© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin Slide 1 CHAPTER FOUR FIXED RATE MORTGAGE LOANS

© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin Slide 2 Chapter 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

© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin Slide 3 Determinants of Mortgage Interest 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

© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin Slide 4 Determinants of Mortgage Interest 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…

© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin Slide 5 Exhibit 4-1 to be inserted by McGraw-Hill

© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin Slide 6 Development of Mortgage Payment 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

© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin Slide 7 Development of Mortgage Payment 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

© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin Slide 8 Development of Mortgage Payment Patterns Graduated payment mortgage (GPM) Mortgage payments are lower in the initial years of the loan GPM payments are gradually increased at predetermined rates

© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin Slide 9 Loan Constants Used prior to financial calculators Loan constant= annual debt service original loan balance

© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin Slide 10 Loan Closing Costs and Effective Borrowing Costs Statutory costs Third party charges Additional finance charges i.e. loan discount fees, points

© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin Slide 11 Effective Interest Cost Examples Contractual loan amount $60,000 Less organization fee(3%) $ 1,800 Net cash disbursed by lender $58,200 Interest rate= 12% Term 30 years

© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin Slide 12 Effective Interest Cost Examples Continued Calculator solution –n=360 –PMT= –PV= 58,200 –FV= 0 –i= (12.41% annualized)

© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin Slide 13 Other 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)

© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin Slide 14 Reverse Annuity Mortgage Example Residential property value $500,000 Loan amount (to be disbursed in monthly installments) $250,000 Term 10 years 120 months Interest Rate 10%

© 2005 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin Slide 15 Reverse Annuity Mortgage Example Continued Calculator solution: –FV=-250,000 –i=10%/ 12 –PMT= ? –n=120 –Solve for payment $