An annual pay ARM is made for $150,000 for a 7 year term with the following terms:
Index rate = 1 year US Treasuries (currently at 5%)
Payments reset each year
Margin = 2%
Interest rate cap = None
Payment cap = Max 3% Increase in payments any year
Discount points = 2 percent
Fully amortizing; however, negative amortization is allowed if the payment cap is reached.
Based on estimated forward rates, the index to which the ARM is tied is forecasted as follows for the beginning of each year:
Start of year 1 (i.e. now), 5%
Start of year 2, 7%
Start of year 3, 10%
Start of year 4, 9.5%
Start of year 5, 12%
Start of year 6, 8%
Start of year 5, 12%
Compute the annual payments, loan balances, and the yield (effect rate of return) for the ARM for the five year period, assuming the loan is paid off at the end of year 7 years.