CHAPTER FOURCHAPTER FOUR

FIXED RATE

MORTGAGE LOANS

Chapter ObjectivesChapter Objectives

• Characteristics of constant payment (CPM), constant amortization (CAM), and graduated payment mortgages (GPM)

• Effective cost of borrowing v.s. lenders effective yield

• Calculate discount points or loan origination fees

Determinants of Mortgage Determinants of Mortgage Interest RatesInterest Rates

• Real rate of interest- the required rate at which economic units save rather than consume

• Rate of inflation

• Nominal rate or constant rate i= r+f

• Nominal rate= real rate plus a premium for inflation

Determinants of Mortgage Determinants of Mortgage Interest RatesInterest Rates

• Default risk- creditworthiness of borrowers• Interest rate risk- rate change due to market

conditions and economic conditions• Prepayment risk- falling interest rates• Liquidity risk• i=r+ f+ P…

Development of Mortgage Development of Mortgage Payment PatternsPayment Patterns

• Constant amortization mortgage (CAM)

• Constant payment• Interest computed on the monthly loan

balance• Constant amortization amount• Total payment= constant amortization

amount plus monthly interest

Development of Mortgage Development of Mortgage Payment PatternsPayment Patterns

• Constant payment mortgage (CPM)• Constant monthly payment on original

loan• Fixed rate of interest for a given term• Amount of amortization varies each

month• Completely repaid over the term of the

loan

Development of Mortgage Development of Mortgage Payment PatternsPayment Patterns

• Graduated payment mortgage (GPM)

• Mortgage payments are lower in the initial years of the loan

• GPM payments are gradually increased at predetermined rates

Loan ConstantsLoan Constants

• Used prior to financial calculators

• Loan constant=

annual debt service

original loan balance

Loan Closing Costs and Loan Closing Costs and Effective Borrowing CostsEffective Borrowing Costs

• Statutory costs

• Third party charges

• Additional finance charges i.e. loan discount fees, points

Effective Interest Cost Effective Interest Cost ExamplesExamples

• Contractual loan amount $60,000

• Less organization fee(3%) $ 1,800

• Net cash disbursed by lender $58,200

• Interest rate= 12%

• Term 30 years

Effective Interest Cost Effective Interest Cost Examples ContinuedExamples Continued

• Calculator solution– n=360– PMT= -617.17– PV= 58,200– FV= 0– i=1.034324 (12.41% annualized)

Other Fixed Rate MortgagesOther Fixed Rate Mortgages

• Characteristics and Requirements:

• Regulation Z- truth in lending (APR)

• RESPA- Real Estate Settlement Procedures Act

• Prepayment penalties and other fees

• Reverse annuity mortgages (RAMs)

Reverse Annuity Reverse Annuity Mortgage ExampleMortgage Example

• Residential property value $500,000• Loan amount (to be disbursed

• in monthly installments) $250,000

• Term 10 years 120 months

• Interest Rate 10%

Reverse Annuity Reverse Annuity Mortgage Example ContinuedMortgage Example Continued

• Calculator solution:– FV=-250,000– i=10%/ 12– PMT= ?– n=120– Solve for payment $1220.44