Question

Teaser Rate Mortgage A mortgage broker is offering a 30-year mortgage with a teaser rate. In the first two years of the mortgage, the borrower makes monthly payments on only a 5.6 percent APR interest rate. After the second year, the mortgage interest charged increases to 9.2 percent APR. What is the effective interest rate in the first two years? What is the effective interest rate after the second year?

5.60%, 9.20% respectively

5.75%, 9.60% respectively

5.49%, 8.92% respectively

13.19%, 13.85% respectively

Answer 1

Teaser Rate Mortgage A mortgage broker is offering a 30-year mortgage with a teaser rate. In the first two years of the mortgage, the borrower makes monthly payments on only a 5.6 percent APR interest rate.

After the second year, the mortgage interest charged increases to 9.2 percent APR.

What is the effective interest rate in the first two years?

What is the effective interest rate after the second year?

Annual Percentage Rate (APR) is the annual interest rate for the whole year.

APR is the simple interest rate for the year.

APR includes the costs and the fees related to the borrowing.

The Effective Interest Rate (EIR) is the effective rate of interest on a loan with annual compound interest.

r = (1 + i / n) ⁿ – 1

r = Effective Interest Rate (EIR)

i = nominal interest rate or APR

n = number of compounding periods per year

Effective Interest Rate in first two years:

i = 5.6% (APR), n = 12.

r = (1 + 0.00467)¹² – 1

r = (1.00467)¹² – 1

r = 1.0575 – 1

r = 0.0575 or 5.75%

Effective Interest Rate after the second year:

i = 9.2% (APR), n = 12.

r = (1 + 0.00767)¹² – 1

r = (1.00767)¹² – 1

r = 1.0960 – 1

r = 0.0960 or 9.60%

Effective Interest Rate in first two years,

Effective Interest Rate after the second year:

5.75%, 9.60% respectively.