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 6.7 percent APR interest rate. After the second year, the mortgage interest charged increases to 11.4 percent APR. What is the effective interest rate in the first two years? What is the effective interest rate after the second year?

Multiple Choice

• 6.59%, 11.12% respectively

• 6.91%, 12.02% respectively

• 14.29%, 16.05% respectively

• 6.70%, 11.40% respectively

Answer 1

First two years:

Annual interest rate = 6.70%
Monthly interest rate = 0.5583%

Effective annual rate = (1 + Monthly interest rate)^12 - 1
Effective annual rate = 1.005583^12 - 1
Effective annual rate = 1.0691 - 1
Effective annual rate = 0.0691 or 6.91%

After second year:

Annual interest rate = 11.40%
Monthly interest rate = 0.95%

Effective annual rate = (1 + Monthly interest rate)^12 - 1
Effective annual rate = 1.0095^12 - 1
Effective annual rate = 1.1202 - 1
Effective annual rate = 0.1202 or 12.02%