Problem 1 [10 points] You want to buy a house for main residence and have the following four choices of mortgage with monthly payments. Suppose that your marginal tax rate is 25% and the market index will stay 10.5% after year 5. Fixed-rate Mortgage Fixed-rate Mortgage $100,000 Adjusted-rate Mortgage 3/1 Interest-only ARM $100,000 $100,000 Mortgage Amount $100,000 Term 30 years with monthly PMT 30 years with monthly PMT 30 years with monthly PMT 30 years with monthly PMT Discounts Points 0 3.5 0 0 Initial Contract Interest Rate 9.75% 8.10% 8.00% 8.00% $5,000 Costs with Loan Orignation $5,000 $5,000 2.25% $5,000 2.25% Margin Caps 1% annual, 3.9% lifetime 6% lifetime Market Index End of Year (EOY) 1: 8.6 % ; EOY 2: 9.5%; EOY 3: 10.5%; EOY 4: 11.5%; EOY 5: 10.5% 1. [5 points] If you hold the loan for the entire term, what is the annual effective cost of each mortgage before-tax? 2. [5 points] If you hold the loan for the entire term, what is the annual effective cost of each mortgage after-tax? Problem 2 [10 points] Suppose that you bought a house in Los Angeles, California in 2006Q1 and the house price was $600,000. Your LTV is 95%, so you borrow a fixed rate mortgage (FRM) of $570,000. The loan term is 30 years with interest rate 6% and monthly payments. Assuming the house price dropped 35% in Los Angeles during the period of 2006Q1 to 2009Q1. 1. [1 points] What is the value of your house at the end of 2009Q1? 2. [1 points] What is your loan balance at the end of 2009Q1 (36 months later)