Suppose that you are considering taking out an adjustable-rate mortgage with the

Question

Suppose that you are considering taking out an adjustable-rate mortgage with the following terms:

Amount borrowed: $225,000

Index rate: Prime Rate (Current value is 3.5%)

Margin: 200 basis points.

Periodic cap: 1.5 percentage points

Lifetime cap: 5 percentage points

Amortization: 25 years

a. What will the initial monthly payment be for this loan?

b. If the loan’s interest rate adjusts every year and the prime rate falls to 2.75% by the end of the first year, what will your payment be in the second year of the loan?

c. What is the highest interest rate that the lender could charge over the life of the loan?

Explanation / Answer

Amount borrowed $                   2,25,000 Index rate 3.50% Margin 200 basis points 2.00% Periodic cap 1.50% Lifetime cap 5.00% Amortization                             25.00 years a) Initial interest rate Index + Margin 5.50% NPER 300 PV $ 2,25,000 FV 0 PMT $ 1,381.70 b) Initial interest rate Index + Margin 4.7500% NPER 288 PV $ 2,20,687 FV 0 PMT $ 1,285.66 c) Highest rate Current rate + lifetime cap 10.50%

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