Question

1. You are a new loan officer with Alpha Mortgage, and the manager of the loan department has just presented a problem to you. He is unable to complete the APR calculation on an adjustable rate mortgage that a borrower applied for yesterday. The loan features initial payments based on a 10 percent rate of interest, while the current composite rate on the loan is 13 percent. No discount points have been paid by any party to the transaction, and any difference between borrower payments and the interest payment required at the composite rate will be accrued in the mortgage balance in the form of negative amortization. The mortgage amount desired by the borrower is $65,000 for a 30-year term, but a one-time mortgage insurance premium of $2,400 is being funded as a part of the loan amount, making the total loan balance $67,400. The borrower is paying $1,600 in prepaid finance charges at closing.

   1.Determine the APR, assuming that the ARM is made with a 2 percent annual and 5 percent over-the-life interest rate cap.

   2. In what way does the APR disclosure aid the borrower in understanding the terms of this specific loan agreement? What are some of the problems with the APR calculations on ARMs?

*** PLEASE SHOW EXCEL FORMULAS, THANK YOU.

Answer 1

SOLUTION:-
The APR stands for the Annual Percentage Rate. It indicates the stated rate of interest on the loan/investment. In order to determine which loan/investment offering is beneficial the APR should be known. The loan with lower APR is preferable. Federal lending truth (FTL) is a legislation which is intended to protect the consumer interest Under the FTL lender should disclose all the financial information in loan agreement in comparable manner. So, that the consumer can compare the loan amount and interest rate among different loan provider. Like the RESPA disclosure which is based on estimates, under the FTL disclosure the Annual percentage rate (APR) is accurately discloses under the FTL Disclosure.

The calculation of Annual percentage rate by the lender may be rounded up to nearest one quarter of a percentage. After rounding the Annual percentage rate adjusted in such a way that it must be closer to the one eighth of the percentage Annual percentage rate that is calculated based on FTL guidance. If the interest rate and so the Annual percentage rate change from the date of loan application to closing of loan the lender requires to make some additional disclosure.

Compute the APR of the worst case when the borrower could take decision of pre-closure of the loan using the spreadsheet. Enter values and formulas in the spreadsheet as shown in the image below ДА в ср 1 Initial interest rate 2 Total loan balance 3 Loan period in years 4 Prepaid Finance charge at closing 5 Initial payment E 0.1 67400 30 1600 PMT(E1/12,E3-12, E2,0,0) Year Composite interest rate (Uncapped) Composite interest rate (Capped) Actual balance (EOY) Borrower Payments Monthly 80 9 1 10 2 113 12 0.13 0.13 0.13 0.1 0.12 0.13 -FV(B9/12,12 E9,-E2) E5 FVB10/12,12,10,-D9,0) -PMT(C10/12,29*12.-D9,0,0) -FV0B11/12,12,011,-D10,0) PMT(C11/12,28*12.-D10,0,0) PMT(0.13/12 29 12,-(67400-1600),0) =PMT(0.13/12,2912.-D9+1600,0) PMT(0.13/12,29*12,-D10+1600,0) The APR in the worst case =RATE(12 A10.89.-(E2-E4),D10,0)*12

F The obtained result is provided below. A B 1 Initial interest rate 2 Total loan balance 3 Loan period in years 4 Prepaid Finance charge at closing 5 Initial payment E 10% $67,400 30 $1,600 $591.48 Borrower Monthly Actual balance (EOY) Payments 8 9 10 11 Composite Composite Year interest rate interest rate (Uncapped) (Capped) 0 1 13% 10% 2 13% 12% 3 13% $69.167.03 $591.48 $730.01 569.616.26 $714.05 $749.61 $69,351.93 $774.92 $754.59 13% 13 The APR in the worst case 13.33% Thus, the APR to the borrower is $13.33%

In the case of Adjustable Rate Mortgage (ARM) it difficult to determine the true APR. The APR truly help the borrowers to know the effective cost of borrowing and to make comparison among the available alternatives. The problem is that the APR does not reflect the true cost of borrowing in the case of ARM the composite interest rate remains constant throughout the life of the company but it is not the actual interest rate that the borrower is paying.