Lecture 5: Front-end Mortgages

1. Lecture 5: Front-end Mortgages byJames R. DeLisle, Ph.D.January 19, 2010

2. Lecture Overview • Fixed Rate Mortgages • CAM • CPM • Interest Only • Loans • Typology of Mortgages • Mortgage Regulations • Mortgage Mechanics: Introduction

3. Introduction to Time Value of Money (TVM) • Definition of TVM • Math of TVM • Core Equation: FV = PV * (1 + r)t • Types: Lump Sum, Annuity • Six Functions of $1 • Future Value • FV$; what is FV of current lump? • FVA; what is FV of annuity? • SF; what annuity draw from PV lump? • Present Value • PV$: what is PV of future lump? • PVA; what is PV of FV annuity? • PR; what annuity payment to amortize $lump?

4. PV$ Principle Interest Periodic Repayment (PR) Future PR1/P Present What is the Periodic Payment to amortize $1?

5. Periodic Repayment (PR): Overview What is the Periodic Payment/Yr that will amortize $1,000 over 5 yr at 7.5%? $1,000 ? $247 $200

6. Typology of Residential Mortgages

7. Front-end Mortgage Overview: Part 1 BDM FRM PAM CAM

8. Front-end Mortgage Overview: Part 2 WRAP PMM

9. Base Case

10. Traditional Mortgage Payment Schedule

11. Traditional Mortgage Amortization Patterns

12. Traditional Mortgage: Prepayment

13. Constant Amortization Mortgage • Advantages • No balloon payment • Declining payments may be appropriate to match declining asset or deflation • Suited for consumer debt on short-lived assets; not common in real estate • Disadvantages • High initial payments • Declining payment pattern independent from property income to service debt • Rapidly declining interest of payments reduces PV of interest tax shield • Rapid paydown of principal reduces leverage faster than many borrowers like • Constantly changing payment obligation difficult to administer and budget

14. CAM Pattern

15. CAM Prepayment

16. Constant Amortization vs. Constant Payment BI = Borrower’s Income Required

17. Buydown Mortgage (BDM) • Advantages • Increase purchasing power • Allow borrower to purchase at full price • Typically Fixed Rate • Disadvantages • Lower equity investment may reduce “will to pay” • Cooperative Lender and Set-up Fee • Reduced interest deduction for taxes • Step-up payment risk at end of BDM term

18. Buydown: Visual Principal Balances Payments

19. Buydown Mortgage: Base Case

20. Mechanics of Buydown

21. Lender Points BDM Yields Lender

22. Pledged Account Mortgage (PAM) • Advantages • Increase purchasing power • Single lender • Fixed Rate • Disadvantages • Higher LV ratio triggers PMI • Set-up Fee • Reduced interest deduction for taxes • Step-up payment risk at end of PAM term

23. PAM Visual Principal Balances Cash Flows

24. PAM Case

25. Mechanics of PAMs

26. Lender with Points PAM Yields Lender

27. WRAP Mortgage: Seller’s Approach • Advantages • Increase access and speed of closing • Lower rate on WRAP vs. new market • Hold price for seller • Provide arbitrage/spread opportunity • Disadvantages • Title not as clearly held by buyer • Seller retains liability • Seller services loan

28. WRAP Part I: Flows $292,390 $57,561 $276,386 $1878 $ 391 $1416 Excess $71

29. Wrap Visualization

30. Wrap Case

31. WRAP Mechanics

32. WRAP Details

33. WRAP Yields

34. Purchase Money Mortgage: PMM • Advantages • Allow borrower to qualify • Pay more than could afford • Hold price for seller • Quick approvals • Disadvantages • Title not as clearly held by buyer • Seller retains claim • Seller services loan • Buyer may not be able to make step

35. PMM Visual Principal Cash Flows

36. PMM Case

37. Mechanics of PMM

38. Seller PMM Yields Lender

39. Operating Period Mortgages

40. Lecture Summary • Mortgages • Mortgage Process • Mortgage Risk Management • Mortgage Concepts • Mortgage Transfer • Foreclosure & Bankruptcy • Types of Loans • Typology of Mortgages • Mortgage Regulations • Mortgage Mechanics: Introduction