Question

You have issued a 30 year a fixed rate mortgage loan to finance the purchase of a home. Interest rates decline every year for four years after you have issued the mortgage loan. You are now locked into paying an interest rate that is above the market rate. There is no way out of this financial contract until the maturity date of the mortgage (thirty years from origination). True or False

A tenant should carefully negotiate with the landlord the terms of a net lease before signing the lease. True or False

If you issued a 5/1 adjustable rate mortgage in 2007 that had an interest rate indexed to the Fed Funds rate, then over the next 7 years you experienced a tremendous increase the interest you owed every year. True or False

Answer 1

You have issued a 30 year a fixed rate mortgage loan to finance the purchase of a home. Interest rates decline every year for four years after you have issued the mortgage loan. You are now locked into paying an interest rate that is above the market rate. There is no way out of this financial contract until the maturity date of the mortgage (thirty years from origination). False

• There's always a way to get out of the contract unless specified explicitly
• By calculating the present value (PV) of all the future cash flow you can repay the amount borrowed
• One just needs to approach another bank who is ready to finance your loan at the floating rate and effectively you can pay the amount and get out.

A tenant should carefully negotiate with the landlord the terms of a net lease before signing the lease. True

• There are two types of lease: Gross lease and net lease
• Gross lease is more tenant-friendly because the rent includes everything and landlord is responsible for paying all other payments such as maintenance, electricity, repairs, property tax etc.
• Net lease is more landlord friendly and the tenant is responsible for the payments of the rate as well as other charges such as insurance, property tax, repairs, etc.
• Hence it's in tenant's best interest to carefully negotiate the agreement.

If you issued a 5/1 adjustable rate mortgage in 2007 that had an interest rate indexed to the Fed Funds rate, then over the next 7 years you experienced a tremendous increase the interest you owed every year. True

• 5/1 Adjustable-rate mortgage (ARM) is a type of model in which the initial 5 years are interest rate is fixed and for subsequent years it was revised every year with respect to some index rates.
• ARM offer lower rates than typical mortgages with fixed rates.
• Thus borrower has to pay lower interest payment at the beginning. Hence after the period of 5 years interest rate increased substantially resulting in an increased interest payment.