Chapter 5

1. A price level adjusted mortgage (PLAM) is made with the following terms:

Loan $96,700.00
Initial Interest 4%
Years of Term 30
Points 6%
Payments to be reset at the beginning of each year.

Assuming inflation is expected to increase at the rate of 6 percent per year for the next five years:
a. Compute the payments at the beginning of each year (BOY).

YEAR 1
Month Interest Payments Principal Loan Balance
0 $96,700.00
1 $322.33 $461.66 $139.33 $96,560.67
2 $321.87 $461.66 $139.79 $96,420.88
3 $321.40 $461.66 $140.26 $96,280.62
4 $320.94 $461.66 $140.73 $96,139.90
5 $320.47 $461.66 $141.19 $95,998.70
6 $320.00 $461.66 $141.66 $95,857.04
7 $319.52 $461.66 $142.14 $95,714.90
8 $319.05 $461.66 $142.61 $95,572.29
9 $318.57 $461.66 $143.09 $95,429.20
10 $318.10 $461.66 $143.56 $95,285.64
11 $317.62 $461.66 $144.04 $95,141.60
12 $317.14 $461.66 $144.52 $94,997.08

YEAR 3
Month Interest Payments Principal Loan Balance
0 $104,747.36
1 $349.16 $518.72 $169.56 $104,577.79
2 $348.59 $518.72 $170.13 $104,407.66
3 $348.03 $518.72 $170.70 $104,236.97
4 $347.46 $518.72 $171.27 $104,065.70
5 $346.89 $518.72 $171.84 $103,893.87
6 $346.31 $518.72 $172.41 $103,721.46
7 $345.74 $518.72 $172.98 $103,548.47
8 $345.16 $518.72 $173.56 $103,374.91
9 $344.58 $518.72 $174.14 $103,200.78
10 $344.00 $518.72 $174.72 $103,026.06
11 $343.42 $518.72 $175.30 $102,850.75
12 $342.84 $518.72 $175.89 $102,674.87

YEAR 5
Month Interest Payments Principal Loan Balance
0 $112,941.96
 1 $376.47 $582.84 $206.36 $112,735.60
2 $375.79 $582.84 $207.05 $112,528.55
3 $375.10 $582.84 $207.74 $112,320.81
4 $374.40 $582.84 $208.43 $112,112.37
5 $373.71 $582.84 $209.13 $111,903.25
6 $373.01 $582.84 $209.83 $111,693.42
7 $372.31 $582.84 $210.52 $111,482.90
8 $371.61 $582.84 $211.23 $111,271.67
9 $370.91 $582.84 $211.93 $111,059.74
10 $370.20 $582.84 $212.64 $110,847.10
11 $369.49 $582.84 $213.35 $110,633.76
12 $368.78 $582.84 $214.06 $110,419.70

b. What is the loan balance at the end of the fifth year?

Year 5 Loan Balance $117,044.88

2. A basic ARM is made for $200,000 at an initial interest rate of 6 percent for 30 years with an annual reset date.
The borrower believes that the interest rate at the beginning of year (BOY) 2 will increase to 7 percent.

Loan $200,000.00
Interest 6%
Years of Term 30
Points 7%

a. Assuming that a fully amortizing loan is made, what will the monthly payments be during year 1?
Monthly Payment $1,199.10

b. Based on (a) what will the loan balance be at the end of year (EOY) 1?
Year 1 Loan Balance $211,372.05

c. Given that the interest rate is expected to be 7 percent at the beginning of year 2,
what will the monthly payments be during year 2
Year 2 BOY Balance $211,372.05
Monthly Payment $1,283.04

d. What will be the loan balance at the EOY 2?

Year 2 Loan Balance $223,182.77

e. What would be the monthly payments in year 1 if they are to be interest only?
Monthly Payment $1,115.91

3. A 3/1 ARM is made for $150,000 at 7 percent with a 30-year maturity.

Loan $150,000.00
Interest 7%
Years of Term 30
Points 6%
a. Assuming that fixed payments are to be made monthly for three years and that the loan is fully amortizing,
what will be the monthly payments? What will be the loan balance after three years?
Monthly Payment $997.95
Loan Balance $145,090.44

b. What would new payments be beginning in year 4 if the interest rate fell
to 6 percent and the loan continued to be fully amortizing?
Monthly Payment $905.34

c. In (a) what would monthly payments be during year 1 if they were interest only?
Interest Payments Year 1 $875.00
What would payments be beginning in year 4 if interest rates fell to 6 percent and the loan became fully amortizing?
Monthly Payment $935.98

8. Assume that a lender offers a 30-year, $150,000 adjustable rate mortgage (ARM) with the following terms:

Loan 150000
Interest Rate 7.5%
Index 1%
Years of Term 30
Margin 2%
Cap Interest 1% 5%
Points 2%

Based on estimated forward rates, the index to which the ARM is tied is forecasted as follows: Beginning of year
BOY 2 7%
BOY 3 8.5%
BOY 4 9.5%
EOY 5 11%
Compute the payments, loan balances, and yield for the ARM for the five-year period.
Year Balance Interest Capped Interest Monthly Rate
1 $150,000.00 7.5% 7.5% 0.63%
2 $148,664.14 9.0% 8.5% 0.71%
3 $147,583.41 10.5% 9.5% 0.79%
4 $146,712.30 11.5 10.5% 0.88%
5 $146,012.67 13.0% 10.5% 0.88%

10. A floating rate mortgage loan is made for $100,000 for a 30-year period at an initial rate of 12 percent interest.
However, the borrower and lender have negotiated a monthly payment of $800.

Loan $100,000.00
Interest 12%
Years of Term 30
Monthly Payment $800.00
a. What will be the loan balance at the end of year 1?
EOY 1 Balance $102,536.50
b. What if the interest rate increases to 13 percent at the end of year 1?
How much interest will be accrued as negative amortization in year 1 if the payment remains at $800? Year 5?
Loan $102,536.50
Interest 13%
Years of Term 30
Monthly Payment $800.00

EOY 1 $106,496.70
EOY 1 Interest $6,496.70
EOY 5 $121,969.35
EOY Interest $21,969.35
 YEAR 2
Month Interest Payments Principal
0
1 $335.66 $489.36 $153.70
2 $335.14 $489.36 $154.22
3 $334.63 $489.36 $154.73
4 $334.11 $489.36 $155.25
5 $333.60 $489.36 $155.76
6 $333.08 $489.36 $156.28
7 $332.56 $489.36 $156.80
8 $332.03 $489.36 $157.33
9 $331.51 $489.36 $157.85
10 $330.98 $489.36 $158.38
11 $330.46 $489.36 $158.90
12 $329.93 $489.36 $159.43

YEAR 4
Month Interest Payments Principal
0
1 $362.78 $549.85 $187.06
2 $362.16 $549.85 $187.68
3 $361.54 $549.85 $188.31
4 $360.91 $549.85 $188.94
5 $360.28 $549.85 $189.57
6 $359.65 $549.85 $190.20
7 $359.01 $549.85 $190.83
8 $358.38 $549.85 $191.47
9 $357.74 $549.85 $192.11
10 $357.10 $549.85 $192.75
11 $356.45 $549.85 $193.39
12 $355.81 $549.85 $194.03
 ual reset date.
cent.

?
amortizing,

e fully amortizing?

wing terms:

inning of year

PMT Capped Monthly Interest Amortization Annual Amortization Balance

$1,048.82 $937.50 $111.32 $1,335.86 $148,664.14
$1,143.10 $1,053.04 $90.06 $1,080.73 $147,583.41
$1,240.96 $1,168.37 $72.59 $871.11 $146,712.30
$1,342.04 $1,283.73 $58.30 $699.63 $146,012.67
$1,335.64 $1,277.61 $58.02 $696.29 $145,316.37

percent interest.
00? Year 5?
Loan Balance
$100,696.90
$100,543.20
$100,388.98
$100,234.25
$100,079.01
$99,923.24
$99,766.96
$99,610.16
$99,452.83
$99,294.98
$99,136.60
$98,977.70
$98,818.26

Loan Balance
$108,835.36
$108,648.30
$108,460.62
$108,272.31
$108,083.37
$107,893.80
$107,703.60
$107,512.77
$107,321.30
$107,129.19
$106,936.44
$106,743.05
$106,549.02
 2. An investor has $60,000 to invest in a $280,000 property. He can obtain either a $220,000 loan at 9.5 percent for 20 years
loan at 9 percent for 20 years and a second mortgage for $40,000 at 13 percent for 20 years.
All loans require monthly payments and are fully amortizing.

Property Value $60,000.00

Investment $280,000.00

a. Which alternative should the borrower choose, assuming he will own the property for the full loan term?
Loan $220,000.00 Loan 180000
Interest 9.5% Interest 9%
Term 20 Term 20

Option A 9.5% is better than 9.76% Monthly Payment $1,619.51

Total Payment $2,088.14
Rate 0.81%
Annual Rate 9.76%

b. Would your answer change if the borrower plans to own the property for five years?
Loan $180,000.00 Loan $40,000.00
Interest 9% Interest 13%
Term 5 Term 5

Monthly Payment $3,736.50 Monthly Payment $910.12

Total Payment $4,646.63
Rate 0.81%
Annual Rate 9.74%

Single loan is still the better option

3. An investor obtained a fully amortizing mortgage five years ago for $95,000 at 11 percent for 30 years.
Mortgage rates have dropped, so that a fully amortizing 25-year loan can be obtained at 10 percent.
There is no prepayment penalty on the mortgage balance of the original loan, but three points will be charged on the new loa
$2,000. All payments are monthly.

Loan $95,000.00 Interest 10%

Interest 11% Years of Term 25
Years of Term 30 Points 3%
Closing $2,000.00

a. Should the borrower refinance if he plans to own the property for the remaining loan term?
Assume that the investor borrows only an amount equal to the outstanding balance of the loan?

Monthly Payment $904.71

5 Year Balance $92,306.41
New Montly Payment $838.79
Points $2,769.19
Total $4,769.19
New Balance $87,537.22
Rate 0.83%
Yes, Refinance
4. Secondary Mortgage Purchasing Company (SMPC) wants to buy your mortgage from the local savings and
loan. The original balance of your mortgage was $140,000 and was obtained five years ago with monthly
payments at 10 percent interest. The loan was to be fully amortized over 30 years.

a. What should SMPC pay if it wants an 11 percent return?

Loan $140,000.00 Loan $140,000.00

Interest 10% Interest 10%
Years of Term 30 Years of Term 5
Monthly Payment $1,228.60 Monthly Payment $1,228.60
Return 10%
Year remamining 25
FV 5 Years $135,204.06

SMPC Payment $135,204.03

6. An investor has owned a property for 15 years, the value of which is now to $200,000. The balance on the original mortgag
the monthly payments are $1,100 with 15 years remaining. He would like to obtain $50,000 in additional financing. A new firs
$150,000 can be obtained at a 12.5 percent rate and a second mortgage for $50,000 at a 14 percent rate with a 15-year term
wraparound loan for $150,000 can be obtained at a 12 percent rate and a 15-year term. All loans are fully amortizing. Which
the investor choose?

Loan $100,000.00 Loan $50,000.00

Interest 11% Interest 14%
Years of Term 30 Years of Term 15
Monthly Payment $1,100.00 Monthly Payment $665.87

Option 1 $1,765.87
Option 2 $1,800.25

10. A borrower is making a choice between a mortgage with monthly payments or

biweekly payments. The loan will be $200,000 at 6 percent interest for 20 years.

a. How would you analyze these alternatives?

Monthly BI-Weekly
Loan $200,000.00 Loan $200,000.00
Interest 6% Interest 6%
Years of Term 20 Years of Term 20
Monthly Payment $1,432.86 BI-Weekly Payment $715.97

Total Monthly $343,886.91

Total Bi-Weekely $343,665.05
9.5 percent for 20 years or a $180,000

term?
Loan 40000
Interest 13%
Term 20

Monthly Payment $468.63

ars.

charged on the new loan and other closing costs will be

ngs and
thly

e on the original mortgage is $100,000 and

onal financing. A new first mortgage for
rate with a 15-year term. Alternatively, a
fully amortizing. Which alternative should

Loan $150,000.00
Interest 12%
Years of Term 15
Monthly Payment $1,800.25