McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved CHAPTER4CHAPTER4 CHAPTER4CHAPTER4 Fixed Rate Mortgage Loans.

McGraw-Hill/Irwin©2008 The McGraw-Hill Companies, All Rights Reserved

CHAPTER

4

CHAPTER

4Fixed Rate

Mortgage Loans

4-2

Copyright ©2008 by The McGraw-Hill Companies, Inc. All Rights Reserved

Mortgage Interest RatesMortgage 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

4-3


Components of the Mortgage Components of the Mortgage Interest RateInterest 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

4-4



• Default Risk

• Interest Rate Risk Anticipated Inflation and Unanticipated

Inflation

• Prepayment Risk

• Liquidity Risk

• Legislative Risk

4-5



r = Real Rate

f1 = Inflation Rate

p1 = Risk Premiums

111 fprit

4-6


Mortgage Payment PatternsMortgage Payment Patterns

• Constant Amortization Mortgage (CAM) Loan Amortization Remains the Same Monthly Payment Changes

• Constant Payment Mortgage (CPM) Loan Amortization Changes Monthly Payment Remains the Same

4-7


Mortgage Payment PatternsMortgage Payment Patterns

• Example 4-1

• Calculating the Payment for a CPM $100,00 Mortgage 7% Interest 30 Years Monthly Payments

4-8


Mortgage Payment Patterns Mortgage Payment Patterns

= $100,000

= 30 x 12 = 360

= $0

= 7/12 = .58333(or change P/Y to 12 and enter 7)

= $665.30

n

i

CPT

FV

PMT

PV

4-9



• Interest paid in the first month (.07/12) x $100,000 = $583.33

• Principal paid in the first month $665.30 - $583.33 = $81.96

• Every month, interest portion declines

• Every month, principal portion increases.

4-10



• 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.

4-11


Computing a Loan BalanceComputing a Loan Balance

• Essentially “removing” the interest that was built into the payment.

• Two mathematical methods Compute the present value of the remaining

payments. Compute the future value of the amortized

loan amount.

4-12


Computing a Loan BalanceComputing a Loan Balance

• There are 3 methods to do this with a financial calculator From Example 4-1, what is the future

expected loan balance in 8 years?

4-13


Computing a Loan BalanceComputing a Loan BalancePresent Value MethodPresent Value Method

= $665.30

= 22 x 12 = 264

= $0

= 7/12 = .58333

= $89,491

n

i

CPT

FV

PMT

PV

4-14


Computing a Loan Balance Computing a Loan Balance Future Value MethodFuture Value Method

= $100,000

= 8 x 12 = 96

= $665.30

= 7/12 = .58333

= $89,491

n

i

CPT FV

PMT

PV

4-15


Computing a Loan BalanceComputing a Loan Balance Amortization Function Method Amortization Function Method

• Step 1: Compute Payment = $665.30

• Step 2: Press

= P1 = 1

= P2 = 96

Balance = $89,491

ENTER

AMORT

↓

ENTER ↓

4-16


Loan Closing CostsLoan Closing Costs

• Statutory Transfer Recording Fees etc.

• Third Party Charges Appraisals Surveys Inspections, etc.

4-17


Loan Closing Costs Loan Closing Costs

• Additional Finance Charges 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

4-18


Loan Closing CostsLoan Closing Costs

• 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.

4-19


Loan Fees & Borrowing CostsLoan Fees & Borrowing Costs

• Calculating the effective interest cost

• Example 4-2: $250,000 home 80% LTV Loan 8% Interest 4 Points 30 Years

4-20



• Step 1: Compute payment using the face value of the loan.

= $200,000

= 360

= 8

= $1467.53

But, with points paid up front, the borrower actually receives less than the face value.

n

i

PMT

PV

4-21



• Step 2:

Loan Amount = $200,000

- Points Paid = (.04 x $200,000)

Amount Received = $192,000

• Compute effective interest cost, using the Amount Received from Step 2 & Payment from Step 1.

4-22



• Compute effective interest cost:

= $192,000 = $1467.53

= 360 = 8.44%

PMTPV

n CPT i

4-23


Loan Fees & Borrowing Costs Loan Fees & Borrowing Costs

• What is the effective cost if we think this loan might be repaid after 8 years? Step 1: Compute PMT = $1467.53 Step 2: Compute Future Loan Balance

P1 = 1

P2 = 96

Balance = $182,035.40

ENTERAMORT ↓

ENTER ↓

4-24



Step 3: Compute effective interest cost.= ($192,000)

= $182,035.40

= $1467.53

= 96

= 8.72%

n

iCPT

FV

PMT

PV

4-25


Other Loan PatternsOther Loan Patterns

• Partially Amortizing Balloon Payment

• Interest Only Loans

• Negative Amortization

• Reverse Annuity Mortgages

McGraw-Hill/Irwin ©2008 The McGraw-Hill Companies, All Rights Reserved CHAPTER4CHAPTER4 CHAPTER4CHAPTER4 Fixed Rate Mortgage Loans.

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