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You have a choice between a 30-year fixed rate loan at 3.5% and an adjustable rate mortgage (ARM)...

Question:

You have a choice between a 30-year fixed rate loan at 3.5% and an adjustable rate mortgage (ARM) with a first-year rate of 2%. Neglecting compounding and changes in principle, estimate your monthly savings with the ARM during the first year on a $250,000 loan. Suppose that the ARM rate rises to 11.5% at the start of the third year. Approximately how much extra will you then be paying over what you would have paid if you had taken the fixed rate loan?

What is the approximate monthly savings with the ARM during the first year?

$_____(Round to the nearest dollar as needed)

Mortgage rates

The difference between a fixed-rate and adjustable-rate mortgage (ARM) loan and details of the benefits and drawbacks of the two monthly mortgage payments plans.

Answer and Explanation:

The interest on the $250,000 loan in the first year will be approximately

3.5%250,000 = $8750

which means the monthly payment will be about $8750/12 = $729.167.

With the 2% ARM the interest will be approximately

2%250,000 = $5000, so the monthly payment will be about $5000/12 = $416.667.

You?ll save $729.167 - 416.667 = $312.5 each month with the ARM.

In the third year, the rate on the ARM will be ( 11.5 - 3.5)% = 8% higher than the fixed rate loan, so the yearly interest payments will be about

250,0000.08 = $20,000 (or $1666.67 per month) higher

Approximately monthly saving = $ 1667 ( nearest dollar)


Learn more about this topic:

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Buying a House: Mortgage Types & Loan Length

from Finance 102: Personal Finance

Chapter 7 / Lesson 4
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