal
      balance, resulting in an increasing principal payment over the life of the loan.


7.    Dollar Amount of Annual Debt Service Payment:

      $908.70 (monthly payment)*12 (months) = $10,904.40

      Annual Constant = Amount of Annual Debt Service = $10,904.40 =
                          Original Loan Balance          $100,000

      Annual Constant = 10.9044% (Rounded)


8.    Total Debt Service Payment over Life of Loan:

      $908.70 (monthly payment)*12(months)*25 (years) = $272,610

      How much is Interest? :

      $272,610 (total payments over term of loan) - $100,000 (total principal payments
      over term of loan) = $172,610 of interest payments over life of loan


9.    Outstanding Principal Balance after 10 Years

      Use your financial calculator or computer to calculate outstanding loan balance
      after 10 years (120 periods). Answer: $84,561.52


10.   Annual Constant Based on Monthly Payments if Term of Loan were 30 Years

      Given that you now have five additional years to pay off (amortize) the original
      principal balance, your monthly payments will be LOWER than those required by a
      25-year term loan. The Annual Constant for a 30-year term loan would be 10.531%
      (Rounded) resulting in a monthly debt service payment of $877.58
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