## Quiz 5 :

Adjustable and Floating Rate Mortgage Loans

Answer:

Price level adjusted mortgage (PLAM) is a kind of mortgage where the mortgage payments get adjusted for inflations. The new mortgage payments after the adjustments are computed using the adjusted balance. In this kind of mortgages interest rate does not get varied while the principal changes. Usually the changes are reflected by index-CPI. For implementation of these changes the intervals are agreed upon by lender and borrower at frequent intervals.

As PLAM is a kind of remedy used to imbalance the problems for the savings institutions. In order to help reduce the risks associated with uncertainties of inflation and its impact over interest rates, it is suggestive for the lenders to originate mortgages at interest rates that which reflect the expectations of real interest rate in addition to a risk premium. This is needed to avoid the likelihood of loss that occurs due to getting defaulted upon a mortgage taken.

Limitations:

1. Indexing of loan balances to CPI would result in increase of loan balances rapidly than of property values. This would impact borrowers with a default of incentive

2. Another problem is with borrower income and mortgage payments, it is not necessary that the income of borrowers has a simultaneous increase along with the increase in inflation. This result in burden over households for payments of mortgage in short run.

3. Indexation price level is measured on the basis of historical data. Thus the index data is based upon the data collected in previous year but published in current year.

Answer:

The term ARM refers to adjustable rate mortgage. As the name it suggests possible adjustments over mortgage, a mortgage loan with ARM modifies the interest rate upon mortgages periodically on the basis of inflation index. These changes would ultimately get reflected upon the lenders of borrowing in credit markets.

Solution (a) monthly payments in interest only payments for 3 years

The following table shows detailed computation of interest rates and amortizations along with BOY, EOY balances.

Therefore, from the above computation the monthly interest only payment in year 1 would be

.

Solution (b) Monthly payments after 3 years when loan is fully amortized, reset rate is 6%

At the end of third year, the outstanding loan balance would be $200,000, reset interest rate is 6% annually, and remaining years are 27, and loan is fully amortized.

Following are the data inputs in spreadsheet to calculate monthly payments using PMT function:

Following are the obtained results:

Therefore, from the above computation the monthly payment for the rest periods would be

Answer:

The term ARM refers to adjustable rate mortgage. As the name itself suggests possible adjustments over mortgage, a mortgage loan with ARM modifies the interest rate upon mortgages periodically on the basis of inflation index. These changes would ultimately get reflected upon the lenders of borrowing in credit markets.

Interest rate caps are defined as the limits to which extent the interest rate or the monthly payments on mortgages can be changed at the each ending adjustment period or the whole tenure of the loan.

The ARM is made for $150,000 for a period of 30 years with maximum 5 % annual payment cap and allowance of negative amortizations. The margin is 2.00% and the initial Rate is 7.0%. Also consider that the payments will reset each year.

Here, uncapped rate is the periodic rate plus the margin:

The calculation of the spreadsheet is given below:

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