Amy is considering the following mortgages: A. 30 year, monthly payments, fixed rate, 4.2%, 1.25 points. B. 30 year, monthly payments, 3/1 adjustable rate mortgage (ARM), 3.5%, $316 in closing fees, 2% cap per year on interest rate changes and a 4% lifetime cap.

Assume Amy will borrow $400,000, can afford either of the options and will pay any up-front costs in cash from her bank account. a) ( If rates were expected to rise no more than 1% total over the foreseeable future, advise Amy on choosing the fixed or adjustable rate mortgage?

Briefly explain. b) Amy is neurotic and fears the worst will happen. Under the worst-case scenario for interest rates (i.e. they go up the max and stay up), give advice to Amy on which holding periods are better for her to choose the ARM and which are better for her to have the fixed rate mortgage? To save time calculating these, the monthly payments and some other information for the ARM under this worst case scenario are given below.

There is no need to recalculate these. They are here to save you time. 1. Payment: Months 1-36: $1,796.18. Balance at end of month 36: $376,141.66 2. Payment: Months 37-48: $2231.03. Balance at end of month 36: $369,901.29 3. Payment: Months 49 and after $2698.09