Introduction to Real Estate Finance Lecture 13 Introduction to Real Estate Finance

Equity Capital v. Debt Capital Equity Capital: Personal funds, earned value Debt Capital: Borrowed Funds

Equity Capital v. Debt Capital Total Capital, or Purchase Price, or Property Value Equity Capital, or Down Payment, or Equity Interest Debt Capital, or Mortgage Loan, or Loan Balance +

Equity Capital (“Down Payment”) Savings Funds saved for real estate investments/use Unsecured Loan No collateral required Secured Loan Collateral required (stocks, other real estate, cars, etc.) Sweat Equity Non-monetary participation in a real estate property or transaction

Debt Capital Mortgage Mortgagor: Creates debt, promises to repay, gives security instrument to lender Mortgagee: Receives security instrument, accepts borrower’s offer to create and repay financial obligations

Debt Capital: Fixed-Rate Mortgages Mortgage interest rate is common throughout the term of the mortgage Loan maturity date set at loan origination, and does not change during the duration of the loan (unless prepayment occurs) P & I payments remain constant throughout the life of the loan Amortization: Loan is fully repaid at the end of loan duration (no balance due)

Debt Capital: Fixed-Rate Mortgages PRINCIPAL + INTEREST = DEBT SERVICE Key to Amortization: As the loan period moves towards maturity, a greater allocation of the debt service is allocated to principal instead of interest. In other words, you pay less interest on the loan as the loan matures.

FRM: Amortization of Debt Service

FRM: Amortization Calculations EXAMPLE LOAN ASSUMPTIONS: Loan Amount: $100,000 Interest Rate: 8.0% Term to Maturity: 30 Years Monthly Debt Service: $733.76 Frequency of Debt Service: MONTHLY

FRM: Amortization Calculations Step One: Calculate the “debiting factor” for the loan Monthly Debiting Factor = Annual Interest Rate # of Payments/Year For Example: 0.08 / 12 = 0.006666667

FRM: Amortization Calculations Step Two: Determine allocation for Mortgage Interest $100,000 Loan Balance for Month One x 0.0066667 Debiting Factor $ 666.67 Mortgage Interest for Month One

FRM: Amortization Calculations Step Three: Determine allocation for Mortgage Principal $733.76 Monthly Debt Service - $666.67 Mortgage Interest for Month One $ 67.09 Mortgage Principal for Month One

FRM: Amortization Calculations Step Four: Calculate New Loan Balance $100,000 Loan Balance for Month One - $ 67.09 Principal Amortization for Month One $ 99,933 Loan Balance for Month Two

FRM: Amortization Calculations CALCULATE AMORTIZATION ALLOCATIONS FOR MONTH TWO, AND THE NEW LOAN BALANCE FOR MONTH THREE

FRM: Amortization Calculations Step One: Calculate the “debiting factor” for the loan Monthly Debiting Factor = Annual Interest Rate # of Payments/Year For Example: 0.08 / 12 = 0.006666667 REMAINS CONSTANT

FRM: Amortization Calculations Step Two: Determine allocation for Mortgage Interest $ 99,933 Loan Balance for Month Two x 0.0066667 Debiting Factor (remains constant) $ 666.22 Mortgage Interest for Month Two

FRM: Amortization Calculations Step Three: Determine allocation for Mortgage Principal $733.76 Monthly Debt Service - $666.22 Mortgage Interest for Month Two $ 67.57 Mortgage Principal for Month Two

FRM: Amortization Calculations Step Four: Calculate New Loan Balance $ 99,933 Loan Balance for Month Two - $ 67.54 Principal Amortization for Month Two $ 99,865 Loan Balance for Month Three

FRM: Amortization Calculations MONTH ONE MONTH TWO Loan Balance: $100,000 $99,933 Mortgage Interest: $ 666.67 $666.22 Mortgage Principal: $ 67.09 $ 67.54

Amortization Schedule

Legal Issues of Mortgage Loans Lecture 13 Legal Issues of Mortgage Loans

Foreclosure: Title Theory v. Lien Theory States Title Theory: Legal title conveyed to the lender to secure the debt, but the mortgagor (borrower) retains possession and equitable title. Lien Theory: Mortgagor holds the legal and equitable title and gives the lender a lien (claim) against the property. **Florida is a lien theory state**

Loan Assumption and Assignment Assumption: Occurs when a buyer purchases equity in real estate, and takes over (“assumes”) the payments due on a remaining loan balance Qualifying vs. Non-Qualifying Assignment: Occurs when a lender sells a loan to another lender

“Mortgage” v “Promissory Note” Lecture 13 “Mortgage” v “Promissory Note”

Mortgage v. Promissory Note The legal instrument giving the lender the right to sell the real estate if a borrower defaults on the loan. Four Requirements: 1. Competent Parties 2. Consideration 3. Object of the contract is Legal 4. Meeting of the minds (offer/accept.) Serves as evidence of debt and is the borrower’s personal IOU to repay

Optional Types of Loans Lecture 13 Optional Types of Loans

Some Optional Loan Types Blanket Mortgage Used for several parcels of property Release Clause Package Mortgage Loans for both real estate and personal property Open-End Mortgage Provides for future advances of additional funds Used in “Fast Track” construction Seller Financing

Obtaining the Benefits of Lower Interest Rates Lecture 13 Obtaining the Benefits of Lower Interest Rates

Refinancing “Taking out a replacement mortgage at prevailing market interest rates and using at least part of the money from the new loan to repay the current mortgage indebtedness.”

Benefits of Refinancing Lower Interest Rate Lower monthly debt service Lower debt service allows borrowers to decrease loan durations, whereby paying off loan earlier Money to pay off other debts Money for Capital Improvements or other investments

Costs of Refinancing Loan Origination Fees (optional) Credit Report Appraisal Legal Fees Discount Points (optional) These fees can typically be paid in cash or “rolled into” the loan amount

Feasibility of Refinancing Savings in monthly payments w/ new loan Any increases in up-front cash available if new loan is greater than existing Up-front closing costs required Borrower’s income due to associated income tax consequences Investment opportunities available to borrower How long borrower expects to keep the loan Prepayment penalties on existing loan