Variable rate mortgage with an initial interest rate

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Reference no: EM131013713

During February 2016, John Smith financed the purchase of his new home by borrowing $250,000 from the Bank of America (BA). Although he was offered a conventional 30-year loan at a fixed rate of 5.4 percent, Mr. Smith chose BA's “5/30” variable rate mortgage with an initial interest rate of 3.0 percent. The “5/30” requires Mr. Smith to pay off his loan over 30 years. However, the first 60 monthly mortgage payments are determined as if the loan were to be amortized (paid off) over 30 years at a fixed rate of 3.0 percent. At the end of 5 years (60 payments) the interest rate on the loan will be reset to the market interest rate, with the monthly mortgage payment being adjusted so that the outstanding balance of the loan will be paid off over the remaining 25-year loan term. Assume that a resurgence of inflation causes a dramatic increase in interest rates, so that during February 2021 the interest rate on Mr. Smith’s loan must be reset to 7.8 percent. Determine the amount of Mr. Smith’s new monthly payment when the interest rate on his loan is reset in February 2021.

Reference no: EM131013713

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