chapter 13 loan to value Flashcards
Which one of the following statements is TRUE?
- The loan-to-value constraint is used by lenders to assess the level of income risk, whereas the debt service ratio constraints are used by lenders to assess the level of capital risk.
- Subprime mortgages represent the majority of residential mortgage lending in Canada.
- The mortgage approval procedure for a residential borrower only requires the examination of the borrower’s personal income as the source of funds to make mortgage payments.
- Character, as a part of the five “Cs” of credit, is a subjective opinion based on the borrower’s current employment situation, educational background, business experience, length of time at current residence, etc.
Correct Answer: 4
Option (4) is correct because character, as a part of the five “Cs” of credit, is a subjective opinion based on the borrower’s current employment situation, educational background, business experience, length of time at current residence, etc. Option (1) is incorrect because the loan-to-value constraint is used by lenders to assess the level of capital risk, whereas the debt service ratio constraints are used by lenders to assess the level of income risk. Option (2) is incorrect because prime (not subprime) mortgages represent the majority of residential mortgage lending in Canada. Option (3) is incorrect because the approval procedure for a residential borrower involves examination of the borrower’s income as well as other credit analysis and the appraisal of the home pledged as security against the loan.
Which one of the following statements regarding lending constraints is TRUE?
- For insured mortgage loans, the maximum loan-to-value ratio is set by statute at 80% for federally chartered financial institutions.
- The total debt service ratio does not consider other debt obligations of the borrower.
- A lender’s primary concern is ensuring they receive an above-market yield.
- The gross debt service ratio is usually defined as the ratio of the sum of the annual mortgage payments (principal and interest) and annual real property taxes to annual gross income.
Correct Answer: 4
Option (4) is correct because the gross debt service ratio is usually defined as the ratio of the sum of the annual mortgage payments (principal and interest) and annual real property taxes to annual gross income. Option (1) is incorrect because the maximum loan-to-value ratio is set by statute at 80% for uninsured mortgage loans. With mortgage loan insurance, borrowers may obtain up to 95% as the maximum loan-to-value ratio. Option (2) is incorrect because the total debt service ratio includes other debt obligations of the borrower, e.g., additional financing, car payments, maintenance fees, and credit card payments. Option (3) is incorrect because a lender’s primary concern is default. In order to obtain protection against default, lenders can restrict the loan so that only a specified portion of the borrower’s income will be needed to repay the mortgage debt.
A prospective home buyer has applied for a mortgage loan to finance the purchase of a townhouse listed at $485,000. The market value of the townhouse is $475,000 and the lender has assigned a $472,000 lending value to it. The lender demands a 35% gross debt service ratio and an 80% loan-to-value ratio. The purchaser’s annual income is $90,000, property taxes are $2,200 per annum and, if approved, the loan is to be repaid with monthly payments over 20 years. The interest rate is 5.75% per annum, compounded semi-annually (j2 = 5.75%).
Calculate the maximum loan allowable under the lender’s loan-to-value criterion. Round your final answer to the nearest $100.
- $377,600
- $388,400
- $300,200
- $355,500
Correct Answer: 1
Option (1) is correct because the maximum loan allowable under the loan-to-value ratio is $377,600. The maximum loan under the loan-to-value ratio is 80% of the lending value. With a loan-to-value ratio of 80% and a lending value of $472,000, the maximum loan is $377,600.
0.8 × $472,000 = $377,600
A prospective home buyer has applied for a mortgage loan to finance the purchase of a townhouse listed at $485,000. The market value of the townhouse is $475,000 and the lender has assigned a $472,000 lending value to it. The lender demands a 35% gross debt service ratio and an 80% loan-to-value ratio. The purchaser’s annual income is $90,000, property taxes are $2,200 per annum and, if approved, the loan is to be repaid with monthly payments over 20 years. The interest rate is 5.75% per annum, compounded semi-annually (j2 = 5.75%).
Calculate the size of the monthly payment necessary to fully amortize the maximum loan amount based on the loan-to-value ratio (from the previous question).
- $2,935.51
- $2,636.50
- $2,381.02
- $2,464.22
Correct Answer: 2
Option (2) is correct because the monthly payment is $2,636.50. With a lending value of $377,600, the monthly payment is calculated as follows:
PRESS
DISPLAY
5.75 ⬛ NOM%
5.75
2 ⬛ P/YR
2
⬛ EFF%
5.832656
12 ⬛ P/YR
12
⬛ NOM%
5.682306
377600 PV
377,600
20 × 12 = N
240
0 FV
0
PMT
−2,636.495693
A prospective home buyer has applied for a mortgage loan to finance the purchase of a townhouse listed at $485,000. The market value of the townhouse is $475,000 and the lender has assigned a $472,000 lending value to it. The lender demands a 35% gross debt service ratio and an 80% loan-to-value ratio. The purchaser’s annual income is $90,000, property taxes are $2,200 per annum and, if approved, the loan is to be repaid with monthly payments over 20 years. The interest rate is 5.75% per annum, compounded semi-annually (j2 = 5.75%).
Assume that the monthly payments on the borrower’s loan are agreed to be $2,500. Calculate the minimum level of borrower’s income necessary to support these monthly payments based on the lender’s gross debt service ratio of 35%.
- $92,000
- $75,200
- $85,100
- $95,000
Correct Answer: 1
Option (1) is correct because the minimum income required is $92,000. Find the minimum borrower’s income necessary given the monthly payments of $2,500 and annual property taxes of $2,200.
Minimum income = PIT ÷ GDSR
Minimum income = [($2,500 × 12) + $2,200] ÷ 0.35
Minimum income = $32,200 ÷ 0.35
Minimum income = $92,000
A borrower has applied to XYZ Bank for a mortgage loan to finance the purchase of a $1,200,000 home in Vancouver. The bank has supplied the following information:
Lending Value:
$1,200,000
Loan-to-Value Ratio:
80%
Gross Debt Service Ratio:
39%
Amortization Period:
20 years
Payment Terms:
Monthly
Property Taxes:
$5,000 per year
Current mortgage rates are 5% per annum, compounded semi-annually and the government-specified qualifying rate is 5.25% per annum, compounded semi-annually. If the borrower’s annual gross income is $185,000 per year, what is the maximum loan, given the stress test borrower qualification rules for uninsured mortgages. Round your final answer to the nearest dollar.
- $601,730
- $960,000
- $727,382
- $892,116
Correct Answer: 3
Option (3) is correct because the maximum loan is $727,382 under the GDSR.
Loan-to-Value Ratio Constraint
Maximum Loan = Loan-to-Value Ratio × Lending Value
Maximum Loan = 0.80 × $1,200,000 = $960,000
Gross Debt Service Ratio Constraint
→
P + I = (0.39 × $185,000) − $5,000
P + I = $67,150 (annual mortgage payment)
Since the loan states that monthly payments are required:
Maximum monthly mortgage payment = $67,150 ÷ 12 = $5,595.83
The minimum qualifying rate is based on the greater of (1) the government-specified qualifying rate of j2 = 5.25% OR (2) an additional 2% above the mortgage’s negotiated contract rate. In this case, you would apply a rate of j2 = 7% (2% + 5%), which is greater than the government-specified rate of j2 = 5.25%. Monthly payments of $5,595.83 over 20 years at an interest rate of j2 = 7% will repay a loan of $727,382, rounded.
PRESS
DISPLAY
7 ⬛ NOM%
7
2 ⬛ P/YR
2
⬛ EFF%
7.1225
12 ⬛ P/YR
12
⬛ NOM%
6.900047
5595.83 +/− PMT
−5,595.82
20 × 12 = N
240
0 FV
0
PV
727,382.378337
Maximum loan amount using loan-to-value ratio constraint = $960,000
Maximum loan amount using gross debt service ratio constraint = $727,382
The maximum loan is the lesser of the amounts calculated under the loan-to value ratio and the gross debt service ratio, which is $727,382 under the GDSR constraint.
A commercial borrower requires assistance determining the maximum loan that could be granted on Maple Place, a commercial building with a lending value of $4,000,000 and a net operating income of $275,000 per year. The lender, Island Financing, requires a debt coverage ratio of 1.25 and a 65% loan-to-value ratio. The loan will be amortized over 15 years with annual payments at an interest rate of 7% per annum, compounded annually.
What is the maximum loan the borrower could expect to receive under the loan-to-value constraint?
- $2,925,000
- $2,600,000
- $4,000,000
- $3,625,000
Correct Answer: 2
Option (2) is correct because the maximum loan available under the loan‑to‑value constraint is found by taking 65% of the lending value, or 0.65 × $4,000,000 = $2,600,000.
A commercial borrower requires assistance determining the maximum loan that could be granted on Maple Place, a commercial building with a lending value of $4,000,000 and a net operating income of $275,000 per year. The lender, Island Financing, requires a debt coverage ratio of 1.25 and a 65% loan-to-value ratio. The loan will be amortized over 15 years with annual payments at an interest rate of 7% per annum, compounded annually.
What is the maximum loan (rounded to the nearest dollar) the borrower could expect to receive under the income constraint?
- $2,003,741
- $2,504,676
- $2,693,218
- $2,361,232
Correct Answer: 1
Option (1) is correct because the maximum loan under the income constraint is $2,003,741, rounded to the nearest dollar. To calculate the maximum loan under the income constraint, the calculator steps are as follows:
PRESS
DISPLAY
7 I/YR
7
1 ⬛ P/YR
1
275000 ÷ 1.25 =
220,000
+/− PMT
−220,000
15 N
15
0 FV
0
PV
2,003,741.08112
A private lender is initiating a mortgage loan using an interest rate of 6.5% per annum, compounded semi-annually, over a 25-year amortization period, calling for monthly payments. The lender applies a 70% loan-to-value ratio and a 32% gross debt service ratio. A lending value of $275,000 has been assigned to the property. The borrower has an annual gross income of $55,000 and property taxes are $2,000 per annum. Given the above information, determine the down payment required if the purchase price is $275,000 and maximum financing is obtained.
- $75,000
- $193,081
- $154,000
- $82,500
Correct Answer: 4
Option (4) is correct because the down payment required is $82,500. Under the loan-to-value constraint, the maximum loan is $192,500 (0.70 × $275,000). Given a GDSR of 32%, the total allowable annual mortgage and tax payments are $17,600 ($55,000 × 0.32). Subtracting the property taxes gives maximum annual payments of principal and interest of $15,600, or $1,300 per month. Using a monthly payment of $1,300 and an interest rate of j2 = 6.5%, the maximum loan under GDSR is calculated as follows:
PRESS
DISPLAY
6.5 ⬛ NOM%
6.5
2 ⬛ P/YR
2
⬛ EFF%
6.605625
12 ⬛ P/YR
12
⬛ NOM%
6.413688
1300 +/– PMT
–1,300
25 × 12 = N
300
0 FV
0
PV
194,080.895181
The maximum allowable loan is $192,500 (the lesser of the loan-to-value and GDSR constraint). The down payment is determined by subtracting the maximum allowable loan from the required purchase price. The down payment required is $82,500 ($275,000 – $192,500).
