Question
Mortgage loan commercials and bank banners can be a little confusing due to the fact they report two rates: 1) the stated nominal annual rate
Mortgage loan commercials and bank banners can be a little confusing due to the fact they report two rates: 1) the stated nominal annual rate that we usually think of as APR which is compounded monthly and is the rate that is used on the actual loan amount to determine the monthly payment, and 2) the APR which is somewhat higher and in some ads significantly higher than the first rate. This second APR is a stated nominal annual rate but assumes the borrower will finance all closing costs necessary to get the loan (instead of paying them in cash when closing the loan) in addition to the amount the borrower needs to complete the purchase of their home.
Heres how this second APR is determined. First, the first stated annual rate is used to figure the monthly payment on the loan amount plus closing costs. Then, the monthly interest rate that equates the present value of these monthly payments with the loan amount without closing costs is found. Finally, this monthly rate is multiplied by 12 to get this second APR. The larger the difference between the two rates the larger the closing costs and fees for the loan. The mortgage ads usually use some fixed loan amount like $100,000, $150,000, or $200,000. Whether the borrower decides to finance the closing costs or not, this second APR can give the borrower a truer cost of borrowing once the closing costs are factored in.
Lets look at a couple of examples of how this works. Imagine the Prof. Fin finds a $280,000 condo he wishes to buy and has a $90,000 down payment and will need to borrow $190,000 before any closing costs. Use this information to answer the questions below.
1. Friendly Mortgage offers a 30-year fixed rate mortgage with a nominal annual rate of 3.25% with $500 in closing costs.
a. What would be Prof. Fins monthly mortgage payment if he pays the closing costs in cash?
b. What would be Prof. Fins monthly mortgage payment if he finances the closing costs?
c. What is the second APR for this loan as described above?
2. Rapid Loans offers a 30-year fixed rate mortgage with a nominal annual rate of 3.0% with $4000 in closing costs.
a. What would be Prof. Fins monthly mortgage payment if he pays the closing costs in cash?
b. What would be Prof. Fins monthly mortgage payment if he finances the closing costs?
c. What is the second APR for this loan as described above?
3. Which of the two mortgage options would you recommend to Prof Fin? Explain why.
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started