Question

A basic ARM is made for $120,000 at an initial interest rate of 3 percent for 30 years with an annual reset date. The borrower believes that the interest at the beginning of year 2 will increase to 4 percent (i.e., the interest rate will reset). Assume no negative amortization. Given that the interest rate will increase to 4 percent as predicted, what will be the balance at the end of year 2 or the beginning of year 3

Answer 1

Answer:

$115,302.71

Explanation:

During the first year, the monthly payments were $505.92, and at the end of the year, the principal's balance was $117,494.70.

Then the interest rate increases to 4%, and your monthly payment also increases to $570.72. At the end of year 2, the principal's balance is $115,305.96 (see amortization schedule).

you can determine the monthly payment by using an annuity formula:

original monthly payment = $120,000 / 237.18938 (PV annuity factor, 0.25%, 360 periods) = $505.9248437 ≈ $505.92

adjusted monthly payment (second year) = $117,494.70 / 205.86942 (PV annuity factor, 0.3333%, 348 periods) = $570.7243941 ≈ $570.72

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