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A borrower received a 30-year ARM mortgage loan for $200,000. Rate caps are 3/2/6. The start rate is 3.50% and the loan adjusts every 12 months for the life of the mortgage. The index used for this mo
A borrower received a 30-year ARM mortgage loan for $200,000. Rate caps are 3/2/6. The start rate is 3.50% and the loan adjusts every 12 months for the life of the mortgage. The index used for this mortgage is LIBOR (for this exercise, 3.00% at the start of the loan, 4.45% at the end of the first year, and 4.50% at the end of the second year). The margin on the loan is 3.00%, which remains the same for the duration of the loan.
- What is the initial rate (start rate) the borrower will pay during the first year?
- What is the interest rate the borrower will pay after the first rate adjustment? (Hint: Remember to use the “stair step method” for determining the new interest rate.)
- What is the fully indexed rate after the second year?
- What is the maximum interest rate the borrower will pay during the 30-year term for this loan?
- If the interest rate is at its maximum, what would the LIBOR index have to be to reach the maximum interest rate?
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