Problem 5-6

A borrower has been analyzing different adjustable rate mortgage (ARM) alternatives for the purchase of a property. The borrower anticipates owning the property for five years. The lender first offers a $147,000, 30-year fully amortizing ARM with the following terms:

Initial interest rate = 6 percent Index = 1year Treasuries Payments reset each year Margin = 2 percent Interest rate cap = None Payment cap = None Negative amortization = Not allowed Discount points = 2 percent

Based on estimated forward rates, the index to which the ARM is tied is forecasted as follows: Beginning of year (BOY) 2 = 7 percent; (BOY) 3 = 8.5 percent; (BOY) 4 = 9.5 percent; (BOY) 5 = 11 percent.

Required:

a. Compute the payments and loan balances for the unrestricted ARM for the five-year period.

b. Compute the yield for the unrestricted ARM for the five-year period.