A basic ARM is made for $204,000 at an initial interest rate of 6 percent for 30 years with an annual reset date. The borrower believes that the interest rate at the beginning of year (BOY ) 2 will increase to 7 percent.

Required:

a. Assuming that a fully amortizing loan is made, what will the monthly payments be during year 1?

b. Based on (a) what will the loan balance be at the end of year (EOY ) 1?

c. Given that the interest rate is expected to be 7 percent at the beginning of year 2, what will the monthly payments be during year 2?

d. What will be the loan balance at the EOY 2?

e. What would be the monthly payments in year 1 if they are to be interest only?