Residential Mortgage Types and Borrower Decisions

Mortgage Mechanics and Calculations Chapter 10 (some from Chap 15)

Oct 16
Real Estate Process #306
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Course Business
Homework #2 posted
Due Friday November 1

No discussion sections NEXT WEEK (week of Oct 21)

Sharon gone October 23-25 No office hours during that time.

Week of Oct 28 (in 1.5 weeks): Discussion sections in Computer Labs (2294). Sessions voluntary

Real Estate Club (REC)

Real Estate Club http://realestateclub.org/
Meetings with RE industry speakers, RE job fair, networking, etc.
Meetings at the Pyle Center (on Langdon Street). Pizza/beverages are from 6:30 - 7:00, and speakers normally begin at 7:15 7:30 PM

Next meeting Thursday October 17!!

Thursday October 17: Hudson Advisors Wednesday-Friday October 23-25: REC trip to Miami, Florida Thursday November 14: TBA Thursday December 5: Colony Capital Thursday December 12: Graduation Celebration Dinner Miami, Florida

Study Trips - Wed-Fri Oct 23-25

Dues: $60 half semester, $100 two semesters

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Real Estate BBA Employment

On Campus Events Information sessions
Transwestern 10/14, 4:30 PM - CANCELLED DTZ 10/28, 7:00 PM and 10/30, 7:00 PM Rouse Properties 11/7, 6:00 PM Deutsche Bank Securities 11/12, 7:00 PM

Resume Submission Deadlines

DTZ (Corp RE Advisory): 10/15 or 10/17? Rouse Properties (Intern): 10/25

UW Real Estate Department Undergraduate Information sessions - Fall 2013

Tuesday, Sept. 24, 4 5pm: General Orientation - 1100 Grainger
Overview of the Department, professors, classes Discussion of the Wisconsin Real Estate Alumni Association (WREAA) and the Real Estate Club Student introductions

Tuesday, Oct 8, 4 5pm: Resumes, Networking and Resources - 3070 Grainger Fast facts on networking via e-mail, phone and in-person Resume tips Employment resources and strategies Student introductions

Tuesday, Oct 22, 4 5pm: The Real Estate Industry - 2510 Grainger
Industry overviews, the major food groups, positions and functions Student introductions

FRIDAY, Nov 8, 10am - 1:15pm: Guest speakers

- Rm: 3070

10:00 AM 12:00 PM:

Kyle Adams, Ruedebusch Commercial Investment Topic: Royster Clark Redevelopment

12:15 1:15 PM: Paul Boneham, EVP, Bentall Kennedy Topic: Overview of the Real Estate Industry and Employment Opportunities.

Coming Up
Wednesday Oct 16 Chapter 10, 15 Res. Mortgage Types (Ch 15:
part Mortgage Mechanics)

Monday Oct 21 Chapter 11 Sources of Funds for Res Mortgages Wednesday Oct 23 - Guest speakers: UW Credit Union
Sharon and TAs gone Oct 23-25: No office hours NO discussion sections this week!

Monday Oct 28 Chapters 16 & 17 Commercial Mortgages Wednesday Oct 30 - Chapters 16 & 17 Commercial Mortgages Monday Nov 4 Chapters 12 & 13 RE Brokerage, Contracts for Sale Wednesday Nov 6 - TBA Monday Nov 11 Second Exam During class time. In two rooms Wednesday Nov 13 Chapter 22 Leases and Property Types Monday Nov 18 Chapter 22 Leases and Property Types Wednesday Nov 20 Chapter 7 Valuation (Sales and Cost)

Mortgage Costs (Chap 15)

Interest rate = Lenders yield AND borrowers cost
When there are NO up front costs/points

Other costs/income will impact the lenders yield and borrowers cost
Effective Interest Rate (EIR) - lender Effective Borrower Cost (EBC) - borrower
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Lenders Yield (EIR) - (Chap 15)

Consider the following cash flows:
Term 360 months Required yield: 7% Monthly payment: $1,000 Initial loan balance is $150,307.57 360
n

P/Y = 12

7
i PV

1,000
Pmt

0
FV

-150,307.57

What if we charge discount points of 3.53%?

Points = .0353 x 150,307.57 = 5,307.57
Net loan amount = $145,000 ($150,307.57 5,307.57)
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Lenders Yield - EIR: (continued) 360

n i

(Chap 15)

What interest rate will result in a loan payment of $1,000 and net loan of 145,000?
-145,000 1,000
PV Pmt

0
FV

7.36%

Implicit yield is 7.36%; that is, the lenders yield, charging 3.53 points, is 7.36% Lenders yield: Implicit interest rate received on a loan (also called in text: equivalent interest rate)
Actual NET cash loaned out Actual cash payments received
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Borrowers Side Effective Borrowing Cost (EBC) (Chap 15)

Considers third-party expenses-some are closing costs: Borrower expenses not paid to lender:
Mortgage insurance premium Taxes on the loan Lenders title insurance Appraisal Survey

Effect: Borrower receives less than lenders actual disbursement

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Effective Borrowing Cost (continued) (Chap 15)

Example: Same loan, but with additional borrower expenses Points: $5,307.57 Borrowers loan expenses: $2,692.43 (Not paid to lender) Total deducted from loan disbursement: $8,000 (5,307.57 + $2,692.43) Total net loan: $142,307.57 What is the implicit interest rate? (term 360 mos., payment $1,000) Net loan amount: $142,307.57

360
n i

-142,307.57 1,000
PV Pmt

0
FV

7.55% With a total of $8,000 in borrower expenses, the EBC 11 of the loan is 7.55%

Special Case of EBC: APR (Chap 15)

Federal Truth in Lending Act (TILA) requires disclosure of annual percentage rate (APR) on virtually all home mortgage loans APR: Yield to maturity (APR somewhat similar to EIR, EBC), after adjusting for:
All loan finance charges (points, fees, mort ins) All compensation to originating brokers All other charges controlled by lender Premiums for any required insurance

Does not consider ALL costs (appraisal, survey, etc) and does not consider impact of prepayment.
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Other Mortgage Topics in Text

(Chap 15)

Impact on prepayment on EBC/EIR and lenders yield

Generally, whenever lender charges points and loan paid off early increases lenders yield and EBC/EIR Know implications for borrowing (p 414)

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Alternative Amortization Schedules (Chap 15)

Interest-only (straight-term)
Seldom with home loans (popular recently, never again) Often with income property loans OLB is constant, never pay any principal

Partially amortized loans (commercial)

One term for maturity (shorter) Another term for amortization (longer) Balloon payment

Early Payment (EPM)

Example: Growing equity mortgage (GEM) Pay off principal faster (payments increase, extra -> principal)
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Adjustable Rate Mortgages: Recent Variations (Chap 15)

3 year - 1 year ARM (3/1 yr)
Interest rate fixed for 3 years Adjusts annually thereafter

Other terms: 5/1 yr; 7/1 yr, 10/1 yr ARMs shift in interest rate risk to borrower Originally created to fix the maturity mismatch between funding long term debt with short term deposits and savings
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Adjustable Rate Mortgages (Ch 10)

LPMs work well when mortgage interest rates are low and stable 1970s and 1980s interest rates on LPM increased greatly. Also more volatile Housing became less affordable and lenders because nervous
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Short term deposits funding long term mortgages (LPMs) maturity imbalance.

Prime rate 1970 - 1989

20 15

10

ARMs became viable alternative

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Mortgages The Industry (Chap 10)

About 65% of households own a house Most have mortgages Most finance part of the purchase price
(2010 census)

Lack of funds Positive financial leverage (more in Chap 16) Better diversification
Homeownership increased dramatically after WWII

Primary and secondary mortgage market

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Primary Mortgage Market

Where loans are created (originated) Retail or street market Players
Mortgage bankers Mortgage brokers Commercial Banks Thrifts (savings and loan associations) Credit Unions

Either keep loans in house or sell them

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Secondary Mortgage Market

Where existing home loans are resold Wholesale market among lenders Dominant role of loan securitization Government-sponsored enterprises (GSEs) * largest purchasers of residential mortgages
Fannie Mae Freddie Mac
*Fannie and Freddie placed under US govt conservatorship in Sept 08 and will likely transition to a new form in the future. More on this in Chap 11..

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Conventional Mortgage Loans

Oldest form of mortgage Any standard home mortgage loan NOT insured by FHA or guaranteed by Veterans Affairs (VA)
Prime, sub-prime and Alt-A loans

Predominantly fixed-rate level payment (LPM)

LPM really started with FHA (1934) LPM accelerated after WW II by start of private mortgage insurance (PMI)
Higher LTVs and longer terms
LPM market has changed over last few years and is changing again 20

The Language of Conventional Mortgage Loans

Conforming conventional home loan: Meets the requirements for purchase by Freddie Mac or Fannie Mae:
Standard application, note and mortgage Certain underwriting standards (pmt % of inc, LTV) Standard appraisal Size limit: Currently $417,000 on SF homes Interest rate advantage due to liquidity (at least .25%)

Nonconforming conventional loan: Does not meet GSE requirements in some respect
Jumbo: Nonconforming in terms of size
Have higher interest rates
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Government Sponsored Mortgage Programs

To help middle and low income households obtain mortgages and buy homes

Federal Housing Administration (FHA)

Insures loans are from private lenders, allows lower down payment

Veterans Affairs
Guarantees loans from private lenders for vets

Some direct loans

Dept of Ag-Rural Housing Service (RHS) State & local programs
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How FHA Insurance Works

Targets borrowers who are weaker financially
Easier underwriting LTV, credit scores, debt-income ratios Limited mortgage amounts Program in transition

Insures 100% of loan

After foreclosure, title is transferred to Housing and Urban Development (HUD)

Premiums:
Up-front and annual premium

Many FHA insurance programs

203b: Standard LPM insurance
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FHA Mortgages
Importance of FHA
Created the LPM
Prior to 1934, most home loans were for 5-15 years; loans non-amortizing

Influenced housing and subdivision standards

Through power to approve/deny loans

Continues to innovate: HECM program (home

equity conversion program)

FHA market share fell from around 15% in early 1990s to about 3% in 2006. With collapse of subprime lending in 2007, gained market share again (about 18-19% in 2009). 2011 trending down (14%)
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Veterans Affairs Guarantees

VA-guaranteed loans Limited to qualified veterans of military service. Guarantees percentage of loan for a fee

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Private Mortgage Insurance (PMI)

For conventional loans. Protects lender against losses due to default Generally required for loans over 80% of value Protects lender for losses up to 25% of loan Up-front costs and annual premium Termination may be allowed if loan falls below 80% of current value and borrower is in good standing (Homeowners Insurance Act of 1999)
Obligation to terminate when loan falls to 78% of original value

Curt Culver MGIC (p 248-250)

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Other Mortgage Types

Purchase money mortgage: Mortgage given by a property buyer simultaneous with receipt of title
Normally a second mortgage loan to reduce the down payment Usually a loan from the seller

Piggy-back Mortgages
2nd mortgage to avoid PMI

Home equity loans, reverse mortgages, option ARM

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Property Value ($100,000)

Home Equity Loans

75% LTV (Required Equity = $25,000)

Some home equity loans are closedend, fixed-term loans Mostly open-end or credit-line loans Tax deductible interest (usually) Strength of the house as security provides favorable rate and longer Available term Equity Usually limited to total mortgage debt (sum of all mortgage loans) of 75% to 80% of value

Mortgage Balance (Debt = $75,000)

Some time in future Property Value ($125,000)

75% LTV (Required Equity = $31,250)

Equity

($33,750) from amortization & value increase)

Mortgage Balance (Debt = $60,000)

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Reverse Annuity Mortgage (RAM)

Many older households are income constrained (house poor) Over 80% own their home Most have little or no mortgage debt Most do not want to sell

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Traditional Mortgage
Building equity through amortization

Time

Principal payments reduce loan balance

Reverse Mortgage
Liquidating equity through regular disbursements

Time

Periodic loan draws plus accruing interest increase the loan, and reduce the owners equity.

How the Reverse Mortgage Works

Reverse mortgage loan converts home equity to income without requiring borrower to move: Requires no payment (p. 257-258)
Regular annuity disbursement (monthly payment) Lump sum disbursement Credit line

Mortality risk: Risk that loan will grow beyond value of mortgaged property, forced sale
FHAs HECM program and private insurance protect lender No foreclosure

Fannie Mae provides secondary market

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Other Mortgage Types

Interest Only (I-O) mortgages
With balloon, or amortizing after period of time

Hybrid ARM
Fixed rate for time period, then adjusts

Option ARM
Can change between fully amortizing, interest only, or minimum payment
If minimum payment could have negative amortization!
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Subprime and Alt-A

In 2006, 20% of all loans were subprime and 13% were Alt-A Subprime Usually ARM, negative amortization, substantial payment increases
Designed to be refinanced

Alt-A
standard conventional loans with one underwriting criteria relaxed (high LTV, no documentation of earnings)
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