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An Adjustable Rate Mortgage 1 Introduction An adjustable rate mortgage (ARM) is a mortgage loan where the interest rate is adjusted from time to time based on some index (such as 1-year treasuries). ARMs are sometimes preferred by borrowers because of their low introductory interest rates. ARMs have changing interest rates that may make the loan more expensive or more favorable than a fixed rate mortgage (where the interest rate never changes). In this project we will compare a fixed rate mortgage to a "worst-case scenario" ARM. 2 Objective The goal of this activity is to compare two different loans, a fixed rate mortgage and a "worst-case scenario" ARM. The task is to determine the total amount paid by the borrower in both cases and to discuss the merits of each loan. 3 Scenario Suppose that you are interested in purchasing an apartment for $250,000. You are able to pay the 20% down payment, but need to borrow the rest. You are given two options by the local bank: Loan 1: This is a 30-year fixed rate mortgage with an annual interest rate, compounded monthly, of 4.8% Loan 2: This is a 10/1 ARM with an initial annual interest rate, compounded monthly, of 3.0%. The terms of the loan are such that you will get the initial interest rate for 10 years. After that, the interest rate will go up by 1% per year (the annual rate increase cap) until it reaches a maximum of 10% (the maximum rate cap). This loan is to be paid off over the course of a 30-year period. Determine the amount the borrower pays to the bank if they accept the terms of Loan 1 and Loan 2. Discuss the pros and cons of each loan. An Adjustable Rate Mortgage 1 Introduction An adjustable rate mortgage (ARM) is a mortgage loan where the interest rate is adjusted from time to time based on some index (such as 1-year treasuries). ARMs are sometimes preferred by borrowers because of their low introductory interest rates. ARMs have changing interest rates that may make the loan more expensive or more favorable than a fixed rate mortgage (where the interest rate never changes). In this project we will compare a fixed rate mortgage to a "worst-case scenario" ARM. 2 Objective The goal of this activity is to compare two different loans, a fixed rate mortgage and a "worst-case scenario" ARM. The task is to determine the total amount paid by the borrower in both cases and to discuss the merits of each loan. 3 Scenario Suppose that you are interested in purchasing an apartment for $250,000. You are able to pay the 20% down payment, but need to borrow the rest. You are given two options by the local bank: Loan 1: This is a 30-year fixed rate mortgage with an annual interest rate, compounded monthly, of 4.8% Loan 2: This is a 10/1 ARM with an initial annual interest rate, compounded monthly, of 3.0%. The terms of the loan are such that you will get the initial interest rate for 10 years. After that, the interest rate will go up by 1% per year (the annual rate increase cap) until it reaches a maximum of 10% (the maximum rate cap). This loan is to be paid off over the course of a 30-year period. Determine the amount the borrower pays to the bank if they accept the terms of Loan 1 and Loan 2. Discuss the pros and cons of each loan

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