2. Teaser Loans (2 points)

Part of the blame following the sub-prime mortgage crisis went to the banks for their policy of teaser loans which sucked people into buying houses they could not afford. This problem considers this issue:

a) Suppose you can afford a monthly payment of $700 for your mortgage. Use the loan formula to find the selling price of the house (P) that this corresponds to at the teaser rate of 3% APR compounded monthly. Assume a 30 year mortgage.

b) Now use the house price from part a) to determine the monthly payment at a rate of 5% APR, representing the true state of things once the period of enticement is over.

c) How much extra are you now paying? Is this likely to be affordable given your choice of monthly amount in part a)?