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In: Finance

You are considering to buy a $250,000 property with a 80% LTVratio and have two...

You are considering to buy a $250,000 property with a 80% LTV ratio and have two mortgage choices: a FRM or a FRM with an IO period. The lender offers the following two loans:

Loan 1: 30 year FRM, fully amortizing monthly payments; 4% interest

Loan 2: 30 year FRM with 4 year IO period, fully amortizing monthly payments; 4.15% interest

Check all the true statements:



If I want to save on interest payments, I would choose Loan 2



If I want to minimize the payments in the first few years, I would choose Loan 2



If I'd like to pay off the loan sooner, I'd choose Loan 1



If I want my payments to remain the same for the duration of the loan, I would pick Loan 1

Solutions

Expert Solution

Loan 1 Features: Loan 1 is an amortizing loan where the interest gets reduces with each payment and principal increases with each payment thus reducing the loan balance $0 before loan 2 balance gets $0

Loan 2 Features: Loan 2 has IO option which means the borrower will pay only interest for 4 years thus increasing the monthly payment and interest expense.

Statement 1 is incorrect If I want to save on interest payments, I would choose Loan 2 because we pay higher interest on Loan 2 as it has IO option where interest payment doesn't reduces with each payment

Statement 2 is correct If I want to minimize the payments in the first few years, I would choose Loan 2 becausewe pay only interest for the first 4 years

Statement 3 is incorrect both loans have the same maturity of 30 years

Statement 4 is Correct If I want my payments to remain the same for the duration of the loan, I would pick Loan 1 because in the Loan 1 the monthly payments will be the same

jeff jeffy answered 1 year ago
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