Question

Tim wants to buy an apartment that costs $750,000 with an 85% LTV mortgage. Tim got a 30 year, 3/1 ARM with an initial teaser rate of 3.75% and monthly payments. The reset margin on the loan is 300 basis points above 1 year CMT. The index was 1% at the time of origination. Tim also had to pay 3 points for this loan. Suppose the index rate will remain 1% for the life of the loan. Compute the IRR for this loan assuming Tim will prepay in 5 years.

Answer 1

Given,

Cost= $750,000 and LTV= 85%

Therefore, loan amount= 750000*85%= $637,500

Interest rate for first 3 years= 3.75%

Interest rate for 4^th and 5^th years= Index 1% + margin 300 bps= 4%

Amount needed to pay off in 5 years= $585,524.41

IRR, if paid off in 5 years= 5.243406%

Calculation as below: