Teaser Rate Mortgage A mortgage broker is offering a 30-year mortgage with a teaser rate. In the first two years of the mortgage, the borrower makes monthly payments on only a 5 percent APR interest rate. After the second year, the mortgage interest charged increases to 8 percent APR. What is the effective interest rate in the first two years? What is the effective interest rate after the second year?

Question

Quizplus · Accepted Answer

To find the effective interest rate in the first two years, we need to use the formula for annual percentage rate (APR) and compound interest:

APR = (1 + r/n)^n - 1

Where r is the nominal interest rate, n is the number of compounding periods per year, and ^ denotes exponentiation.

For the first two years, r = 5% and n = 12, since the interest is compounded monthly. Plugging these values into the formula, we get:

APR = (1 + 0.05/12)^12 - 1 = 0.0512 or 5.12%

Therefore, the effective interest rate in the first two years is 5.12%.

After the second year, the interest rate increases to 8%, so we can use the same formula with r = 8% and n = 12 to find the new effective interest rate:

APR = (1 + 0.08/12)^12 - 1 = 0.0830 or 8.30%

Therefore, the effective interest rate after the second year is 8.30%.

The correct answer is C.

Teaser Rate Mortgage a Mortgage Broker Is Offering a 30-Year