California Real Estate Finance Bond, McKenzie, Fesler & Boone Ninth Edition
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Transcript of California Real Estate Finance Bond, McKenzie, Fesler & Boone Ninth Edition
© 2011 Cengage Learning created by Dr. Richard S. Savich.
California Real Estate FinanceBond, McKenzie, Fesler & Boone
Ninth Edition
Chapter 4Adjustable Rate and Other
Alternative Mortgage Instruments
© 2011 Cengage Learning created by Dr. Richard S. Savich.
Objectives After completing this chapter, you should be able
to: Discuss why, under certain market conditions, the fixed
rate mortgage is again popular with some lenders. List and briefly describe the various types of alternative
mortgage instruments. Explain how negative amortization works. Give reason why balloon mortgages are not favored by
consumers. Demonstrate how a reverse annuity mortgage may be
helpful for some older homeowners. Compare the differences between 15-year loans and
biweekly loan payments, and the payments on a standard 30-year loan.
© 2011 Cengage Learning created by Dr. Richard S. Savich.
Outline
Objectives and Rationale Adjustable Rate Mortgages (ARMs) Hybrid Loan Options Balloon Payment Fixed Rate Loans Reverse Annuity Mortgage (RAM) Miscellaneous Alternative Plans Epilogue
© 2011 Cengage Learning created by Dr. Richard S. Savich.
Objectives and Rationale Transfer risk from lender to borrower Tailor loans to the borrower’s financial
circumstances As interest rates on deposits rise, so do
interest rates on mortgages and vice versa Avoids problem of “borrowing short and
lending long” Cal-Vet loan program has been using ARMs
for nearly 90 years
© 2011 Cengage Learning created by Dr. Richard S. Savich.
Purpose of ARMs Qualify for larger loan Lower initial payments Make principal reduction payments
© 2011 Cengage Learning created by Dr. Richard S. Savich.
Adjustable Rate Mortgages (ARMs) (Slide 1 of 3)
Principal and interest payments rise and fall with inflation Lower initial interest rate (teasers) Tied to an “index”
11th District Cost of funds U.S. Treasury bills and securities LIBOR (London Interbank Offered Rate)
Maintain a “margin” (difference between index and rate charged) Rates change every month, quarter, six months or year Caps (ceilings and floors on interest rates per change and for life of
loan) Can lead to negative amortization
Monthly payments cannot cover interest, so difference is added to principal
Until it exceeds 20%, in which case, loan must be recast Notice of payment adjustments Prepayment Penalty Assumability
© 2011 Cengage Learning created by Dr. Richard S. Savich.
Disclosure Requirements for Adjustable Rate Mortgages (ARMs) (Slide 2 of 3)
Index Where found Five year history How interest and margin rates interact How teaser rates can change When rates can change and lead time Negative amortization features Maximum caps
Annual interest increase Total for loan
All in Consumer Handbook on Adjustable Rate Mortgages by Federal Reserve and Federal Home Loan Bank Board
© 2011 Cengage Learning created by Dr. Richard S. Savich.
Adjustable Rate Mortgages (ARMs) (Slide 3 of 3)
Advantages Lower initial interest rates Easier qualifying Initial costs are smaller Ability to qualify for larger
loan Payments come down with
index Easier assumability upon
resale No prepayment penalties Lower interest rates in
early years Ability to make principal
reduction payments Better investment
Disadvantages Income may not rise with
payments Slow market lack of
appreciation Negative amortization Borrower has risk of rising
interest rates
© 2011 Cengage Learning created by Dr. Richard S. Savich.
Hybrid Loan Options Fixed to ARM Two-Step Mortgage
Low interest in beginning Switch to fixed or ARM
ARM to Fixed Charge for conversion Must convert during “window period”
© 2011 Cengage Learning created by Dr. Richard S. Savich.
Balloon Payment Fixed Rate Loans
Balloon mortgage Amortize over 30 years, but due in 5 or 7 years Payment more than double the amount of a
regular installment is a Balloon Usually seller carry back loans during high
interest periods Not popular because of uncertainty of
rollover to new loan Points Interest rates
© 2011 Cengage Learning created by Dr. Richard S. Savich.
Reverse Annuity Mortgage (RAM) (Slide 1 of 4)
Tap equity with no monthly repayments Must be 62 or older Must own free and clear or have low existing
loan Single family dwellings FHA approved condos 1-4 unit apartment buildings Manufactured homes on separate lots
Due and payable Death Sale
© 2011 Cengage Learning created by Dr. Richard S. Savich.
RAM programs (Slide 2 of 4)
Home Equity Conversion Mortgage FHA limits apply ARM loan Tied to 1-year T-bills
Home Keeper Program Fannie Mae limits apply ARM loan Tied to 1-month CD rates
Conventional Programs Not backed by FHA or Fannie Mae No limits
© 2011 Cengage Learning created by Dr. Richard S. Savich.
RAM payment options (Slide 3 of 4)
Term Equal monthly payments for a fixed number of
years Tenure
Equal monthly payments for as long as borrower occupies home
Line of credit option Funds drawn as needed up to max
© 2011 Cengage Learning created by Dr. Richard S. Savich.
RAM basics (Slide 4 of 4)
Borrower pays loan fees, closing costs and monthly servicing fee
Mortgage insurance premiums will be charged Due and payable on death or sale or vacancy Due and payable if vacated for > one year All payments plus interest But not more than value of home If sale price higher than loan, heirs keep balance Must attend education session Funds received are tax free, because this is a loan which
must be repaid
© 2011 Cengage Learning created by Dr. Richard S. Savich.
Miscellaneous Alternative Plans
Fifteen year mortgage Save ¼ to ½% on interest
Biweekly loan payments (26 payments/year) Pay off 1/3 faster
© 2011 Cengage Learning created by Dr. Richard S. Savich.
Epilogue Borrower beware!
© 2011 Cengage Learning created by Dr. Richard S. Savich.
Questions and Comments?