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Ch. 4: Fixed-Rate Mortgages

Ch. 4: Fixed-Rate Mortgages. Determinants of Mortgage Rates Pure Time-value of money (k) Inflation Premium Default Premium Liquidity Premium Pre-Payment Premium. Development of the mortgage mkt. FHA, VA Constant Amortization Mortgage (CAM) Principal Pmt = Mortgage Amt/No. Pmts.

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Ch. 4: Fixed-Rate Mortgages

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  1. Ch. 4: Fixed-Rate Mortgages • Determinants of Mortgage Rates • Pure Time-value of money (k) • Inflation Premium • Default Premium • Liquidity Premium • Pre-Payment Premium

  2. Development of the mortgage mkt. • FHA, VA • Constant Amortization Mortgage (CAM) • Principal Pmt = Mortgage Amt/No. Pmts. • Interest Pmt = r * Outstanding Balance • Monthly Pmt = Principal + Interest • Pmt is high in early years and falls over time. Principal is paid in a constant dollar amt. over time.

  3. Constant Amortization Mortgage (CAM) Example: $100,000 @7% for 30 yrs. Pmt Payment Principal Interest Ending Bal. 1 $861.11 $277.78 $583.33 $99,722.22 2 $859.49 $277.78 $581.71 $99,444.44 12 $843.29 $277.78 $565.51 $96,666.67 60 $765.51 $277.78 $487.73 $83,333.33 360 $279.40 $277.78 $ 1.62 ($0.00)

  4. Constant Payment Mortgage (CPM) • Determining Monthly Payment PV=100,000; n=360; r=7%/12, FV=0; PMT= $665.30 • Amortization Schedule on HP10B {PMT#} INPUT {Gold Bar} AMORT Push the = sign. • Determining Loan Balance • Loan Pay-Off Schedule

  5. Constant PMT Mortgage (CPM) - Pmt Payment Principal Interest Balance 1 $665.30 $81.97 $583.33 $99,918.03 2 $665.30 $82.44 $582.86 $99,835.59 12 $665.30 $87.38 $577.92 $98,984.22 60 $665.30 $115.52 $549.78 $94,131.77 360 $665.30 $661.42 $3.88 $3.04

  6. Problem 4-1 (page 113) CPM for $125,000, n=240, I=11%/12 PMT = $1,290.24 CAM for $125,000, Prin. Pmt. = 520.83 • Prin=520.83, Int=1,145.83, Pmt=1,666.66 • Prin=520.83, Int=1,141.06, Pmt=1,661.89 • Prin=520.83, Int=1,136.28, Pmt=1,657.11

  7. Points & Fees 1 Point = 1% of the Loan Often Lenders Charge Points on a Loan. For example, 7% + 2 points. On a $100K loan, the borrower must pay 2% * 100K = $2,000 at closing. Sometimes Points are called “origination fees” but the effect is the same.

  8. Calculate the effect of Points on the effective rate: PV = 100,000 - $2,000 PMT = $665.30 FV = 0 n = 360 i = 0.60011/month or 7.2% annual Charging 2 points raises the effective rate by 0.2%

  9. Suppose the loan is repaid in 3 yrs. PV = 100,000 - $2,000 PMT = $665.30 FV = 96,726.96 {balance after 36 mos.} n = 36 i = 0.64672/month or 7.76% annual Charging 2 points raises the effective rate by 0.76%, if the loan is repaid at 3 yrs. The earlier the loan is repaid, the higher the effective rate.

  10. Graduated Payment Mortgage Designed to help young families whose income is expected to grow over time to buy a larger house now. With a GPM the PMT is set below full amortization in the early years. The PMT rises in steps over time. The final payments ends up above full amortization. While the PMT is below full amortization there is negative amortization.

  11. Homework Problems 1- 6, beginning on page 113.

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