Question

Mia wants to borrow £6000 and repay it, with interest, after two years. she sees two offers for loans: offer 1 compound interest 3% per year offfer 2 compound interest first year 1% second year 3% mia says, iwill payback the same amount because the average of 1% and 5% is 3% is she correct?

Answer 1

Answer:

she is wrong, offer 2 results in lower interests

Step-by-step explanation:

total amount paid if offer 1 is accepted:

$6,000 x (1 + 3%)² = $6,000 x 1.0609 = $6,365.40

she will pay $365.40 in interests

total amount paid if offer 2 is accepted:

($6,000 x 1.01) x 1.05 = $6,060 x 1.05 = $6,363

she will pay $363 in interests

Compounding interest refers to interest that earns more interest itself, e.g. in the first offer, the $180 of interests charged for the first year will earn $5.40 in extra interests. While offer 2 only charges $60 in interests during the first year which will in turn earn $3 of interests. The difference between both offers is that interest charges in offer 1 earn more interests than the interest in offer 2 = $5.40 - $3 = $2.40