California Real Estate Finance Bond, McKenzie, Fesler

1
California Real Estate FinanceBond, McKenzie,
Fesler BooneNinth Edition

• Chapter 4
• Adjustable Rate and Other Alternative Mortgage
  Instruments

2
Objectives

• After completing this chapter, you should be able
  to
• Discuss why, under certain market conditions, the
  fixed rate mortgage is again popular with some
  lenders.
• List and briefly describe the various types of
  alternative mortgage instruments.
• Explain how negative amortization works.
• Give reason why balloon mortgages are not favored
  by consumers.
• Demonstrate how a reverse annuity mortgage may be
  helpful for some older homeowners.
• Compare the differences between 15-year loans and
  biweekly loan payments, and the payments on a
  standard 30-year loan.

3
Outline

• Objectives and Rationale
• Adjustable Rate Mortgages (ARMs)
• Hybrid Loan Options
• Balloon Payment Fixed Rate Loans
• Reverse Annuity Mortgage (RAM)
• Miscellaneous Alternative Plans
• Epilogue

4
Objectives and Rationale

• Transfer risk from lender to borrower
• Tailor loans to the borrowers financial
  circumstances
• As interest rates on deposits rise, so do
  interest rates on mortgages and vice versa
• Avoids problem of borrowing short and lending
  long
• Cal-Vet loan program has been using ARMs for
  nearly 90 years

5
Purpose of ARMs

• Qualify for larger loan
• Lower initial payments
• Make principal reduction payments

6
Adjustable Rate Mortgages (ARMs) (Slide 1 of 3)

• Principal and interest payments rise and fall
  with inflation
• Lower initial interest rate (teasers)
• Tied to an index
• 11th District Cost of funds
• U.S. Treasury bills and securities
• LIBOR (London Interbank Offered Rate)
• Maintain a margin (difference between index and
  rate charged)
• Rates change every month, quarter, six months or
  year
• Caps (ceilings and floors on interest rates per
  change and for life of loan)
• Can lead to negative amortization
• Monthly payments cannot cover interest, so
  difference is added to principal
• Until it exceeds 20, in which case, loan must be
  recast
• Notice of payment adjustments
• Prepayment Penalty
• Assumability

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Disclosure Requirements for Adjustable Rate
Mortgages (ARMs) (Slide 2 of 3)

• Index
• Where found
• Five year history
• How interest and margin rates interact
• How teaser rates can change
• When rates can change and lead time
• Negative amortization features
• Maximum caps
• Annual interest increase
• Total for loan
• All in Consumer Handbook on Adjustable Rate
  Mortgages by Federal Reserve and Federal Home
  Loan Bank Board

8
Adjustable Rate Mortgages (ARMs) (Slide 3 of 3)

• Advantages
• Lower initial interest rates
• Easier qualifying
• Initial costs are smaller
• Ability to qualify for larger loan
• Payments come down with index
• Easier assumability upon resale
• No prepayment penalties
• Lower interest rates in early years
• Ability to make principal reduction payments
• Better investment

• Disadvantages
• Income may not rise with payments
• Slow market lack of appreciation
• Negative amortization
• Borrower has risk of rising interest rates

9
Hybrid Loan Options

• Fixed to ARM
• Two-Step Mortgage
• Low interest in beginning
• Switch to fixed or ARM
• ARM to Fixed
• Charge for conversion
• Must convert during window period

10
Balloon Payment Fixed Rate Loans

• Balloon mortgage
• Amortize over 30 years, but due in 5 or 7 years
• Payment more than double the amount of a regular
  installment is a Balloon
• Usually seller carry back loans during high
  interest periods
• Not popular because of uncertainty of rollover to
  new loan
• Points
• Interest rates

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Reverse Annuity Mortgage (RAM) (Slide 1 of 4)

• Tap equity with no monthly repayments
• Must be 62 or older
• Must own free and clear or have low existing loan
• Single family dwellings
• FHA approved condos
• 1-4 unit apartment buildings
• Manufactured homes on separate lots
• Due and payable
• Death
• Sale

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RAM programs (Slide 2 of 4)

• Home Equity Conversion Mortgage
• FHA limits apply
• ARM loan
• Tied to 1-year T-bills
• Home Keeper Program
• Fannie Mae limits apply
• ARM loan
• Tied to 1-month CD rates
• Conventional Programs
• Not backed by FHA or Fannie Mae
• No limits

13
RAM payment options (Slide 3 of 4)

• Term
• Equal monthly payments for a fixed number of
  years
• Tenure
• Equal monthly payments for as long as borrower
  occupies home
• Line of credit option
• Funds drawn as needed up to max

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RAM basics (Slide 4 of 4)

• Borrower pays loan fees, closing costs and
  monthly servicing fee
• Mortgage insurance premiums will be charged
• Due and payable on death or sale or vacancy
• Due and payable if vacated for gt one year
• All payments plus interest
• But not more than value of home
• If sale price higher than loan, heirs keep
  balance
• Must attend education session
• Funds received are tax free, because this is a
  loan which must be repaid

15
Miscellaneous Alternative Plans

• Fifteen year mortgage
• Save ¼ to ½ on interest
• Biweekly loan payments (26 payments/year)
• Pay off 1/3 faster

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Epilogue

• Borrower beware!

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Questions and Comments?