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

2. © 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

3. © 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

4. © 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…

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

6. © 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

7. © 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

8. © 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

9. © 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

10. © 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

11. © 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

12. © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved McGraw-Hill/Irwin Slide 12 Effective Interest Cost Examples Continued Calculator solution –n=360 –PMT= -617.17 –PV= 58,200 –FV= 0 –i=1.034324 (12.41% annualized)

13. © 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)

14. © 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%

15. © 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 $1220.44