Chapter 10 (plus 11) Flashcards
What are the four types of residential mortgage loans? Two most popular?
Conventional mortgage loans (POPULAR)
FHA and VA gov. mortgages (POPULAR)
Home equity loans
Reverse mortgages
Conventional mortgage loan
Any loan that’s not a government loan (FHA and VA)
Conforming conventional loan
Form of conforming loan that Meets the requirement for purchase by the GSEs (ex. Fannie Mae and Freddie Mac)
What is typical of a non-conforming loan relative to conforming?
Non-conforming is generally riskier, lower liquidity, higher rate. Ex. subprime mortgages are non-conforming.
Private mortgage insurance (PMI)
Protects lender against loss due to borrower default. Think “deficiency insurance”
When is PMI required and how can this be circumvented?
PMI required when LTV > 80%. Borrowers can piggyback two loans (ex. 80% LTV loan and 15% LTV loan) to avoid paying PMI.
How much of the loan amount will PMI insure and why?
Up to 30%, generally the “top 30%” of the loan amount. This is because the property is collateral and covers the rest.
Mortgage insurance premium (MIP)
Pay down payment on the PMI and then pay monthly.
How long does PMI last?
Until the loan gets down to 80% LTV, then you can cancel PMI. Value = original value at purchase or current market value.
How does PMI differ from piggyback mortgage?
PMI is insuring up to 30% of the loan amount. Second piggyback mortgage (ex. 15% LTV if first is 80% LTV) will have a higher rate and shorter term, but this higher rate is only on 15% of the loan!
FHA mortgage
FHA is a government loan insurance program, gives borrowers who can’t get a conventional loan to receive a loan. FHA loans through PRIVATE sellers.
How much of the loan does FHA insure, and who are they insuring?
FHA insures 100% of loan (cf. PMI 6-30%). It’s impossible for a lender to lose money on an FHA loan.
What is the maximum LTV for an FHA loan?
96.5% LTV
How does an FHA loan differ from a conventional loan in terms of insurance paid?
Conventional: Borrower stops paying MIP once loan reaches 80% LTV.
FHA: Ongoing MIP, more expensive! Upfront premium is added to loan.
Equity = ???
Home value - loan balance
HELOC
Home equity line of credit. It’s open-end and revolving, so it goes up and down like credit card debt.
How do rates for mortgages compare to consumer loans?
Home equity loans have better rates. Home as collateral is very secure!
Reverse mortgage
Convert home equity to income as payments without requiring borrower to sell more. Restricted to 62+ year old.
When is a reverse mortgage paid back?
The earlier date between death and moving out of the house.
What are the two types of reverse mortgages?
Term: Equal monthly payments for fixed period/occupancy. RARE! Ex. $1000 monthly payments for 60 mo. At mo. 61, you won’t receive $1000 but interest will continue to add to loan amt.
Tenure: Equal monthly payments for life/occupancy. Loan amount determined by borrower’s age, int rate, and home val.
FHA’s Home Equity Conversion mortgage
Non-recourse reverse mortgage. Insurance pays any deficiency if balance exceeds value of home at time of repayment. MIP like FHA mortgages, which are expensive!
Interest-only mortgage
Bullet loan! Typically adjustable rate and short term. Common for development/construction.
Interest only amortizing loan
Pay interest-only for some period (ex. 5 years). At the end the loan converts to a fully amortizing LPL.
Hybrid ARM
A loan that adjusts after some fixed period. Fully amortizing over life of loan. Lower rates than fully amortizing LPL.
Define a 5-1 hybrid ARM
Loan is fixed for 5 years. Adjusts 1 time/year thereafter.
Option ARM
Borrowers select from several initial payment options. Arbitrarily low start rate (as low as 1%), rate adjusts monthly. At end of initial period (ex. 5 yrs) or max loan amt (ex. 120% of original loan) it converts to a fully amortizing LPL. HUGE payment increases.
Which type of ARM is negative amortizing?
Subprime loans and Option ARM. Payment caps so negatively amortizes.
What is the only way a negatively amortizing loan would be viable?
If the property appreciates in value faster than the negative amortization. Then borrower could refinance after initial period.
APR
Annual Percentage Rate. A standardized way of stating the REAL costs of a loan (interest + costs)
What’s the flaw with APR?
Assumes that up-front costs are spread over full life of loan. If you only hold a 30-year loan for 7 years, the borrowing rate will be HIGHER than APR.
Net benefit
Benefit - Cost
Benefit: Sum of savings in future interest payments over remaining holding period
Cost: Up-front costs associated with refinancing
Interest rate spread rule
Refinance if spread between old and new rate is greater than 2%. TERRIBLE!
Payback period rule
(Cost of switching. Think upfront) / (total monthly savings between two loans) = payback period. Ex. If cost of switching is $20,000 and total monthly savings is $2000, the payback period is 10 months. If we expect to hold prop longer than 10 months, refinance!
Net benefit rule
Sum of savings over holding - cost
What is the issue with the int rate spread rule, payback period rule, and net benefit rule?
We are paying the cost up-front but enjoying benefits over time. We need to adjust those future cash flows to PV and these methods don’t do that.
Loan underwriting
Determining whether to approve a particular loan for a particular borrower.
What are the three C’s of traditional underwriting
- Collateral. This is the HOUSE, value determined by appraisal.
- Creditworthiness. Determined by FICO score.
- Capacity. Ability to repay, may look at income.
What is the difference between approvals for residential and commercial loans?
For commercial, appraisal will also make thorough estimations of cash flows (CF). Lender gets paid back from CF, so personal financial stability isn’t taken into account.
PITI
Principal, interest, taxes, and insurance. These are the four components of a mortgage payment.
GMI
Gross monthly income.
Housing expense ratio (“front-end”)
= PITI/GMI. Can I pay the mortgage payment with my monthly income?
What is the max housing expense ratio for conventional and FHA loans?
Conventional: 28%
FHA: 31%
Total debt ratio (“back-end”)
= (PITI + LTO) / GMI. LTO is long-term obligations such as child support or car loans.
What is the max total debt ratio for conventional and FHA loans?
Conventional: 36%
FHA: 43%
