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Chapter 4

Chapter 4. History of Real Estate Finance and the Fixed-Rate Mortgage. Chapter 4 Learning Objectives. Understand how residential lending evolved from the earliest of times through World War II Understand the mechanics of the standard fixed-rate mortgage. History Of Real Estate Finance.

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Chapter 4

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  1. Chapter 4 History of Real Estate Finance and the Fixed-Rate Mortgage

  2. Chapter 4Learning Objectives • Understand how residential lending evolved from the earliest of times through World War II • Understand the mechanics of the standard fixed-rate mortgage

  3. History Of Real Estate Finance • ROMAN LAW • Transfer of title and possession until repayment • No transfer of title or possession. Lender could take title and possession under suspicion of default • No transfer of title or possession. Lender could take title under actual default

  4. History Of Real Estate Finance • GERMAN LAW • Gage is a deposit made to fulfill an agreement • Mort is French for Dead. Real property (not transportable) was a dead gage • In default the lender could take title but could not look further for relief

  5. History Of Real Estate Finance • ENGLISH LAW • Concept of usury in that charging interest was sinful • Equitable Right Of Redemption - Allowing borrower to redeem the property after default

  6. History Of Real Estate Finance • U.S. law is a mix of Roman, German, And English law • EARLY EXPANSION • Little need for lending • Some building societies formed to consolidate funds for home buying • POST-CIVIL WAR • Increased mortgage lending to finance westward expansion • Typical loan was short-term, interest-only

  7. History Of Real Estate Finance • Early 1900s through 1920s • Federal Reserve in 1913 allowed banks to write 5-year, 50% loan-to-value ratio, non-amortizing mortgages • Building and Loan Associations expanded rapidly • Real estate prices rose rapidly • After 1929 market crash, real estate prices dropped dramatically

  8. History Of Real Estate Finance • 1930s • Market crash in 1929 ushered in the Great Depression • Banking system collapsed, money supply plummeted, unemployment soared • Refinancing short-term, non-amortizing loans became a problem • A number of federal agencies created including FSLIC (1934), FHA (1934), and Fannie Mae (1938)

  9. Fixed-Rate Mortgages • PRESENT VALUE OF AN ANNUITY PVANN = (1+i)n – 1 (i) (1+i)n • MORTGAGE CONSTANT MCi = (i) (1+i)n (1+i)n - 1

  10. Fixed-Rate Mortgages • IMPORTANT VARIABLES • Amount Borrowed • Contract Interest Rate • Maturity (Term) • Outstanding Balance • Amortization • Payment • Financing Costs Including Discount Points • Annual Percentage Rate (APR)

  11. Fixed-Rate Mortgages • Suppose You Borrow $100,000 @ 7.50% For 30 Years, Monthly Payments • What Is Your Monthly Payment To Fully Amortize The Loan Over Its Term?

  12. Fixed-Rate Mortgages PMT = AMT. BORROWED (MCi,n) PMT = $100,000 (MC7.5,30) PMT = $100,000 x (.075/12) (1+.075/12)360 (1+.075/12)360 – 1 = $100,000 (.0069921) = $699.21

  13. Fixed-Rate Mortgages • KEYSTROKES FOR PAYMENT CALCULATION • Enter amount borrowed as negative PV • Enter the contract rate (adjusted monthly) • Enter the number of payments • Solve for payment (PMT) • Caution: If your calculator is set on one payment per year, you must divide the interest rate by 12 and multiply the years by 12.

  14. Fixed-Rate Mortgages • LOAN AMORTIZATION • Payment consists of interest and repayment of principal • AMORTIZATION FOR MONTH ONE • Payment is $699.21 • Interest portion is $100,000 (.075/12) = $625 • Repayment of principal portion is remainder, $699.21 - 625 = $74.21 • Each month’s interest is calculated as the loan balance at the beginning of the month times the monthly interest rate

  15. Fixed-Rate Mortgages • OUTSTANDING BALANCE • Present value of the remaining stream of payments discounted at the contract rate • FOR OUR EXAMPLE AT THE EOY 5: • Enter the payment (699.21) • Enter the contract rate (.075/12) • Enter the number of remaining payments (300) • Solve for present value (PV) ($94,617)

  16. Fixed-Rate Mortgages • Annual Percentage Rate (APR) • The effective cost of the loan assuming it is held for its full term • Some Items Included In APR Calculation: • Origination Fee, Lender Inspection Fee, Assumption Fee, Underwriting Fee, Tax Service Fee, Document Prep Fee, Prepaid Interest, Mortgage Insurance Premium, Discount Points

  17. Fixed-Rate Mortgages

  18. Fixed-Rate Mortgages

  19. Contract Rate 7% 6.75% 6.50% 6.25% Discount Points 0 1.00 2.875 3.00 Trade Off Between Contract Rate and Discount Points

  20. Calculating The APR • Assumption: Borrow $100,000 for 30 years, monthly payments 7% & O pts: 100,000 - 0 = $665.30 (PVAFi/12,360) i =7% 6.75% & 1 pt: 100,000 - 1,000 = $648.60 (PVAFi/12,360) i = 6.85%

  21. Calculating The APR Cont. 6.50% & 2.875 pts: 100,000-2,875= $632.07 (PVAFi/12,360) i = 6.78% 6.25% & 3 pts: 100,000-3,000= $615.72(PVAFi/12,360) i = 6.54%

  22. Calculating the Effective Cost Under Shortened Holding Period • Assumption: Borrow $100,000 for 30 years, monthly payments, hold for five years 7% & 0 pts: $100,000 - 0 = $665.30 (PVAFi/12,60) + $94,132 (PVFi/12,60) i = 7% 6.75% & 1 pt: $100,000 - $1,000 = $648.60 (PVAFi/12,60) + $93,876 (PVFi/12,60) i = 6.99%

  23. Calculating the Effective Cost Under Shortened Holding Period 6.50% & 2.875 pts: $100,000 - 2,875 = $632.07(PVAFi/12,60) + $93,611(PVFi/12,60) • i = 7.2% 6.25% & 3 pts: $100,000 - $3,000 = $615.72(PVAFi/12,60) + $93,337(PVFi/12,60) • i = 6.98%

  24. Summary of Effective Costs • Option APR 5 Years 7% & 0 pts 7% 7% 6.75% & 1 pt 6.85% 6.99% 6.50% &2.875 pts 6.78% 7.21% 6.25% & 3 pts 6.54% 6.98%

  25. Prepayment Penalty • Assumptions: $100,000 at 7.5% for 30 years, monthly payments. Five percent prepayment penalty over entire term. Repay at the end of year 5 • PMT = $699.21 • BalanceEOY5 =94,617 • Effective cost with no points $100,000 - 0 = $699.21(PVAFi/12,60)+$94,617(1.05)(PVFi/12,60) i = 8.28%

  26. Fifteen Year Mortgage • Borrow $100,000 at 7.50% for 15 years, monthly payments PMT15 =$100,000( MC7.5,15) = $927.01 PMT30 = $100,000 (MC7.5,30) = $699.21 Total interest over 15 year term • $927.01(180) - $100,000 = $66,862 Total interest over 30 year term • $699.21(360) - $100,000=$151,716 Difference in interest paid • $151,716 - $66,862 = $84,854

  27. Extra Payment Monthly • PMT= $100,000 (MC7.5,30) = $699.21 $699.21/12= $58.27 Extra paid monthly • New PMT= $699.21 + $58.27 = $757.48 • Number of payments at new payment amount $100,000 = $757.48 (PVAF7.5/12, n) • n= 279.84, approximately 23 years • Amount saved $699.21 ( 80.16) - $58.27 (279.84) $56,049 - $16,306 = $39, 743

  28. Calculating Discount Points • Suppose you borrow $100,000 at 7% for 30 years, monthly payments. The APR on the loan is 7.25%. What amount of points were charged? • 100,000 – pts = 665.30 (PVAF7.25/12, 360) • 100,000 – pts = 97526 • Pts = $2474 • 2474/100,000 = 2.47 points

  29. Extra Payment-Lump Sum • PMT= $100,000 ( MC7.5,30) = $699.21 • $10,000 Extra paid at the end of year 3 • BALEOY3 : $97,014 Minus extra payment: $10,000 New balanceEOY3 : $87,014 • Number of payments remaining after extra payment $87,014= $699.21 ( PVAF7.5/12, n) • n= 241.41 • Amount saved: $699.21 (82.59) - $10,000= $47,748

  30. Calculating Discount Points w/ a Shortened Holding Period • Suppose you take a FRM for $100,000 at 7% for 30 years, monthly payments. The effective cost with a 5-year holding period is 7.375%. What amount of discount points were charged? 100,000 – pts = 665.30 (PVAF7.375/12, 60) + 94,132 (PVF7.375/12, 60) 100,000 – pts = 98476 pts = $1524 or 1524/100,000 = 1.524 pts

  31. Equalizing APRs • Option 1: $100,000 at 6.5% for 30 years, monthly payments. APR = 6.60% • Option 2: $100,000 at 6.25% for 30 years, monthly payments. How many points must be charged to equalize the APR on the two options?

  32. Equalizing APRs (con’t) 100,000 – pts = 615.72 (PVAF6.60/12, 360) 100,000 – pts = 96,408 Pts = $3,592 Pts = 3,592/100,000 = 3.592 pts

  33. Calculating Financing Fees Other Than Discount Points • You borrow $100,000 at 6% for 30 years, mthly pmts. You pay 2.50 discount points. Your APR is 6.375%. What is the amount of your other fees? 100,000 – 2,500 – fees = 599.55 (PVAF6.375/12, 360) 100,000 – 2,500 – fees = 96,102 Other Financing Fees = $1,398

  34. Interest-Only Fixed-Rate Mortgage • Suppose you take a $140,000, 10/20 interest-only FRM at 7%, monthly payments. • What is the interest-only payment? Pmt = 140,000 (.07/12) = $816.67 • What is the payment for the last 20 years to fully amortize the loan? Pmt = 140,000 (MC7, 20) = $1085.42 • What is the balance at the EOY20? BalEOY20 = 1085.42 (PVAF7/12, 120) = $93,483

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