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. Perezs total monthly payments and end-of-year loan balances for

the first five years. Calculate the lenders 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