Consider a one-year, $150,000 ARM with a 30-year amortization period. The index rate is currently 3.75 percent, and you estimate that it will increase by 25bp (0.25%) each year for the following 2 years. The fixed margin is 225bp (2.25%), but the lender is offering a teaser rate of 5 percent for the first year of the mortgage.

Required: a. Calculate the contract rate, remaining loan balance, and monthly payment for each of the three years.

b. Suppose that the ARM has a 1 percent annual adjustment cap and a 6 percent overall cap. What is the loan balance and monthly payment for each of the three years? Assume the rate cap applies to the teaser rate.