Consider the following scenario: John buys a house for $150,000 and takes out a

Question

Consider the following scenario: John buys a house for $150,000 and takes out a five year adjustable rate mortgage with a beginning rate of 6%. He makes annual payments rather than monthly payments.

Unfortunately for John, interest rates go up by 1% for each of the five years of his loan (Year 1 is 6%, Year 2 is 7%, Year 3 is 8%, Year 4 is 9%, Year 5 is 10%).

Calculate the amount of John's payment over the life of his loan. Compare these findings if he would have taken out a fix rate loan for the same period at 7.5%. Which do you think is the better deal?

Explanation / Answer

following is an amortization table for $150,000 5-years 7.5% interest loan paid annually: Pmt # Principal Interest Balance 1 $25824.71 $11250.00 $124175.29 2 $27761.56 $9313.15 $96413.73 3 $29843.68 $7231.03 $66570.05 4 $32081.96 $4992.75 $34488.09 5 $34488.10 $2586.61 Total interest to be paid is $35373. Amortization table for the loan with adjustable interest will be Pmt # Principal Interest Balance 1 - 6% $26609.46 $9000.00 $123390.54 2 - 7% $27791.02 $8637.34 $95599.52 3 - 8% $29447.86 $7647.96 $66151.66 4 - 9% $31651.51 $5953.65 $34500.15 5 - 10% $34500.15 $3450.02 $0.00 Total interest to be paid is $34,688.97. So far - adjustable interest loan is preferable over a fix rate loan.

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