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A recently married couple are interested in purchasing a home and have an annual (stabilized) income of $90,000. Current loan terms for a 3/1 adjustable rate mortgage on an owner-occupied house are: 80% loan to value ratio, 30 year term and 3.5% interest rate (assume monthly amortization). The couple have a deposit of $60,000 saved to use for the house purchase. a. Using the 28% rule, what is the maximum purchase price of a home these buyers can afford? Assume that taxes and insurance are not taken into account in the calculation and that the couple do not wish to pay for private mortgage insurance. b. The couple have disclosed that their combined payment on two auto loans is $5,000 per year. Using the 36% rule, how will this impact on the maximum house price they can purchase. Assume that taxes and insurance are not taken into account in the calculation and that the couple do not wish to pay for private mortgage insurance. c. Assume the couple went ahead with the purchase of the house under the maximum loan amount calculated in part (a). After three years assume the interest rate on the loan increases to 4.5%, what is the new monthly loan payment? d. Discuss how interest rate caps and payment caps may alter the risk to a borrower with an ARM. Use a diagram to illustrate your answer.

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