You expect to live in a house you are planning to own for 5 years, with a $300K

Question

You expect to live in a house you are planning to own for 5 years, with a $300K loan. You could get a 3/1 ARM amortized over 15 years at 3.9 % or a fixed 15 year loan at 5.0%. Assume the upfront costs and insurance under both loan options are the same. Moreover, suppose the expected interest rate of the ARM for years 4 and 5 is 8.25%. MARR is 10% per year compounded monthly. Which loan would be a better choice (i.e. has lower discounted interest costs)? Just consider the PV of the payments (principle and interest), do not consider tax benefits of interest, or any differences in ownership equity at the end of the loan term.

1) ARM Loan (PV)

2) Fixed Loan (PV)

3) Your choice?____________________________

Please include all the procedures and forms

Explanation / Answer

ARM 3/1 means where interest is fixed for 36 months and changes 4 and 5th year.

Loan figure = 300000

The PV would be 300000PVIF(8.25%,2) PVIF(3.9%,3) is 228254

Now the value after 15 years is 228254 FVIF(3.9%,15) = 405183

The fixed loan would be 300000 PVIF(5%,5) is 235057

The value of the loan 15 years hence will be 235057 FVIF(5%,15) = 488668

The loan amount under ARM is lower hence preferred

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