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

ChapterChapter 44History of Real Estate History of Real Estate

Finance and the Finance and the

Fixed-Rate MortgageFixed-Rate Mortgage

Chapter 4Chapter 4Learning ObjectivesLearning Objectives

Understand how residential lending Understand how residential lending evolved from the earliest of times evolved from the earliest of times through World War IIthrough World War II

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

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History Of Real Estate History Of Real Estate FinanceFinance

ROMAN LAWROMAN LAW Transfer Of Title And Possession Until Transfer Of Title And Possession Until

RepaymentRepayment No Transfer Of Title Or Possession. No Transfer Of Title Or Possession.

Lender Could Take Title And Lender Could Take Title And Possession Under Suspicion Of DefaultPossession Under Suspicion Of Default

No Transfer Of Title Or Possession. No Transfer Of Title Or Possession. Lender Could Take Title Under Actual Lender Could Take Title Under Actual DefaultDefault

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History Of Real Estate History Of Real Estate Finance Con’tFinance Con’t

GERMAN LAWGERMAN LAW Gage Is A Deposit Made To Fulfill An Gage Is A Deposit Made To Fulfill An

AgreementAgreement Mort Is French For Dead. Real Mort Is French For Dead. Real

Property (Not Transportable) Was A Property (Not Transportable) Was A Dead GageDead Gage

In Default The Lender Could Take Title In Default The Lender Could Take Title But Could Not Look Further For ReliefBut Could Not Look Further For Relief

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History Of Real Estate History Of Real Estate Finance Con'tFinance Con't

ENGLISH LAWENGLISH LAW Concept Of Usury In That Charging Concept Of Usury In That Charging

Interest Was SinfulInterest Was Sinful Equitable Right Of Redemption Equitable Right Of Redemption

Allowing Borrower To Redeem The Allowing Borrower To Redeem The Property After DefaultProperty After Default

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U.S. Law Is A Mix Of Roman, German, And U.S. Law Is A Mix Of Roman, German, And English LawEnglish Law

EARLY EXPANSIONEARLY EXPANSION Little Need For LendingLittle Need For Lending Some Building Societies Formed To Some Building Societies Formed To

Consolidate Funds For Home BuyingConsolidate Funds For Home Buying POST-CIVIL WARPOST-CIVIL WAR

Increased Mortgage Lending To Finance Increased Mortgage Lending To Finance Westward ExpansionWestward Expansion

Typical Loan Was Short-term, Interest OnlyTypical Loan Was Short-term, Interest Only

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1920s BOOM1920s BOOM S&Ls Expanded RapidlyS&Ls Expanded Rapidly Real Estate Prices Rose RapidlyReal Estate Prices Rose Rapidly

1930s DEPRESSION1930s DEPRESSION Banking System Collapsed, Money Supply Banking System Collapsed, Money Supply

PlummetedPlummeted Short-term, Non-Amortizing Loans Became Short-term, Non-Amortizing Loans Became

A ProblemA Problem A Number Of Federal Agencies Created A Number Of Federal Agencies Created

Including FSLIC, FHA, And Fannie MaeIncluding FSLIC, FHA, And Fannie Mae

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Fixed-rate MortgagesFixed-rate Mortgages

PRESENT VALUE OF AN ANNUITYPRESENT VALUE OF AN ANNUITY PVPVANNANN = = (1+i)(1+i)nn – 1 – 1

(i) (1+i)(i) (1+i)nn

MORTGAGE CONSTANTMORTGAGE CONSTANT MCMCii = = (i) (1+i)(i) (1+i)nn

(1+i)(1+i)nn - 1 - 1

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IMPORTANT VARIABLESIMPORTANT VARIABLES Amount BorrowedAmount Borrowed Contract Interest RateContract Interest Rate Maturity (Term)Maturity (Term) Outstanding BalanceOutstanding Balance AmortizationAmortization PaymentPayment Financing Costs Including Discount PointsFinancing Costs Including Discount Points Annual Percentage Rate (APR)Annual Percentage Rate (APR)

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Suppose You Borrow $100,000 @ Suppose You Borrow $100,000 @ 7.50% For 30 Years, Monthly 7.50% For 30 Years, Monthly PaymentsPayments

What Is Your Monthly Payment To What Is Your Monthly Payment To Fully Amortize The Loan Over Its Fully Amortize The Loan Over Its Term?Term?

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PMT = AMT. BORROWED (MCPMT = AMT. BORROWED (MCi,ni,n))

PMT = $100,000 (MCPMT = $100,000 (MC7.5,307.5,30)) PMT = $100,000 x PMT = $100,000 x (.075/12) (1+.075/12)(.075/12) (1+.075/12)360 360

(1+.075/12)(1+.075/12)360360 – 1 – 1

= $100,000 (.0069921)= $100,000 (.0069921)

= $699.21= $699.21

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Fixed-rate MortgagesFixed-rate Mortgages LOAN AMORTIZATIONLOAN AMORTIZATION

Payment Consists Of Interest And Payment Consists Of Interest And Repayment Of PrincipalRepayment Of Principal

AMORTIZATION FOR MONTH ONEAMORTIZATION FOR MONTH ONE Payment Is $699.21Payment Is $699.21 Interest Portion Is $100,000 (.075/12) = Interest Portion Is $100,000 (.075/12) =

$625$625 Repayment Of Principal Portion Is Repayment Of Principal Portion Is

Remainder, $699.21 - 625 = $74.21Remainder, $699.21 - 625 = $74.21 Each Month’s Interest Is Calculated As The Each Month’s Interest Is Calculated As The

Loan Balance At The Beginning Of The Loan Balance At The Beginning Of The Month Times The Monthly Interest RateMonth Times The Monthly Interest Rate

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OUTSTANDING BALANCEOUTSTANDING BALANCE Present Value Of The Remaining Stream Of Present Value Of The Remaining Stream Of

Payments Discounted At The Contract RatePayments Discounted At The Contract Rate FOR OUR EXAMPLE AT THE EOY 5:FOR OUR EXAMPLE AT THE EOY 5:

Enter The Payment (699.21)Enter The Payment (699.21) Enter The Contract Rate (.075/12)Enter The Contract Rate (.075/12) Enter The Number Of Remaining Payments Enter The Number Of Remaining Payments

(300)(300) Solve For Present Value (PV) ($94,617)Solve For Present Value (PV) ($94,617)

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KEYSTROKES FOR PAYMENT CALCULATIONKEYSTROKES FOR PAYMENT CALCULATION Enter Amount Borrowed As Negative PVEnter Amount Borrowed As Negative PV Enter The Contract Rate (Adjusted Monthly)Enter The Contract Rate (Adjusted Monthly) Enter The Number Of PaymentsEnter The Number Of Payments Solve For Payment (PMT)Solve For Payment (PMT) Caution: If Your Calculator Is Set On One Caution: If Your Calculator Is Set On One

Payment Per Year, You Must Divide The Payment Per Year, You Must Divide The Interest Rate By 12 And Multiply The Years Interest Rate By 12 And Multiply The Years By 12. By 12.

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APRAPR The Effective Cost Of The Loan The Effective Cost Of The Loan

Assuming It Is Held For Its Full TermAssuming It Is Held For Its Full Term Some Items Included In APR Calculation:Some Items Included In APR Calculation:

Origination Fee, Lender Inspection Origination Fee, Lender Inspection Fee, Assumption Fee, Underwriting Fee, Assumption Fee, Underwriting Fee, Tax Service Fee, Document Prep Fee, Tax Service Fee, Document Prep Fee, Prepaid Interest, Mortgage Fee, Prepaid Interest, Mortgage Insurance Premium, Discount PointsInsurance Premium, Discount Points

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ContractRate

Term Disc.Points

APR PMT @100,000

5.50% 30 yrs 0.00 5.56% $567.79

5.375% 30 yrs 1.00 5.705% $559.97

5.25% 30 yrs 2.00 5.534% $552.20

5.125% 30 yrs 2.50 5.42% $544.49

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ContractRate

Term Disc.Points

APR Pmt @100,000

4.875% 15 yrs 0.00 5.09% $784.30

4.75% 15 yrs 1.00 5.302% $777.83

4.625% 15 yrs 1.25 4.787% $771.40

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Trade Off Between Trade Off Between Contract Rate and Contract Rate and

Discount PointsDiscount Points

Contract RateContract Rate 7%7% 6.75%6.75% 6.50%6.50% 6.25%6.25%

Discount PointsDiscount Points 00 1.001.00 2.8752.875 3.003.00

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Calculating The APRCalculating The APR

Assumption: Borrow $100,000 for 30 Assumption: Borrow $100,000 for 30 years, monthly paymentsyears, monthly payments 7% & O pts: 7% & O pts: 100,000 - 0 = $665.30 (PVAF100,000 - 0 = $665.30 (PVAFi/12,360i/12,360) )

i =7%i =7% 6.75% & 1 pt: 6.75% & 1 pt: 100,000 - 1,000 = $648.60 (PVAF100,000 - 1,000 = $648.60 (PVAFi/12,360i/12,360) ) i = 6.85%i = 6.85%

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Calculating The APR Calculating The APR Cont.Cont.

6.50% & 2.875 pts: 6.50% & 2.875 pts: 100,000-2,875= $632.07 100,000-2,875= $632.07

(PVAF(PVAFi/12,360i/12,360) ) i = 6.78%i = 6.78%

6.25% & 3 pts: 6.25% & 3 pts: 100,000-3,000= 100,000-3,000=

$615.72(PVAF$615.72(PVAFi/12,360i/12,360) ) i = 6.54%i = 6.54%

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Calculating the Calculating the Effective Cost Under Effective Cost Under

Shortened Holding PeriodShortened Holding Period

Assumption: Borrow $100,000 for 30 years, Assumption: Borrow $100,000 for 30 years, monthly payments, hold for five yearsmonthly payments, hold for five years 7% & 0 pts: $100,000 - 0 = 7% & 0 pts: $100,000 - 0 = $665.30 (PVAF$665.30 (PVAFi/12,60i/12,60) + $94,132 (PVF) + $94,132 (PVFi/12,60i/12,60) )

i = 7%i = 7%

6.75% & 1 pt: $100,000 - $1,000 = 6.75% & 1 pt: $100,000 - $1,000 = $648.60 (PVAF$648.60 (PVAFi/12,60i/12,60) + $93,876 (PVF) + $93,876 (PVFi/12,60i/12,60))

i = 6.99%i = 6.99%

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Calculating the Effective Calculating the Effective Cost Under Shortened Cost Under Shortened

Holding PeriodHolding Period 6.50% & 2.875 pts: $100,000 - 2,875 6.50% & 2.875 pts: $100,000 - 2,875

= = $632.07(PVAF$632.07(PVAFi/12,60i/12,60) + $93,611(PVF) + $93,611(PVFi/12,60i/12,60))

i = 7.2%i = 7.2% 6.25% & 3 pts: $100,000 - $3,000 = 6.25% & 3 pts: $100,000 - $3,000 =

$615.72(PVAF$615.72(PVAFi/12,60i/12,60) + $93,337(PVF) + $93,337(PVFi/12,60i/12,60)) i = 6.98%i = 6.98%

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Summary of Effective Summary of Effective CostsCosts

OptionOption APRAPR 5 5 YearsYears 7% & 0 pts7% & 0 pts 7%7% 7%7% 6.75% & 1 pt6.75% & 1 pt 6.85%6.85% 6.99%6.99% 6.50% &2.875 pts6.50% &2.875 pts 6.78%6.78%

7.21%7.21% 6.25% & 3 pts6.25% & 3 pts 6.54%6.54% 6.98%6.98%

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Prepayment PenaltyPrepayment Penalty

Assumptions: Assumptions: $100,000 at 7.5% for 30 $100,000 at 7.5% for 30 years, monthly payments. Five percent years, monthly payments. Five percent prepayment penalty over entire term. Repay prepayment penalty over entire term. Repay at the end of year 5 at the end of year 5

PMT = $699.21PMT = $699.21 BalanceBalanceEOY5 EOY5 == 94,61794,617 Effective cost with no pointsEffective cost with no points

$100,000 - 0 = $699.21(PVAF$100,000 - 0 = $699.21(PVAFi/12,60i/12,60)+)+$94,617(1.05)(PVF$94,617(1.05)(PVFi/12,60i/12,60))

i = 8.28%i = 8.28%

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Fifteen Year MortgageFifteen Year Mortgage

Borrow $100,000 at 7.50% for 15 Borrow $100,000 at 7.50% for 15 years, monthly paymentsyears, monthly payments PMTPMT15 15 == $100,000( MC$100,000( MC7.5,157.5,15) = $927.01) = $927.01 PMTPMT30 30 = $100,000 (MC= $100,000 (MC7.5,307.5,30) = $699.21) = $699.21 Total interest over 15 year termTotal interest over 15 year term

$927.01(180) - $100,000 = $66,862$927.01(180) - $100,000 = $66,862 Total interest over 30 year termTotal interest over 30 year term

$699.21(360) - $100,000=$151,716$699.21(360) - $100,000=$151,716 Difference in Interest PaidDifference in Interest Paid

$151,716 - $66,862 = $84,854 $151,716 - $66,862 = $84,854

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Extra Payment MonthlyExtra Payment Monthly

PMT= $100,000 (MCPMT= $100,000 (MC7.5,307.5,30) = $699.21) = $699.21 $699.21/12= $58.27 Extra Paid Monthly$699.21/12= $58.27 Extra Paid Monthly

New PMT= $699.21 + $58.27 = $757.48New PMT= $699.21 + $58.27 = $757.48 Number of Payments at New Payment Number of Payments at New Payment

AmountAmount $100,000 = $757.48 (PVAF$100,000 = $757.48 (PVAF7.5/12, n7.5/12, n))

n= 279.84, approximately 23 yearsn= 279.84, approximately 23 years Amount SavedAmount Saved

$699.21 ( 80.16) - $58.27 (279.84)$699.21 ( 80.16) - $58.27 (279.84) $56,049 - $16,306 = $39, 743$56,049 - $16,306 = $39, 743

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Extra Payment-Lump Extra Payment-Lump SumSum

PMT= $100,000 ( MCPMT= $100,000 ( MC7.5,307.5,30) = $699.21) = $699.21 $10,000 Extra Paid at the end of year 3$10,000 Extra Paid at the end of year 3 BALBALEOY3EOY3 : : $97,014 $97,014 Minus Extra Payment: Minus Extra Payment: $10,000$10,000

New BalanceNew BalanceEOY3 EOY3 : : $87,014$87,014 Number of Payments Remaining After Extra Number of Payments Remaining After Extra

PaymentPayment $87,014= $699.21 ( PVAF$87,014= $699.21 ( PVAF7.5/12, n7.5/12, n))

n= 241.41n= 241.41

Amount Saved: Amount Saved: $699.21 (82.59) - $10,000= $47,748$699.21 (82.59) - $10,000= $47,748

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Documents

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