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Below is interest rate information from the XL Bank:
Term Posted Rate (APR)
5 Year 6.45%
25 Year 8.25%
XL Bank calculates monthly payments using 25-year amortization regardless of the term the customer chooses. The "term" of the mortgage simply refers to the length of the period for which the interest rate is fixed. Rita and Greg Smith want to buy a house in Hawaii for $400,000. They have $100,000 in savings that they can use as a down payment and they plan to borrow the rest from XL Bank.
a. Assume the Smiths choose the five-year term mortgage.
i. What is the monthly payment over the five-year term of the mortgage?
ii. What will the outstanding principal balance be at the end of the mortgage term of five years?
iii. What will the monthly payment be if, at the end of five years, the loan is renewed at a 9.5% APR? (The remaining amortization period is 20 years.)
b. Now assume the Smiths choose the 25-year term mortgage. What is the monthly payment over the 25-year term of the mortgage? Why would anyone choose the 25-year term?
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