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Derrick is going to graduate from college in three months with a degree in criminal justice. However, his real passion is real estate and he has found his dream home. Derrick has the option of getting a conventional loan or a balloon mortgage. He "knows" he will be making more money when the balloon payments increase in three years. The monthly payment of the conventional loan is $1,000. The monthly payment for the balloon mortgage is $700 for the first three years, and then it jumps to $1,300 after that. At his current job, Derrick makes enough to cover a $1,000 mortgage payment.
Problem 1. Is the conventional loan the better option for Derrick? Why or why not?
Problem 2. Should Derrick take advantage of the balloon mortgage? Explain your answer.
Problem 3. Are there any better options available to Derrick that he hasn't thought about yet? If so, what are they?
Problem 4. What would you advise Derrick to do in this situation? Justify your answer.
Hubbard argues that the Fed can control the Fed funds rate, but the interest rate that is important for the economy is a longer-term real rate of interest. How much control does the Fed have over this longer real rate?
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