Chapter 5

1. Make Nu Mortgage Company is offering home buyers a new mortgage instrument called the Stable Home Mortgage. This mortgage is composed of both a fixed rate and adjustable rate component. Mrs. Maria Perez is interested in financing the purchase of a new home. The home, which costs $100,000, is to be financed by Stable Home Mortgages (SHM) on the following terms:

a. The SHM requires a 5 percent down payment, costs the borrower 2 discount points, and allows 75 percent of the mortgage to be fixed and 25 percent to be adjustable. The fixed portion of the loan is for 30 years at an annual interest rate of 10.5 percent. Having neither an interest rate cap nor payment cap, the adjustable portion is also for 30 years with the following terms:

Initial interest rate = 9 percent

Index = 1-year Treasuries

Payments adjust each year

Margin = 2 percent

Interest rate cap = None

Payment cap = None

The projected one-year U.S. Treasury-bill index, to which the ARM is tied, as follows BOY2 = 10 percent; BOY3 = 11 percent; BOY4 = 8 percent; BOY5 = 12 percent.

Calculate Mrs. Perez's total monthly payments and end-of-year loan balances for the first five years. Calculate the lender's yield, assuming Mrs. Perez repays the loan after five years.

Repeat part (a) under the assumption that the initial interest rate is 9.5 percent and there is an annual interest rate cap of 1 percent.

2. An ARM for $100,000 is made at a time when the expected start rate is 5 percent. The loan will be made with a teaser rate of 2 percent, for the first year, after which the rate will be reset. The loan is fully amortizing, has a maturity of 25 years and payments will be made monthly.

a. What will be the payments during the first year?

b. Assuming that the reset rate is 5 percent at the beginning of year 2 (BOY)2, what will the payments be?

c. By what percentage will monthly payments increase?

a. What if the reset date is three years after loan origination and the reset rate is 6 percent, what will loan payments be beginning in year 4 through 25.

Chapter 6

1. A borrower is purchasing a property for $180,000 and can choose between two possible loan alternatives. Loan A is a 90% loan for 25 years at 9% interest and 1 point and Loan B is a 95% loan for 25 years at 9.25% interest and 1 point.

a. Assume the loans will be held to maturity, what is the incremental cost of borrowing the extra money.

b. Assume that the loans will be repaid in 5 years. What is the incremental cost of borrowing the extra money?

c. Rework parts (a) and (b) assuming the lender is charging 2 points on Loan A and 1 point on Loan B. What is the incremental cost of borrowing?

d. Assume Loan B now has a maturity of 20 years. What is the incremental cost of borrowing? Both loans held to maturity with no points charged

2. A loan was made 10 years ago for $140,000 at 10.5% for a 30 year term. Rates are currently 9.25%. What is the market value of the loan?