Reference no: EM132375661

Mortgage loan commercials and bank banners can be a little confusing due to the fact they report two rates: 1) the stated nominal annual rate that we usually think of as APR which is compounded monthly and is the rate that is used on the actual loan amount to determine themonthly payment, and 2) the "APR" which is somewhat higher and in some ads significantly higher than the first rate. This second "APR" is a stated nominal annual rate but assumes theborrower will finance all closing costs necessary to get the loan (instead of paying them in cash when closing the loan) in addition to the amount the borrower needs to complete the purchase of their home.

Here's how this second "APR" is determined. First, the first stated annual rate is used to figurethe monthly payment on the loan amount plus closing costs. Then, the monthly interest rate that equates the present value of these monthly payments with the loan amount without closing costs is found. Finally, this monthly rate is multiplied by 12 to get this second "APR".The larger the difference between the two rates the larger the closing costs and fees for the loan. The mortgage ads usually use some fixed loan amount like $100,000, $150,000, or $200,000. Whether the borrower decides to finance the closing costs or not, this second APR can give the borrower a truer cost of borrowing once the closing costs are factored in.

Let's look at a couple of examples of how this works. Imagine the Prof. Fin finds a $275,000condo he wishes to buy and has a $100,000 down payment and will need to borrow $175,000 before any closing costs. Use this information to answer the questions below.

1. Friendly Mortgage offers a 30-year fixed rate mortgage with a nominal annual rate of 3.5% with $700 in closing costs.

1. What would be Prof. Fin's monthly mortgage payment if he pays the closing costsin cash?
2. What would be Prof. Fin's monthly mortgage payment if he finances the closingcosts?
3. What is the second "APR" for this loan as described above?

2. Rapid Loans offers a 30-year fixed rate mortgage with a nominal annual rate of 3.25% with $4100 in closing costs.

1. What would be Prof. Fin's monthly mortgage payment if he pays the closing costs in cash?
2. What would be Prof. Fin's monthly mortgage payment if he finances the closingcosts?
3. What is the second "APR" for this loan as described above?

3. Which of the two mortgage options would you recommend to Prof Fin? Explain why.