Chapter 4 History of Real Estate Finance and

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 n Understand the mechanics of the standard fixed-rate mortgage n

History Of Real Estate Finance n 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

History Of Real Estate Finance n 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

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

History Of Real Estate Finance n n n 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

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

History Of Real Estate Finance n 1930 s – 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)

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

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

Fixed-Rate Mortgages n 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?

Fixed-Rate Mortgages PMT = AMT. BORROWED (MCi, n) PMT = $100, 000 (MC 7. 5, 30) PMT = $100, 000 x (. 075/12) (1+. 075/12)360 – 1 = $100, 000 (. 0069921) = $699. 21

Fixed-Rate Mortgages n 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.

Fixed-Rate Mortgages n LOAN AMORTIZATION – Payment consists of interest and repayment of principal n 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

Fixed-Rate Mortgages n OUTSTANDING BALANCE – Present value of the remaining stream of payments discounted at the contract rate n 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)

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

Fixed-Rate Mortgages

Fixed-Rate Mortgages

Trade Off Between Contract Rate and Discount Points n Contract Rate 7% 6. 75% 6. 50% 6. 25% n Discount Points 0 1. 00 2. 875 3. 00

Calculating The APR n 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%

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%

Calculating the Effective Cost Under Shortened Holding Period n 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%

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) n i = 7. 2% 6. 25% & 3 pts: $100, 000 - $3, 000 = $615. 72(PVAFi/12, 60) + $93, 337(PVFi/12, 60) n i = 6. 98%

Summary of Effective Costs n Option 7% & 0 pts 6. 75% & 1 pt 6. 50% &2. 875 pts 6. 25% & 3 pts APR 5 Years 7% 6. 85% 6. 78% 6. 54% 7% 6. 99% 7. 21% 6. 98%

Prepayment Penalty n n 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 Balance. EOY 5 = 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%

Fifteen Year Mortgage n Borrow $100, 000 at 7. 50% for 15 years, monthly payments PMT 15 = $100, 000( MC 7. 5, 15) = $927. 01 PMT 30 = $100, 000 (MC 7. 5, 30) = $699. 21 Total interest over 15 year term n $927. 01(180) - $100, 000 = $66, 862 Total interest over 30 year term n $699. 21(360) - $100, 000=$151, 716 Difference in interest paid n $151, 716 - $66, 862 = $84, 854

Extra Payment Monthly n PMT= $100, 000 (MC 7. 5, 30) = $699. 21/12= $58. 27 Extra paid monthly New PMT= $699. 21 + $58. 27 = $757. 48 n Number of payments at new payment amount n $100, 000 = $757. 48 (PVAF 7. 5/12, n) n n n= 279. 84, approximately 23 years Amount saved $699. 21 ( 80. 16) - $58. 27 (279. 84) $56, 049 - $16, 306 = $39, 743

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? n 100, 000 – pts = 665. 30 (PVAF 7. 25/12, 360) n 100, 000 – pts = 97526 n Pts = $2474 n 2474/100, 000 = 2. 47 points n

Extra Payment-Lump Sum n n PMT= $100, 000 ( MC 7. 5, 30) = $699. 21 $10, 000 Extra paid at the end of year 3 BALEOY 3 : $97, 014 Minus extra payment: $10, 000 New balance. EOY 3 : $87, 014 Number of payments remaining after extra payment $87, 014= $699. 21 ( PVAF 7. 5/12, n) n n n= 241. 41 Amount saved: $699. 21 (82. 59) - $10, 000= $47, 748

Calculating Discount Points w/ a Shortened Holding Period n 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 (PVAF 7. 375/12, 60) + 94, 132 (PVF 7. 375/12, 60) 100, 000 – pts = 98476 pts = $1524 or 1524/100, 000 = 1. 524 pts

Equalizing APRs Option 1: $100, 000 at 6. 5% for 30 years, monthly payments. APR = 6. 60% n 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? n

Equalizing APRs (con’t) 100, 000 – pts = 615. 72 (PVAF 6. 60/12, 360) 100, 000 – pts = 96, 408 Pts = $3, 592 Pts = 3, 592/100, 000 = 3. 592 pts

Calculating Financing Fees Other Than Discount Points n 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 (PVAF 6. 375/12, 360) 100, 000 – 2, 500 – fees = 96, 102 Other Financing Fees = $1, 398

Interest-Only Fixed-Rate Mortgage n n Suppose you take a $140, 000, 10/20 interestonly 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 (MC 7, 20) = $1085. 42 What is the balance at the EOY 20? Bal. EOY 20 = 1085. 42 (PVAF 7/12, 120) = $93, 483