Rick is buying a home worth $150,000. He takes out a mortgage. He then decides to move 3 years into the mortgage agreement. The bank offers him 2 options for the mortgage. Both are monthly payments over a 25-year amortization period.

Option 1 has a nominal interest rate of j₂ = 5%. This mortgage has a condition that if you pay off the mortgage any time in the first 5 years you have to pay a penalty of 3 months interest on the outstanding balance at the time of repayment.

Option 2 has a nominal interest rate of j₂ = 5.5% with no conditions or penalties applied at repayment. As he will have to repay the mortgage in 3 years and he can then save money at j₁ = 2%.

Which mortgage is the best option? How much would he accumulate in savings by choosing the lower monthly payment option?