## Quiz 15 :

Mortgage Calculations and Decisions

Answer:

We are asked to consider the following variables: Suppose a one-year ARM loan has a margin of 2.75 percent, a teaser rate for the first year of 4.00 percent, and a cap of 1.00 percent.

If the index rate is 3.00 percent at the end of the first year, what will be the interest rate on the loan in year 2 If there is more than one possible answer, what does the outcome depend on

If the periodic cap applies to the beginning or opening rate, in year two the interest rate will be limited to 5.00 percent. If the cap applies only to margin plus index, in year two the interest rate would be 5.75 percent.

Answer:

We are asked to consider the following variables: A homeowner is attempting to decide between a 15-year mortgage loan at 5.5 percent and a 30-year loan at 5.90 percent. What would you advise What would you advise if the borrower also has a large amount of credit card debt outstanding at a rate of 15 percent

If the borrower is not carrying a large debt at a rate significantly higher than the rates on the loan, then the variance in the mortgage rates can be considered to be a maturity premium difference. Bearing this information in mind, the borrower can see the loans as roughly the same on a purely financial basis.

If the borrower is carrying a large consumer debt at a rate significantly higher, then a longer term loan may be preferable. So, if the debt rates of the consumer credit are significantly higher than the mortgage interest rate, it would be better to choose the longer-term mortgage loan.

Answer:

We are asked to calculate the following variables: Assume the following for a one-year rate adjustable rate mortgage loan that is tied to the one-year Treasury rate:

Loan amount: $150,000

Annual rate cap: 2%

Life-of-loan cap: 5%

Margin: 2.75%

First-year contract rate: 5.50%

One-year Treasury rate at end of year 1: 5.25%

One-year Treasury rate at end of year 2: 5.50%

Loan term in years: 30

Given these assumptions, calculate the following for a. through g.:

(a) Using the information in the introduction, we need to calculate an initial monthly payment. Using your financial calculator, please enter the values as shown in Table 1 to solve for the initial monthly payment.

Table 1:

Solve for PMT = $851.68

Your calculator should display the first year payment, based on an interest rate of 5.5 percent, to equal $851.68.

(b) Using the information in the introduction, we need to calculate the loan balance at the end of year 1. Using your financial calculator, please enter the values as shown in Table 2 to solve for the loan balance at the end of year 1.

Table 2:

Solve for PV = $147,979

Your calculator should display the loan balance at the end of year one equals $147,979.

(c) Using the information in the introduction, we need to calculate the contract rate for year two.

We will use the annual cap that applies to the teaser rate in our calculations. Our solution equals a 7.50 percent interest rate in year.

(d) Using the information in the introduction, we need to calculate the monthly payment for Year 2. Using your financial calculator, please enter the values as shown in Table 3 to solve for monthly payment for Year 2.

Table 3:

Solve for PMT = $1,044.32

Your calculator should display the monthly payment for Year 2 as equal to $1,044.32 considering the following variables:

• remaining term of 29 years

• interest rate of 7.5 percent

• balance of $147,979.41

(e) Using the information in the introduction, we need to calculate the Loan balance end of year 2. Using your financial calculator, please enter the values as shown in Table 4 to solve for the loan balance at the end of Year 2.

Table 4:

Solve for PV = $146,496

Your calculator should display the loan balance at the end of year two as equal to $146,496.

(f) Using the information in the introduction, we need to calculate the contract rate for Year 3. We know that we need to use the interest rate is index plus margin, or 8.25 percent to find the year three contract rate.

(g) Using the information in the introduction, we need to calculate the Year 3 payment. Based on a balance of $146,496, the year three payment is $1,119, considering the remaining term of 28 years and an interest rate of 8.25 percent.