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Evolution of Residential Lending: From Ancient Times to Fixed-Rate Mortgages

Explore the history of real estate finance, from Roman to modern US law, and understand the mechanics of fixed-rate mortgages. Learn about key concepts like usury, loan amortization, outstanding balance, and APR calculations.

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Evolution of Residential Lending: From Ancient Times to Fixed-Rate Mortgages

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  1. Chapter4 History of Real Estate Finance and the Fixed-Rate Mortgage

  2. 4-1 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. 4-2 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. 4-3 History Of Real Estate Finance Con’t • 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. 4-4 History Of Real Estate Finance Con't • ENGLISH LAW • Concept Of Usury In That Charging Interest Was Sinful • Equitable Right Of Redemption Allowing Borrower To Redeem The Property After Default

  6. 4-5 History Of Real Estate Finance Con’t • 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. 4-6 History Of Real Estate Finance Con’t • 1920s BOOM • S&Ls Expanded Rapidly • Real Estate Prices Rose Rapidly • 1930s DEPRESSION • Banking System Collapsed, Money Supply Plummeted • Short-term, Non-Amortizing Loans Became A Problem • A Number Of Federal Agencies Created Including FSLIC, FHA, And Fannie Mae

  8. 4-7 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

  9. 4-8 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)

  10. 4-8 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?

  11. 4-9 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

  12. 4-10 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

  13. 4-11 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)

  14. 4-12 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.

  15. 4-13 Fixed-rate Mortgages • 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

  16. 4-14 Fixed-rate Mortgages

  17. 4-15 Fixed-rate Mortgages

  18. 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 4-16

  19. 4-17 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%

  20. 4-18 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%

  21. 4-19 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%

  22. 4-20 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%

  23. 4-21 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%

  24. 4-22 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%

  25. 4-23 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

  26. 4-24 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

  27. 4-25 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

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