WEEK 4 RE FIN HW What is the difference between an Adjustable Rate and Fixed Rat

Question

WEEK 4 RE FIN HW

What is the difference between an Adjustable Rate and Fixed Rate Mortgage?

Name and Explain two adjustable rate mortgages?

How can Inflationary Expectations influence Interest Rates on Mortgage Loans?

Name and Explain two factors when considering refinancing?

Define Cash Equivalence?

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Explanation / Answer

Question 1:

Adjustable rate mortgage is a mortgage in which the interest rate changes as per the market interest rate. For example, if the interest rates were low when you took the mortgage and now, the US Fed has hiked rates; your home mortgage rate will also increase in the same proportion. On the other hand if you took a mortgage when the rates were high and now the rates are low, you get the advantage of lower rate.

In a fixed rate mortgage your interest rate on the mortgage will not change as per the current market interest rate. This type of loans are attractive when the in the interest rates are low and customers can lock in the low rate. They are unattractive when interest rates are high.

Question 2: Types of adjustable rate mortgage (ARM)

1. 7/1 ARM - this is a type of an adjustable rate mortgage in which the interest rate is fixed for the first seven years, After this period the interest rates change as per the market conditions and based on several other factors

2. Interest only ARM - this type of adjustable rate mortgage is one in which you pay interest only for the first few years (typically between 3-10 years) and after that your monthly payment become higher. In this way, you can have smaller initial monthly payments and have larger ones as your pay check increases.

Question 3: Yes, the inflation expectations play a critical role. If the inflation in the economy is high, the central bank which is the US Federal reserve will hike the benchmark interest rates. Because of this the mortgage interest rates also increase and the vice-versa is also true.

Question 4: The two factors when considering refinancing

1. You have taken a fixed rate mortgage and the current market interest rates are low. Therefore, you want to look at refinancing to take advantage of the lower rate

2. Another thing that you will have to consider is the refinancing. Banks and financial institutions make have high closing costs. SO you have to consider the closing costs and the up-front fee for the new loan when considering the refinancing option

Question 5:

This doctrine of cash equivalence under the US federal law treats certain non cash payments as cash transactions for the income tax purposes. For example accrued interest which is payable at the end and is guaranteed may be considered regular income in each year although the interest is paid at the end of the term.

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