Quiz 4: Fixed Interest Rate Mortgage Loans

Business

Use the formulas in excel to make following calculations as follows: img The results of the formulas will appear as follows: img Therefore, the answers are as follows: (a) The payment at the beginning of Year 2 is $535.96, Year 3 is $576.16, Year 4 is $619.37, and Year 5 is $665.82. (b) If the CPM loan is available the payment is $648.03. (c) The effective yield is 9.07%.

Introduction: Inflation is the situation of increase in price of commodities and decline in value of dollar. Inflation leads to the decrease in interest rates of the loan. Inflation affects the economy as a whole and several measures are taken by the government to remove the situation of inflation. Effect of inflation on monthly mortgage payment: The monthly payment will consist of principal mortgage payment and interest payment. The interest rate under PLAM method is computed in the following manner: img Here, i = Interest rate r = Real rate of interest p = Risk premium f = Expected inflation The monthly payment includes interest payment and interest will depend on inflation. The increase in inflation rate will increase inflation. Therefore, the monthly payment will increase with the increase in the inflation. Tilt effect: • Tilting effect refers to the increase in monthly payments in the initial years of mortgage payment to cover up the loss of purchasing power in later periods of loan term. • Tilt effect will increase as the inflation increases. • The increase in inflation will increase the interest payments. • The increase in the interest will increase the monthly payments of mortgage loan. • Hence, the mortgage payments will increase with the tilt effect. It will create burden on the borrower of loan.

Determine the monthly payments: Monthly payment is the amount to be paid for the loan repayment. As a text book notation, financial calculator should be used to calculate the monthly payment (PMT). It is given that the borrower obtains a loan of $125,000 at 11% interest for 10 years. Hence, the following inputs should be given to the financial calculator to derive the monthly payment: img Hence, the monthly payment should be $1,721.88. In the next case, if the loan period is increased to 30 years, the input 'n' will be changed to 30 years instead of 10 years. The remaining inputs will remain same. Hence, the following inputs should be given to the financial calculator to derive the monthly payment: img Hence, the monthly payment should be $1,190.40.

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