Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

PLEASE ANSWER ALL QUESTIONS Problem Set 2 Background Information A family is looking to buy a home, which they intend to stay in for the

PLEASE ANSWER ALL QUESTIONS
Problem Set 2
Background Information
A family is looking to buy a home, which they intend to stay in for the next 5 years, after which they plan to sell it. They are deciding between taking an ARM or an FRM. They think interest rates are falling, and so would prefer to have an ARM to benefit from the falling interest rates. But they are also risk averse, and prefer the idea of an FRM, so that they know exactly how much they have to pay each month. They are doing the math to work out the best scenario. They have 3 options they are considering:
Take the ARM and hold it for 5 years until they sell the property.
Take the FRM and hold it for 5 years untll they sell the property.
Take the FRM now, and if rates fall sufficiently, to refinance the FRM with another FRM at the end of the Y3.
Here are the terms of the ARM and FRM they are considering now.
Adjustable-Rate Mortgage:
Amortization period: 30 years
80% LTV
5.50% teaser rate.
Margin of 3.00%.
Their financial advisor predicts index rates for the ARM to change over the next 5 as follows: Year 2: 3.00%. Year 3: 2.75%. Year 4:2.65%. Year 5:2.60%
Closing costs of 2.0%
Price of the property $500,000
Fixed Rate Mortgage:
Amortization period: 30 years
80% LTV
7.03% interest rate
3
Prepayment penalty of 2% of the outstanding loan balance in the first 2 years, stepping down to 1% for the next 2 years.
Closing costs of 2.5%.
Price of the property $500,000
Questions
Calculate the outstanding loan balance on the ARM at the end of year 5.
Calculate the interest paid on the ARM over the first 5 years.
Calculate the total cost paid (closing costs + interest cost) on the ARM over the first 5 years.
Calculate the total cost paid (closing costs + interest cost) on the single FRM over the first 5 years.
If the borrower chooses to refinance the FRM at the end of year 3, to a new 30-year FRM, what would the interest rate of the new FRM need to be in order for the borrower to pay the same total cost (interest + prepayment penalties + closing costs) as they would if they just stayed with the original FRM (i.e. if they chose to not refinance). Assume that the new FRM has 2.5% closing costs.
If the borrower decides to take the FRM and chooses to refinance at the end of year 3(as per questions 4), what would the interest rate of the new refinanced FRM need to be in order for the borrower to pay the same total cost (interest + prepayment penalties + closing costs) as if they had decided to take the ARM for 5 years?
Problem Set 2
Background Information
A family is looking to buy a home, which they intend to stay in for the next 5 years, after which they plan to sell it. They are deciding between taking an ARM or an FRM. They think interest rates are falling, and so would prefer to have an ARM to benefit from the falling interest rates. But they are also risk averse, and prefer the idea of an FRM, so that they know exactly how much they have to pay each month. They are doing the math to work out the best scenario. They have 3 options they are considering:
Take the ARM and hold it for 5 years until they sell the property.
Take the FRM and hold it for 5 years until they sell the property.
Take the FRM now, and if rates fall sufficiently, to refinance the FRM with another FRM at the end of the Y3.
Here are the terms of the ARM and FRM they are considering now.
Adjustable-Rate Mortgage:
Amortization period: 30 years
80% LTV
5.50% teaser rate.
Margin of 3.00%.
Their financial advisor predicts index rates for the ARM to change over the next 5 as follows: Year 2: 3.00%. Year 3: 2.75%. Year 4:2.65%. Year 5:2.60%
Closing costs of 2.0%
Price of the property $500,000
Fixed Rate Mortgage:
Amortization period: 30 years
80% LTV
7.03% interest rate
3
Prepayment penalty of 2% of the outstanding loan balance in the first 2 years, stepping down to 1% for the next 2 years.
Closing costs of 2.5%.
Price of the property $500,000
Questions
Calculate the outstanding loan balance on the ARM at the end year 5.
Calculate the interest paid on the ARM over the first 5 years.
Calculate the total cost paid (closing costs + intere
image text in transcribed

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image

Step: 3

blur-text-image

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Money Banking And Financial Markets

Authors: Stephen Cecchetti

2nd Edition

0073523097, 9780073523095

More Books

Students also viewed these Finance questions

Question

Discuss how to use job evaluation to build job structures.

Answered: 1 week ago

Question

Discuss why unions exist.

Answered: 1 week ago

Question

Discuss the alternative types of health care plans.

Answered: 1 week ago