Question
George would like to borrow $175,000 using an adjustable-rate mortgage instrument. He has the following two options available: a) 1-year ARM, 15-year amortization schedule, 5.50%
George would like to borrow $175,000 using an adjustable-rate mortgage instrument. He has the following two options available: a) 1-year ARM, 15-year amortization schedule, 5.50% initial interest rate, 2% margin, 2% annual interest rate cap, 4% lifetime cap. b) 1-year ARM, 20-year amortization schedule, 5.00% initial interest rate, 1.5% margin, no caps. Assume that each of these loans is indexed to the 1-year Treasury rate, and that this index is expected to have a value of 6% at the end of the first year and 8.5% at the end of the second year. If Georges expected holding period is 3 years, how much is the effective borrowing cost of each loan option?
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