Jane plans to borrow from a bank to finance her investment in a real estate proj
ID: 2717169 • Letter: J
Question
Jane plans to borrow from a bank to finance her investment in a real estate project. She considers an ARM loan with three-year loan term, $100,000 loan amount. The loan has the following terms: 1) initial interest rate = 8.5%; 2) margin = 3%; 3) loan amortization period = 15 years; 4) frequency of adjustment = 1 year (monthly compounding); 5) interest rate cap = none; 6) payment cap = none; and 7) discount points = 3%; 8) no negative amortization is allowed. The index rates (i.e., based on 3 year treasure rate) for next two years (i.e., the 2nd and 3rd year) are expected to be 11% and 8%, respectively.
(a) If the loan will be repaid after 3 years, what would be the monthly payment and the ending loan balance for each of the three years?
(b) What is the effective mortgage yield for borrowing this mortgage?
(c) Now suppose that there is an annual interest rate cap of 2% specified in the loan contract. What is the effective mortgage yield for borrowing this mortgage, assuming that no negative amortization is allowed?
(d) Now suppose, instead of the annual interest rate cap of 2%, the bank prefers a 3% annual payment cap. Assume that negative amortization is allowed, what is the effective mortgage yield for borrowing this mortgage?
Explanation / Answer
Jane plans to borrow from a bank to finance her investment in a real estate project. She considers an ARM loan with three-year loan term, $100,000 loan amount. The loan has the following terms: 1) initial interest rate = 8.5%; 2) margin = 3%; 3) loan amortization period = 15 years; 4) frequency of adjustment = 1 year (monthly compounding); 5) interest rate cap = none; 6) payment cap = none; and 7) discount points = 3%; 8) no negative amortization is allowed. The index rates (i.e., based on 3 year treasure rate) for next two years (i.e., the 2nd and 3rd year) are expected to be 11% and 8%, respectively.
(a) If the loan will be repaid after 3 years, what would be the monthly payment and the ending loan balance for each of the three years?
(c) Now suppose that there is an annual interest rate cap of 2% specified in the loan contract. What is the effective mortgage yield for borrowing this mortgage, assuming that no negative amortization is allowed?
(d) Now suppose, instead of the annual interest rate cap of 2%, the bank prefers a 3% annual payment cap. Assume that negative amortization is allowed, what is the effective mortgage yield for borrowing this mortgage?
Ending Balance at the end of 1st year $97,000 - ($955.20 x 12 months)
Ending Balance at the end of 2nd year $85,537.63 - ($1319.67 x 12 months)
Ending Balance at the end of 1st year $69,701.53 - ($1171.30 x 12 months)
Jane plans to borrow from a bank to finance her investment in a real estate project. She considers an ARM loan with three-year loan term, $100,000 loan amount. The loan has the following terms: 1) initial interest rate = 8.5%; 2) margin = 3%; 3) loan amortization period = 15 years; 4) frequency of adjustment = 1 year (monthly compounding); 5) interest rate cap = none; 6) payment cap = none; and 7) discount points = 3%; 8) no negative amortization is allowed. The index rates (i.e., based on 3 year treasure rate) for next two years (i.e., the 2nd and 3rd year) are expected to be 11% and 8%, respectively.
(a) If the loan will be repaid after 3 years, what would be the monthly payment and the ending loan balance for each of the three years?
(b) What is the effective mortgage yield for borrowing this mortgage?(c) Now suppose that there is an annual interest rate cap of 2% specified in the loan contract. What is the effective mortgage yield for borrowing this mortgage, assuming that no negative amortization is allowed?
(d) Now suppose, instead of the annual interest rate cap of 2%, the bank prefers a 3% annual payment cap. Assume that negative amortization is allowed, what is the effective mortgage yield for borrowing this mortgage?
a) Loan Amount $100,000 Discount Points 3% Present Value(PV) $100,000-(1-3%) $97,000 Year 1 ARM 8.50% 0.71% Per month Year 2 ARM = Index + Margin; 11% + 3% 14.00% 1.17% Per month Year 3 ARM = Index + Margin; 8% + 3% 11.00% 0.92% Per month Year 1 NPER = 15 years x 12 months 180 months Year 2 NPER = 14 years x 12 months 168 months Year 3 NPER = 13 years x 12 months 156 months Monthly Payment for year 1 (using excel PMT function) $955.20 Monthly Payment for year 2 (using excel PMT function) $1,319.67 Monthly Payment for year 3 (using excel PMT function) $1,171.30Ending Balance at the end of 1st year $97,000 - ($955.20 x 12 months)
$85,537.63Ending Balance at the end of 2nd year $85,537.63 - ($1319.67 x 12 months)
$69,701.53Ending Balance at the end of 1st year $69,701.53 - ($1171.30 x 12 months)
$55,645.91 Monthly payment after 3 years $1,171.30 b. Effective Rate (calculated using Effect Function in excel 11.57%Related Questions
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