Problem 2: Fixed rate mortgage

You take out a15year fixed rate mortgage for $500,000, and buy down the interest rate by purchasing two points. After the points, the interest rate you agree to is 3.25% per annum. You subsequently retain this mortgage for 3 years, before prepaying it.

a) What is the monthly payment on this mortgage? How much of the initial payment is interest, and how much is principal?

b) Over the three years, what is the total of all the interest payments you make on this loan? What is the total value of the principal payments?

c) Given that you paid off the loan after three years, would you have been better off (in termsof the effective interest rate) if you hadn't paid points but taken a3.75% interest rate? How would this answer change if you had held the loan until maturity instead?

e) What types of borrowers would generallynotwant to buy points on a fixed rate mortgage? f) Are prepayment penalties common for this type of loan? Explain.