3. A 5-year ARM (5/1 ARM) is a loan with a fixed rate for the first 5 years and a rate that subsequently changes once a year for its remaining life. Your lender locks in your rate for the first 5 years, but thereafter it changes on an annual basis moving up or down in conjunction with a specific interest-rate index, such as LIBOR. That said, suppose you’re analyzing a 5/1 ARM with a 30-year initial amortization period. The ARM is quoted at a 2.4% APR. You obtain an $800,000 adjustable rate loan.
a. Calculate your monthly payments for the first 5 years.
b. Determine the balance of principal due on the loan after 5 years or the 60th payment.
c. After 5 years the APR on your loan advances to 4.8% due to higher inflation. Calculate your new monthly payments beginning in month 61.
d. Recalculate your results to parts a, b and c assuming the 5/1 ARM is an interest-only ARM for the first five years and will be fully amortized over the final 25 years.
