Scott originates a closed-end adjustable rate mortgage with a 3% introductory rate for two years. What APR must he use in applying the APR coverage test?

When determining the Annual Percentage Rate (APR) for a closed-end adjustable-rate mortgage featuring an introductory rate, it’s crucial to consider the full terms of the loan, including what will occur after the introductory period ends. The introductory rate of 3% is only applicable for the first two years. After this time, the interest rate will adjust according to the terms of the mortgage.

In this scenario, it is essential to apply the APR coverage test that reflects the anticipated payment shocks that borrowers might experience when the interest rate adjusts. A higher APR, such as 6%, would represent a more realistic expectation of the total cost of financing, taking into account potential rate adjustments in the future.

Using an APR of 6% aligns with the need to sufficiently prepare borrowers for future payment increases after the introductory period. This helps in ensuring that the APR coverage test is applicable and protective in assessing the borrower’s ability to repay the loan once the interest rate adjusts, thus fulfilling compliance requirements.