A borrower has been analyzing different adjustable rate mortgage (ARM) alternatives for the purchase of a property. The borrower anticipates owning the property for five years. The lender first offers a $156,000, 30-year fully amortizing ARM with the following terms:
Initial interest rate = 6 percent
Index = 1-year Treasuries
Payments reset each year
Margin = 2 percent
Interest rate cap = None
Payment cap = None
Negative amortization = Not allowed
Discount points = 2 percent
Based on estimated forward rates, the index to which the ARM is tied is forecasted as follows: Beginning of year (BOY) 2 = 7 percent; (BOY) 3 = 8.5 percent; (BOY) 4 = 9.5 percent; (BOY) 5 = 11 percent.
a. Compute the payments and loan balances for the unrestricted ARM for the five-year period.
b. Compute the yield for the unrestricted ARM for the five-year period.