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## Lesson 6:

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**Lesson 6:**Basic Features of a Residential Loan**Introduction**• In this lesson we will cover: • how a loan is amortized • length of repayment period • loan-to-value ratio • mortgage insurance and loan guaranty • secondary financing • fixed and adjustable interest rates**Amortization**• Loan amortization refers to how principal and interest are paid to lender during loan term.**Amortization**• Loan amortization refers to how principal and interest are paid to lender during loan term. • Amortized loan • Borrower required to make regular installment payments that include principal and interest.**Amortization**Fully amortized loan • Payments of fully amortized loan are enough to pay off all principal and interest by end of loan term.**Amortization**Fully amortized loan • Payments of fully amortized loan are enough to pay off all principal and interest by end of loan term. • Payments include both principal and interest.**Amortization**Fully amortized loan • Payments of fully amortized loan are enough to pay off all principal and interest by end of loan term. • Payments include both principal and interest. • Every month the interest portion of the payment is smaller.**Amortization**Partially amortized loan • Partially amortized loan requires regular payments of principal and interest.**Amortization**Partially amortized loan • Partially amortized loan requires regular payments of principal and interest. • Payments insufficient to pay off debt by end of loan term.**Amortization**Partially amortized loan • Partially amortized loan requires regular payments of principal and interest. • But payments aren’t enough to pay off debt by end of loan term. • Balloon payment is required to pay remainder of principal.**Amortization**Interest-only loan • Interest-only loan calls for only interest payments during loan term. • At end of term, entire principal amount is due and must be paid off.**Amortization**Interest-only loan • Interest-only loan calls for only interest payments during loan term. • At end of term, entire principal amount is due and must be paid off. • No principal is paid off by monthly payments.**Repayment Period**• Repayment period is number of years borrower has to repay loan.**Repayment Period**• Repayment period is number of years borrower has to repay loan. • Until 1930s, typical repayment period was 5 years, with balloon payment of principal due at end.**Repayment Period**• Repayment period is number of years borrower has to repay loan. • Until 1930s, typical repayment period was 5 years, with balloon payment of principal due at end. • Now, loan terms are generally 30 years, although lenders offer 15-year and 20-year loans.**Repayment Period**• Length of repayment period affects: • amount of monthly payment, and • total amount of interest paid over life of loan.**Repayment Period**Monthly payment amount • Longer repayment period reduces amount of monthly payment. • 30-year loan thus more affordable than 15-year loan.**Repayment Period**Monthly payment amount • Shorter loan term: • higher payment amount • equity builds faster • more difficult to qualify for**Repayment Period**Total interest • Shorter repayment period substantially decreases total amount of interest paid on loan.**Repayment Period**Interest rate • Lenders generally charge lower interest rates for short-term loans.**Advantages of 15-year loan:**• lower interest rate • total interest much less • clear ownership in half the time**Advantages of 15-year loan:**• lower interest rate • total interest much less • clear ownership in half the time • Disadvantages of 15-year loan: • higher monthly payments • tax deduction lost sooner**Repayment Period**20-year loans • 20-year loan is compromise between 15-year and 30-year loan. • Monthly payments are higher than 30-year loan payments.**Amortization and Repayment Period**Fully amortized Partially amortized Balloon payment Interest-only loan Loan term Interest rate 15-year loan 30-year loan 20-year loan**Loan-to-Value Ratio**• Loan-to-value ratio (LTV) expresses relationship between loan amount and value of home being purchased.**Loan-to-Value Ratio**• Loan-to-value ratio (LTV) expresses relationship between loan amount and value of home being purchased. • The higher the LTV ratio, the smaller the downpayment.**Loan-to-Value Ratio**• Loan-to-value ratio (LTV) expresses relationship between loan amount and value of home being purchased. • The higher the LTV ratio, the smaller the downpayment. • Loan with lower LTV is generally less risky than one with high LTV.**Loan-to-Value Ratio**• Lenders use loan-to-value ratios to establish maximum loan amounts. • LTV is key factor in determining what borrower can afford to buy.**Loan-to-Value Ratio**• Lenders use loan-to-value ratios to establish maximum loan amounts. • LTV is key factor in determining what borrower can afford to buy. • Many lenders allow LTVs no higher than 80%.**Loan-to-Value Ratio**• Lenders use loan-to-value ratios to establish maximum loan amounts. • LTV is key factor in determining what borrower can afford to buy. • Many lenders allow LTVs no higher than 80%. • High LTVs help people who don’t have money for large downpayments.**Mortgage Insurance/Loan Guaranty**• Purpose of mortgage insurance or guaranty is to protect lender from foreclosure loss.**Mortgage Insurance/Loan Guaranty**• Purpose of mortgage insurance or guaranty is to protect lender from foreclosure loss. • Also provides incentive for lenders to make loans that would otherwise be too risky.**Mortgage Insurance/Loan Guaranty**Mortgage insurance • Mortgage insurance works like other types of insurance: • policyholder pays premiums, and • insurer provides coverage for certain types of losses.**Mortgage Insurance/Loan Guaranty**Mortgage insurance • Policy protects the lender against losses from borrower default and foreclosure. • Insurer agrees to indemnifylender. • Insurer will make up any deficiency after foreclosure.**Mortgage Insurance/Loan Guaranty**Mortgage insurance • Policy protects the lender against losses from borrower default and foreclosure. • Insurer agrees to indemnifylender. • Insurer will make up any deficiency after foreclosure. • Insurer also underwrites loan.**Mortgage Insurance/Loan Guaranty**Loan guaranty • In loan guaranty, a third party (guarantor) agrees to take on secondary legal responsibility for borrower’s obligation to lender. • Guarantor reimburses lender for losses from borrower default.**Mortgage Insurance/Loan Guaranty**Loan guaranty • Guarantor might be: • private party,**Mortgage Insurance/Loan Guaranty**Loan guaranty • Guarantor might be: • private party, • nonprofit organization,**Mortgage Insurance/Loan Guaranty**Loan guaranty • Guarantor might be: • private party, • nonprofit organization, or • governmental agency.**Mortgage Insurance/Loan Guaranty**Loan guaranty • Guarantor might be: • private party, • nonprofit organization, or • governmental agency. • Guarantor may also underwrite the loan.**Secondary Financing**• Secondary financing • Second loan obtained to pay part of downpayment or closing costs for a home.**Secondary Financing**• Lender making primary loan usually restricts type of secondary financing a borrower can use. • Buyer must qualify for combined payments on both loans.**Secondary Financing**• Lender making primary loan usually restricts type of secondary financing a borrower can use. • Buyer must qualify for combined payments on both loans. • Restrictions intended to minimize risk of default on second loan.**LTV, Insurance or Loan Guaranty**Loan-to-value ratio Mortgage insurance Indemnify Loan guaranty Secondary financing**Fixed or Adjustable Interest Rate**Fixed-rate loan • Fixed-rate mortgage • Interest rate charged on loan remains constant through loan term. • Considered industry standard.**Fixed or Adjustable Interest Rate**Fixed-rate loan • Fixed-rate mortgage • Interest rate charged on loan remains constant through loan term. • Considered industry standard. • When market rates rise or fall, loan rate stays the same.**Fixed or Adjustable Interest Rate**Adjustable-rate loan • Adjustable-rate mortgage • ARM allows lender to adjust loan’s interest rate to reflect changes in cost of money.**Fixed or Adjustable Interest Rate**Adjustable-rate loan • Adjustable-rate mortgage • ARM allows lender to adjust loan’s interest rate to reflect changes in cost of money. • Transfers risk of rate fluctuations to borrower.**Fixed or Adjustable Interest Rate**Adjustable-rate loan • Adjustable-rate mortgage • ARM allows lender to adjust loan’s interest rate to reflect changes in cost of money. • Transfers risk of rate fluctuations to borrower. • Generally lower interest rate than fixed-rate loans.**Fixed or Adjustable Interest Rate**How ARMs work • Borrower’s interest rate first determined by market interest rates at time loan is made.