Question

1. A borrower takes out a 30-year adjustable rate mortgage loan for $200,000 with monthly payments. The first two years of the loan have a “teaser” rate of 4%, after that, the rate can reset with a 5% annual payment cap. On the reset date, the composite rate is 6%. What would the Year 3 monthly payment be?

1. $955
2. $1,003
3. $1,067
4. $1,186
5. Because of the payment cap, the payment would not change.

Answer 1

We will find the step by step solution for the problem

Step 1: Calculating monthly payment for first 2 years on the basis on teaser rate

Loan = $200000, Teaser rate = 4%, No of years of loan = 30 years

Monthly rate = 4% /12, No of months = 12 x 30 = 360 months

We can find the monthly payment for first two years by using PMT function in excel

Formula to be used in excel: =PMT(rate,nper,-pv)

Using PMT function in excel, we get monthly loan payment for first two years = $954.83

Step 2: Calculating Loan Balance after 2 years

We will use monthly loan payment calculated above to find the loan balance at end of 2 years.

After two years, No of years of loan left = 28, No of months of loan left = 12 x 28 = 336 months

We can find the loan balance using PV function in excel

Formula to be used in excel: =PV(rate,nper,-pmt)

Using PV function in excel, we get Loan balance after 2 years = 192812.24

Step 3: Calculating monthly loan payment for year 3

Now loan has an annual payment cap of 5%, it means monthly payment can increase maximum by 5% in year 3

Maximum monthly payment in year = 954.83 (1+5%) = 954.83 x 1.05 = 1002.57 = $1003 (rounded to nearest dollar

Now we will calculate monthly payment on the basis of composite rate of 6%

Monthly rate = 6%/12, Loan balance = 192812.24, No of months = 336

We can use PMT function to find the monthly loan payment

Using PMT function in excel, we get monthly loan payment for year 3 on basis of composite rate = $1186.03

As this monthly payment on basis of composite rate is greater than the maximum monthly payment on basis of annual payment cap.

Hence Monthly payment in year 3 = $1003

Answer b. $1003