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Types of Mortgages
Types of Collateral:
Residential
1 to 4 family homes (up to 4 units)
Commercial
Larger apartments & non-residential
Government Involvement
Government-Insured (FHA, VA)
Conventional
Terminology
Owner begins with "O", so: "...or" ===>
Owner
"Lessor" is Owner (Landlord), "Lessee"
is Renter.
"Mortgagor" is Owner (Borrower),
"Mortgagee" is Lender.
3) Hazard Insurance
Borrower must insure value of the property (at least
up to mortgage amount) against fire, storm, etc.
5) Escrow
Borrower required to pay insurance and property tax
installments to lender in advance, who holds funds in
escrow until due to insurer and property tax authority,
when lender pays these bills for the borrower.
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etc., etc. . . .
Anything the borrower and lender
mutually agree on to include in the
contract.
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More Terminology
Purchase Money Mortgage" vs
Refinancing
"Land Contract"
Title does not pass until contract paid off
Priority of Claims in
Foreclosure
Lien Priority established by Date of Recording,
except:
Property Tax Lien comes first
Sometimes Mechanics Liens
Explicit Subordination Clause
Bankruptcy Proceedings may modify debtholder
rights
Example:
1st Mortgage = $90,000
2nd Mortgage= $20,000
3rd Mortgage = $10,000
Property sells in foreclosure for $100,000:
1st Mortgagee gets $90,000
2nd Mortgagee gets $10,000
3rd Mortgagee gets 0.
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Mortgage Math
What is PV of $1000 per month for 15
months plus $10,000 paid 15 months from
now at 10% nominal annual interest?
$22,875
$1,000
$1,000
1 .10 12
1 .10 12 15
$10,000
1 .10 12 15
= (14.045)1000 + (0.8830)10000
= $14,045 + $8,830
= (PVIFA.00833,15)*PMT + (PVIF.00833,15)*FV
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PMT
PMT
PMT
2
N
1 r 1 r
1 r
FV
1 r
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r = i / m,
i = Nominal annual interest rate
m = Number of payment
periods per year (mP/YR).
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Example:
10%, 20-yr fully-amortizing mortgage with payments
of $1000/month.
The calculator solves the following equation for PV:
0 PV
1000
1000
1000
1.00833 1.00833 2
1.00833 240
1.00833 240
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4) OLB0 = P
Know how to set up these rules in a spreadsheet, so you
can calculate payment schedule, interest, principal,
and outstanding balance after each payment, for any
type of loan that can be dreamed up! (See
schedpmt.xls, downloadable from course web site.)
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4) Fully-Amortizing loans:
Initial contract principal is fully paid off by maturity of
loan:
PPt=P over all t=1,,N.
5) Partially-Amortizing loans:
Loan principal not fully paid down by due date of loan:
PPt<P, so OLBN must be paid as balloon at maturity.
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6) Interest-Only loans:
The principal is not paid down until the end:
PMTt=IEt, all t
(equivalently: OLBt=P, all t, and in calculator equation: FV =
-PV).
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Classical Fixed-Rate
Mortgage
The classical mortgage is both FRM &
CPM:
PMT = P/(PVIFAr,N) = P / [(1 1/(1+r)N )/r]
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BEG.
BAL.
INTEREST
PMT
PRIN
END BAL.
$60,000.
00
$600.00
$617.17
$17.17
$59,982.
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$59,982.
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$599.83
$617.17
$17.34
$59,965.
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$59,965.
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$599.65
$617.17
$17.51
$59,947.
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UsingYourCalculator
1) Calculate Loan Payments:
Example: $100,000 30-year 10% mortgage
with monthly payments:
360----> N
10----> I/YR
100000
----> PV
0 ----> FV
PMT----> - 877.57
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Enter:
I/YR = 10, PV = -58000, PMT = 500, FV = 0,
Compute: N = 410.
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PMT
PMT
PMT
2
N
1 r 1 r
1 r
FV
1 r
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Let:
PV= CF0
PMT= CFt , t=1,2,...,N-1
PMT + FV
= CFN
N= Holding Period
where: CFj represents actual cash flow at
end of period "j".
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CFN
CF1
CF2
2
N
1 r 1 r
1 r
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1 r
FV
1 r
PMT FV
1 r
CFN
1 r N
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Example
$200,000mortgage,30year
maturity,monthlypayments
10%annualinterest
Theloanhas2points
(discountpointsorprepaid
interest)
Alsoa3pointprepayment
penaltythroughendof5thyear.
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Step 1)
360----> N
10----> I/YR
200000 ----> PV
0 ----> FV
PMT----> - 1755.14
Step 2)
48----> N
FV----> - 194804 X 1.03 = - 200,649 ----> FV
196000 ----> PV
Step 3)
I/YR----> 11.22%
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UsingMarketYieldsto
ValueMortgages
(Note: This is performing a DCF NPV
analysis of the loan as an investment,
finding what price can be paid for the
loan so the deal is NPV=0. Markets
required yield is r, the opportunity cost
of capital for the loan.)
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Example
$100,000 mortgage, 30-year, 10%, 3
points prepayment penalty before 5
years.
Expected time until borrower prepays
loan = 4 years.
How much is the loan worth today if the
market yield is 11.00%?
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Step 1)
360--->N,
10--->I/YR,
100000--->PV,
0--->FV,
Compute PMT---> -877.57.
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Step 2)
48--->N,
FV---> -97,402 * 1.03 = -100,324 --->FV.
Step 3)
I/YR---->11.00%.
Step 4)
PV----> 98,697.
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1.30% =
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Yield-Maintenance
Prepayment Penalty
Suppose previously described 30-year,
$100,000, 10% loan is issued with one
discount point up front, but a
prepayment penalty is also specified
calling for a penalty amount such that if
the loan is paid off early the lender must
receive a yield of 12% instead of the
10% contract interest rate.
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Example:
What is MEY equivalent to 10% BEY?
2----> P/YR
10----> I/YR
EFF%----> 10.25
12----> P/YR
NOM%----> 9.80
(1 + .10/2)2 -1 = .1025
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Refinancing
This is essentially a comparison of two loans.
NPV is the evaluation (decision) framework.
OCC (disc.rate, r) = Eff. int. rate in current loan
market (mkt yield).
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2.
3.
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Example of Step 1
Loan refinancing NPV calculation:
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Step 2, including
transaction costs
Suppose there will be $1500 of transaction
costs associated with finding and
obtaining the new mortgage.
(This might include title insurance, appraisal, etc.)
(after Step 2)
(This still lacks consideration of opportunity
cost of giving up refinancing option value.)
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Step 3:
Incorporating option value
The old loan not only contains a negative
value to the borrower represented by the
PV of the future cash outflow liabilities.
It also contains a positive value in the
refinancing option.
(This is a call option on a bond, from the
prepayment clause in the loan, making it
like a callable bond.)
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Step 3 example:
Refinancing
Suppose we believe the following subjective
probability distribution describes what interest
rates (on the new loan) will be like in one
year:
6% with 50% chance;
10% with 50% chance.
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Additional Points
What about the prepayment option value in the
new loan?
The prepayment option value is actually already included in the NPV
evaluation we did in Step 3, at least in an approximate way. Recall that the
NPV in Step 3 is based on the NPV without the option calculated in Step 1
(the +$7,440). Now recall that we used the new loan yield as the opportunity
cost of capital applied to discount the old loan cash flows to arrive at that
Step 1 NPV. In fact, in the mortgage market the new loan interest rate is set
high enough to fully price the new loan prepayment option which the lender
is giving the borrower in the new mortgage, so as to make the new loan a
NPV=0 transaction from the lenders perspective at the time of refinancing.
That is, if the new loan did not have a prepayment option, it would have a
lower interest rate. By applying this callable bond yield rate in Step 1, we
arrive at a lower present value for the remaining old loan cash flows, and
hence a lower NPV from refinancing in Step 1, than we otherwise would if
we were using a non-callable bond yield rate as the opportunity cost of
capital. This difference (very closely) incorporates the value of the new loan
prepayment option, that is, gives us a Step 1 NPV which is already net of
the new loan prepayment option value.
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Purpose:
1)
6) Illiquidity Premium
25%
33%
45%
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Borrower Criteria:
1)
2)
3)
4)
2)
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