Question

A customer would like to take out a 25-year adjustable rate mortgage loan for $260,000 with monthly payments. The first two years of the loan have a “teaser” rate of 4%, after that, the rate can reset with a 2% annual rate cap. On the reset date, the composite rate is 6%. What would the Year 3 monthly payment be?

$955

$1,567

$1,655

$1,586

Because of the rate cap, the payment would not change.

Answer 1

Solution :

Here,

First we need to calculate the monthly payment as follows :

We use PMT function in Excel to calculate the monthly payment as

Monthly payment =PMT(RATE,NPER,PV,FV)

=PMT(4%/12,25*12,-260000,0)

= $1,372.38

Secondly, calculate the loan balance at the end of year 2

Hence, the no. of years will be ( 25 - 2 ) i.e., 23 years.

Here,

We use PV function in Excel to calculate the price at the end of year 2 as

=PV(RATE,NPER,PMT,FV)

=PV(4%/12,23*12,-1372.38,0)

= $247,386.91

Price at the end of year 2 is $247,386.91

Now,

Calculate the monthly payment at the end of year 3 as follows :

Here,

We use PMT function in Excel to calculate the monthly payment as

Monthly payment =PMT(RATE,NPER,PV,FV)

=PMT(6%/12,23*12,-247386.91,0)

= $1,654.64 ( or ) 1,655 (Rounded off)

Therefore,

The monthly payment at the end of year 3 is $1,655

The answer is option (3) i.e., $1,655