Project Engineering Economics

Topics: Mortgage loan, Mortgage, Interest Pages: 13 (3668 words) Published: December 13, 2012
Nanjing University of Aeronautics and Astronautics

Project: Fundamentals of Engineering Economics

Class: 1910641

Submitted by:
莱尼 Leni Kamelina Wasini(191064127)
叶念爱 Ayreen Japutri(191064145)

Adjustable-Rate Home Mortgage Loan
Buying a home today is much more confusing than in the past. The mortgage market has changed completely from the days when “home mortgage" meant a 30- year, fixed-rate loan. Then, the mortgage market was something like the ice cream market - all you could get was “vanilla," but today we have “3l flavors”. As with ice cream, the more choices a consumer has, the better. For example, the current mortgage market offers financing plans such as the traditional fixed rate mortgage (FRM) the adjustable rate mortgage (ARM), the graduated payment mortgage (GPM), the growing equity mortgage (GEM), the wraparound mortgage (WM), and the buy-down mortgage (BDM). These choices may seem confusing initially, but they provide a real opportunity for the homebuyer to tailor a loan to his or her particular financial circumstances. A fixed-rate mortgage is one in which the interest rate and monthly payments remain constant for the loan term, which has traditionally been 30 years. The advantage of this method is that homebuyers are protected against rising interest rates and the monthly payment does not change. The disadvantage is that lenders usually charge a higher interest rate for these loans than for adjustable rate loans and homebuyers are locked in at those rates for the duration of the loan.

In recent years, adjustable rate mortgages (ARMs), for which the interest rate or monthly payment changes at specific intervals to an agreed-upon market rate, have gained popularity. The benefit of this type of mortgage is that the initial mortgage interest rate is usually lower than the prevailing rate for a long-term, fixed-rate mortgage. Therefore, the monthly payment is lower, and less income is needed to qualify for a loan. If interest rates decline, the mortgage payment is adjusted downward when the adjustment interval is reached. The disadvantage of the ARM is that it is difficult to predict whether interest rates will rise or fall, and thus it is hard to plan for future payments. Since future mortgage interest rates are bound to fluctuate according to prevailing economic conditions, probable variations in the mortgage rate have been of concern to most homebuyers when considering this type of mortgage.

Description of the ARM Features
There are several features that characterize the ARM.
1. Basic Features
There are as many different types of ARMs as there are styles of houses. All ARMs, however, have four basic features: (1) initial interest rate, (2) adjustment interval, (3) index, and (4) margin. 1.1 Initial Interest Rate

The initial interest rate is the beginning interest rate on any ARM. It will stay the same until it is adjusted either up or down for the adjustment period specified in the mortgage. 1.2 Adjustment Interval

The adjustment interval is a period of time between changes in either the interest rate or the monthly payment. The interest rate on most ARMs could change after one, three, or five years. 1.3 Index

The index is a published measure of interest rates on certain types of borrowing or investments. There are several types of indexes, and they are used by lenders to determine the mortgage loans’ new interest rate at the time of adjustment. The two most common indexes are: 1. One-, three-, and five-year U.S. Treasury security (T-bill) yields (interest rates), 2. The monthly average cost-of-funds incurred by savings and loan institutions. Most lenders use one-year T-bill yields as their indexes. The T-bill rate tends to fluctuate much more dramatically than the cost-of-funds rate, which reflects the average price a savings institution must pay for its money. Because indexes reflect the...

References: 1. Fundamentals of engineering economics, Chan S. Park
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