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Chapter 4

• Fixed Rate Mortgage Loans

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Overview

• Mortgage Interest Rates
• Components of the Mortgage Interest Rate
• Constant Amortization Mortgage (CAM)
• Constant Payment Mortgage (CPM)
• CAM and CPM Payment Patterns
• Computing a Loan Balance
• Loan Closing Costs
• Pricing a Loan
• Other Loan Patterns
• Partially Amortizing Loan
• Negative Amortization
• Option Mortgages
• Reverse Annuity Mortgage (RAM)

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Mortgage Interest Rates

• What will borrowers pay for the use of funds?
• What are lenders willing to accept for the use of
  funds?
• Housing Demand Factors Income Demographics
• Mortgage Funds Supply Factors Alternative
  Investments

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Components of the Mortgage Interest Rate

• Real Rate of Interest
• Time Preference for Consumption
• Compensation to delay a purchase
• Production Opportunities in the Economy
• Competition for funds when there are other
  investment opportunities
• Inflation Expectation
• Retain purchasing power

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Components of the Mortgage Interest Rate
Continued

• Default Risk
• Interest Rate Risk
• Anticipated Inflation and Unanticipated Inflation
• Prepayment Risk
• Liquidity Risk
• Legislative Risk

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Components of the Mortgage Interest Rate
Continued

• r Real Rate
• f1 Inflation Rate
• p1 Risk Premiums

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Constant Amortization Mortgage (CAM)

• Opening Balance Previous Period Ending Balance
• Interest Opening Balance Periodic Rate
• Periodic Rate Annual Rate / Payment per Year
• Amortization Original Loan Balance / Number of
  Payments
• Monthly Payment Interest Amortization
• Ending Balance Opening Balance Amortization

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Constant Payment Mortgage (CPM)

• FRM payments are structured as an ordinary
  annuity
• PV of the annuity is the amount borrowed
• The monthly payment on a 30-year, 12, 60,000
  loan is
• Notes
• To get the answer press CPT and then what you are
  trying to get
• To clear the calculator memory use 2nd CLR TVM
• To change P/Y, press 2nd P/Y, enter the amount
  and press ENTER. To get out of this mode use 2nd
  QUIT
• Annuity due setting is BGN (for beginning) 2nd
  BGN, 2nd SET, 2nd QUIT

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Constant Payment Mortgage (CPM) Continued

• Beginning Loan Balance Previous Period Ending
  Balance
• Monthly Payment Determined using Excels PMT
  function
• Interest Beginning Loan Balance Periodic Rate
• Periodic Rate Annual Rate / Payment per Year
• Amortization Monthly Payment Interest
• Ending Loan Balance Beginning Loan Balance
  Amortization

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CAM and CPM Payment Patterns

• Comparing the CAM CPM
• Higher initial monthly payments for the CAM
• More difficult for a borrower to qualify for a
  loan
• Amortization of CPM is slower than CAM
• CAM payment declines over time

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Computing a Loan Balance

• The outstanding loan balance is the PV of the
  remaining loan payments discounted at the
  original loan rate
• After computing the PMT of the original loan just
  change N to number of remaining payments then CPT
  PV
• Alternatively, to determine the outstanding
  balance of the loan in the previous example after
  10 years
• Compute PMT (617.17)
• 2nd AMORT
• 120 ENTER 120 ENTER This will allow you to see
  loan information (self explanatory) at that point
  in time
• You can change P1 and P2 to get the data for the
  specified payment range

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Computing Payment Components

• How much interest do you pay during the second
  year?
• 7,160.67
• How much principal do you pay during the second
  year?
• 245.34
• What is the interest component of 72nd payment?
• 582.37

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Loan Closing Costs

• There are three categories of loan closing costs
• Statutory Costs These charges are associated
  with the legal transfer of title and other fees.
  They are paid for services by governmental
  agencies
• Third Party Charges Payments for legal fees,
  appraisals, surveys, inspection, and title
  insurance
• Additional Finance Charges These charges
  provide additional income to the lender and
  therefore should be included as a part of cost of
  borrowing
• Loan Origination Fees
• Cover origination expenses
• Loan Discount Fees Points
• Used to raise the yield on the loan
• Borrower trade-off points vs. contract rate
• 1 Point 1 of the loan amount

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Loan Closing Costs Continued

• Why Points?
• Sticky mortgage rates
• Price in the risk of a borrower
• Early repayment of a loan does not allow recovery
  of origination costs
• Earn a profit on loans sold to investors at a
  yield equal to the loan interest rate

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Loan Closing Costs Continued

• If there are fees and points, then the effective
  interest cost is higher
• If the previous loan has 3 points, then the
  lender will disburse 60,000 (60,000 X 0.03)
  58,200
• Loan payments are based on 60,000 and the
  borrower receives less, increasing the return to
  lender
• Note that fees and points work the same way
• We also assume that the loan is not prepaid
• Lenders are required to disclose by law
  (Truth-in-Lending Act) an annual percentage rate
  (APR) computed in a similar manner
• The effective interest cost is

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Loan Closing Costs and Prepayment

• What would be effective interest cost if the loan
  is paid early
• Assume that after 5 years (60 payments), the loan
  is paid off
• We need to determine the outstanding balance of
  the loan after 60 payments
• Make sure that calculator has the original loan
  data without fees and points
• 2nd AMORT
• 60 ENTER 60 ENTER This will allow you to see
  loan information at that point in time
  (58,598.16)
• Loan balance becomes an entry for future value

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Loan Closing Costs and Prepayment Penalty

• What would be effective interest cost if the loan
  is paid early
• Assume that after 5 years (60 payments), the loan
  is paid off
• We need to determine the outstanding balance of
  the loan after 60 payments
• Make sure that calculator has the original loan
  data without fees and points
• 2nd AMORT
• 60 ENTER 60 ENTER This will allow you to see
  loan information at that point in time
  (58,598.16)
• Apply 3 prepayment penalty 58,598.16 (1
  0.03) 60,356
• Loan balance becomes an entry for future value

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Yield and Prepayment Time
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Pricing a Loan

• How can a lender earn 13 return on a 12
  interest rate, 30-year fixed rate mortgage that
  is expected to prepay in 10 years?
• This is same as asking for points to be charged
  to achieve the desired yield
• Payment on the loan
• Balance of the loan after 120 payments 0.934180
• PV of payments to lender at the desired return
• The fees should total 100 - 94.53 5.47

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Partially Amortizing Loan

• What is the payment on a 60,000 loan with 12
  interest rate, 30-year term, monthly payments,
  and 40,000 balloon payment at maturity?

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Negative Amortization

• What is the payment on a 60,000 loan with 12
  interest rate, 30-year term, and monthly
  payments?
• What is the balance of this loan if the lender
  and borrower agree on a monthly payment of 400
  rather than 617.17 after 5 years?

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Option Mortgages

• In a simple case, a borrower pays interest only
  for a certain period and then converts the loan
  into a fixed rate fully amortizing loan
• What is the interest only payment for the first
  ten years on a 60,000 loan with 12 interest
  rate, 30-year term, and monthly payments?
• What is the monthly payment when the loan
  converts into a fixed rate fully amortizing loan?

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Reverse Annuity Mortgage (RAM)

• A RAM is a raising debt falling equity mortgage
• It requires large payment later in its life
• It is designed for retired home owners who have
  little debt on their home
• It allows owners to take out equity
• What is the payment on a 250,000 RAM with 10
  interest rate, 10-year term, monthly payments?

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Three Loans when LTV

1. Conventional loan with PMI

2. First and second loan
3. FHA insurance
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Not So Special Specials

• A land developer purchases land, or purchases on
  option on land, with the intention of developing
  or enhancing the value of the property through
  improvements
• With an option the developer ties up less cash
  than with an outright purchase. A developer may
  be able to control property worth many millions
  of dollars with an option that may cost only in
  the thousands
• The developer makes a profit not through the
  appreciation in the value of the land but through
  the value added from the improvements

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Not So Special Specials Continued

• Zoning compliance making sure that there are no
  legal restrictions to the type of development
  that is contemplated. If there are, then efforts
  must be made to have the zoning changed if
  possible, or the development modified to meet the
  existing zoning regulations
• Engineering and surveying specialists in this
  field must be employed to make sure that the
  types of structures that are contemplated can be
  built on the land. The land may have to be
  modified to accommodate certain types of
  structures. In extreme cases it may be
  impossible to build certain types of structures
  on the available land
• Subdividing the large land parcel is divided
  into smaller parcels. The smaller parcels are
  sold to other developers or to the final consumer
  who, in turn, constructs a structure
• Physical work the actual grading of the land,
  landscaping, installation of utilities, and so
  forth

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Authority to Assess Specially

• Why a city would get into this type of an
  activity?

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Specials Example and Computations
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Specials Computations