1. Lecture 5: Front-end Mortgages
by James R. DeLisle, Ph.D. January 19, 2010

2. Lecture Overview Fixed Rate Mortgages Loans CAM CPM Interest Only
Typology of Mortgages
Mortgage Regulations
Mortgage Mechanics: Introduction

3. Introduction to Time Value of Money (TVM)
Definition of TVM
Math of TVM
Core Equation: FV = PV * (1 + r)t
Types: Lump Sum, Annuity
Six Functions of $1
Future Value
FV$; what is FV of current lump?
FVA; what is FV of annuity?
SF; what annuity draw from PV lump?
Present Value
PV$: what is PV of future lump?
PVA; what is PV of FV annuity?
PR; what annuity payment to amortize $lump?

4. Periodic Repayment (PR)
Future
PV$
PR1/P
Interest
Principle
Present
What is the Periodic Payment to amortize $1?

5. Periodic Repayment (PR): Overview
What is the Periodic Payment/Yr that will amortize $1,000 over 5 yr at 7.5%?
$1,000 ?
$247
$200

6. Typology of Residential Mortgages

7. Front-end Mortgage Overview: Part 1
BDM
FRM
PAM
CAM

8. Front-end Mortgage Overview: Part 2
WRAP
PMM

9. Base Case

10. Traditional Mortgage Payment Schedule

11. Traditional Mortgage Amortization Patterns

12. Traditional Mortgage: Prepayment

13. Constant Amortization Mortgage
Advantages
No balloon payment
Declining payments may be appropriate to match declining asset or deflation
Suited for consumer debt on short-lived assets; not common in real estate
Disadvantages
High initial payments
Declining payment pattern independent from property income to service debt
Rapidly declining interest of payments reduces PV of interest tax shield
Rapid paydown of principal reduces leverage faster than many borrowers like
Constantly changing payment obligation difficult to administer and budget

14. CAM Pattern

15. CAM Prepayment

16. Constant Amortization vs. Constant Payment
BI = Borrower’s Income Required

17. Buydown Mortgage (BDM)
Advantages
Increase purchasing power
Allow borrower to purchase at full price
Typically Fixed Rate
Disadvantages
Lower equity investment may reduce “will to pay”
Cooperative Lender and Set-up Fee
Reduced interest deduction for taxes
Step-up payment risk at end of BDM term

18. Buydown: Visual
Principal Balances
Payments

19. Buydown Mortgage: Base Case

20. Mechanics of Buydown

21. Lender Points
BDM Yields
Lender

22. Pledged Account Mortgage (PAM)
Advantages
Increase purchasing power
Single lender
Fixed Rate
Disadvantages
Higher LV ratio triggers PMI
Set-up Fee
Reduced interest deduction for taxes
Step-up payment risk at end of PAM term

23. PAM Visual
Principal Balances
Cash Flows

24. PAM Case

25. Mechanics of PAMs

26. Lender with Points
PAM Yields
Lender

27. WRAP Mortgage: Seller’s Approach
Advantages
Increase access and speed of closing
Lower rate on WRAP vs. new market
Hold price for seller
Provide arbitrage/spread opportunity
Disadvantages
Title not as clearly held by buyer
Seller retains liability
Seller services loan

28. WRAP Part I: Flows
$292,390
$57,561
$276,386
$1878
$ 391
$1416
Excess $71

29. Wrap Visualization

30. Wrap Case

31. WRAP Mechanics

32. WRAP Details

33. WRAP Yields

34. Purchase Money Mortgage: PMM
Advantages
Allow borrower to qualify
Pay more than could afford
Hold price for seller
Quick approvals
Disadvantages
Title not as clearly held by buyer
Seller retains claim
Seller services loan
Buyer may not be able to make step

35. PMM Visual
Principal
Cash Flows

36. PMM Case

37. Mechanics of PMM

38. Seller
PMM Yields
Lender

39. Operating Period Mortgages

40. Lecture Summary Mortgages Types of Loans Mortgage Process
Mortgage Risk Management
Mortgage Concepts
Mortgage Transfer
Foreclosure & Bankruptcy
Types of Loans
Typology of Mortgages
Mortgage Regulations
Mortgage Mechanics: Introduction