Chapter 15 HOW TO PROFIT WITH DISCOUNTED MORTGAGES Flashcards
1
Q
What is the goal of this chapter?
A
To explore the potential profits from purchasing mortgages at a discount.
2
Q
What is a discounted mortgage?
A
A mortgage sold for less than the current amount owed, which includes outstanding principal and unpaid interest.
3
Q
How does purchasing a discounted mortgage benefit the buyer?
A
The buyer receives a greater yield than the original mortgage due to the lower purchase price.
4
Q
In the example with Frank and Bob, what is the face value of Frank’s second mortgage?
A
$50,000.
5
Q
What is the annual payment Bob receives from the mortgage he purchased?
A
$5,000.
6
Q
What yield does Bob earn on his investment in the mortgage?
A
12.5 percent.
7
Q
What is the balloon payment due at the end of the mortgage term?
A
$50,000.
8
Q
What bonus does Bob receive if the mortgage is paid off?
A
$10,000.
9
Q
What is the formula used to calculate the ultimate compounded amount in a mortgage?
A
(1 + i) N × Pv = Ca.
10
Q
What does ‘N’ represent in the mortgage formula?
A
The period of time for which interest is calculated.
11
Q
What does ‘Pv’ stand for in the mortgage formula?
A
The present value or the amount paid for the mortgage.
12
Q
What happens to the yield if the loan is paid off earlier than the due date?
A
The yield increases.
13
Q
What must be considered when calculating interest rates for a mortgage?
A
The number of periods per year and how interest is compounded.
14
Q
What effect does changing the compounding periods have on the interest rate calculation?
A
The interest rate will be adjusted based on how many times per year interest is applied.
15
Q
Fill in the blank: The interest rate of any bonus with no principal reduction during the term will be found using _______.
A
Table C in the Appendix.
16
Q
True or False: The yield Bob receives is based on the original mortgage amount of $50,000.
A
False.
17
Q
What is the relationship between the number of periods (N) and the interest rate (i)?
A
The interest rate must be adjusted according to the number of periods per year.
18
Q
What is the interest rate if compounded semiannually for a 12% annual rate?
A
6%.
19
Q
How many compounding events occur in a 10-year balloon mortgage with quarterly compounding at an 8% annual rate?
A
40 events.
20
Q
What does the term ‘compounding’ refer to in finance?
A
The process of earning interest on previously earned interest.
21
Q
What type of payment structure is described in the example of Frank and Bob’s mortgage?
A
Interest-only payments with a balloon payment.
22
Q
What must be calculated to determine Bob’s total yield from the discounted mortgage?
A
The total yield including interest and the bonus at payoff.
23
Q
What is the compounded amount (Ca) in the example given?
A
$50,000.
24
Q
What is the formula used to calculate the interest rate in the mortgage example?
A
(1 + i) N = Pv / Ca
Here, N is the number of periods, Pv is the present value, and Ca is the cash amount.
25
In the mortgage example, what is the value of N when the mortgage is paid off at the end of six years?
6
26
What is the result of dividing 50,000 by 40,000 in the calculation?
1.25
27
What value is derived from Table C for six periods at 3.75 percent interest?
1.24718
28
What value is derived from Table C for six periods at 4 percent interest?
1.26532
29
What is the estimated interest rate for Bob's investment based on the calculations?
3.8 percent
30
What is the annual return Bob can expect if the mortgage is paid off early?
18.2 percent
31
What does the yield from an investment depend on?
When the payments are made and what percentage of the total are those payments.
32
What happens to the yield when the mortgage is paid off earlier?
The yield increases.
33
What is the total payment received at the end of the first year if $50,000 is lent at 10 percent interest per annum?
$55,000
34
What is the return on investment when equal principal payments plus interest are made?
10 percent per annum
35
What would the first payment be if $500,000 is lent at 10 percent interest over five years with equal principal repayments?
$150,000
36
What is a Zero Coupon Mortgage?
A mortgage where no payments are made until the end of the term.
37
If a borrower pays $1,000,000 at the end of 10 years for a $500,000 loan at 10 percent, what is the average yield?
Less than 10 percent
38
What is the effect of discounting the value of money paid later?
It reduces the effective yield received by the lender.
39
What amount needs to be paid annually at a 6 percent return to reach $500,000 in 10 years?
$36,933.50
40
What does the mortgage document state about the interest rate?
It states a fixed percentage, but the real yield may be lower.
41
What is the conventional type of mortgage used in the United States?
Amortized mortgages with fixed payments of variable interest and principal.
42
How does a constant rate of debt service work?
It combines principal and interest into a fixed payment.
43
What is the maximum cash investment if a borrower has $250,000 at a 75 percent loan-to-value ratio?
$1,000,000
44
What is positive amortization?
Reducing principal with each payment.
45
What is the total debt service rate for a loan of $600,000?
9 percent
## Footnote
This includes the combined interest and principal totals of each payment.
46
What is the annual mortgage payment for a loan of $600,000 at a 9 percent debt service rate?
$54,000
47
Define positive amortization.
Reducing principal every time you make a payment.
48
What are the two choices offered to the seller for the remaining $150,000?
* Second mortgage at 5% for three years, then 5.5% for three years, then 6% for four years, balloon payment after
* Give a lot in Sedona worth $150,000 with a buyback option after five years
49
True or False: Creativity can stimulate a transaction's success.
True
50
What does the seller need to consider when presented with a creative offer?
Whether the offer is acceptable or worth fine-tuning.
51
How does a typical mortgage amortization table function?
Payments remain the same over the life of the mortgage, but the combination of principal and interest changes.
52
What is the constant interest rate for 8 percent interest for a 25-year term?
9.262
53
How do you calculate the total annual payment for a mortgage of $500,000 at 8 percent interest?
Multiply 0.09262 by $500,000 to get $46,310.
54
What is the amount owed at the end of the first year for a $500,000 mortgage after 12 months of payments?
$493,446
55
How much principal is paid off in the first year of a $500,000 mortgage?
$6,554
56
How much interest is paid in the first year of a $500,000 mortgage?
$39,756
57
What factors affect the discounting of a mortgage for cash?
* Need for cash
* Yield obtainable with the cash
* Alternatives like obtaining a loan against the mortgage
58
Define underperforming mortgages.
Mortgages that have not met all their payments and are in default or close to it.
59
What is the significance of the loan-to-value ratio?
It establishes the risk factor when purchasing the mortgage.
60
How does the ranking of mortgages affect their marketability?
A second mortgage is less saleable than a first mortgage; a third mortgage may be more marketable than a first mortgage on another property.
61
What is a creative solution for selling a difficult-to-sell mortgage?
Combine it with other benefits to increase its value.
62
What is the contract rate and monthly payment for the mortgage Castile wants to sell?
* Contract rate: 8 percent
* Monthly payment: $1,528.88
63
What yield does the investor seek when purchasing Castile's mortgage?
10 percent
64
What was the estimated value of the property related to Castile's mortgage?
$600,000
65
What percentage of the total value does the mortgage represent in Castile's example?
17.5 percent
66
How can Castile improve the security on the loan he is selling?
By offering additional collateral.
67
What is one potential reason for a seller's reluctance to hold a third mortgage?
Fear of holding a third position on the property.
68
What is one way Castile could sweeten the deal on a mortgage?
By offering additional collateral to improve security on the loan
## Footnote
Examples of collateral include a second or third position on apartments or other property.
69
What should an investor offer as part of a total transaction when buying property?
Any paper that investor holds, especially if it has a yield less than the expected return on the property being purchased.
70
What was Redding's total equity available to acquire the strip store?
$400,000 (up to $250,000 in cash and a $150,000 first mortgage).
71
What was the asking price for the strip store that Redding wanted to buy?
$1,650,000.
72
What was Redding's initial offer for the strip store?
$1,500,000.
73
What was the second mortgage amount that Shelly agreed to hold in Redding's counter offer?
$150,000.
74
What is the interest rate on the second mortgage that Redding proposed to Shelly?
8 percent.
75
What is the constant payment rate for Redding's second mortgage at day one?
13.846 percent.
76
How long will it take to amortize Redding's second mortgage if the payment is $1,500 per month?
11 years.
77
What is the total annual debt service for a $150,000 mortgage at 10 percent interest over 15 years?
$19,345.
78
What would be the purchase price of a $150,000 mortgage if the buyer demands a 14 percent yield?
$118,476.
79
How is the discounted percentage calculated?
Constant annual percent ÷ Demand rate constant.
80
What is the formula to calculate yield on a mortgage that is offered at a discount?
Constant annual percent ÷ Discounted value percent.
81
What is the yield on a discounted mortgage if the face amount is $50,000 and the discounted sale price is $40,000?
Approximately 11.87 percent.
82
Why will any buyer pay more for a property on terms than in cash?
Because the buyer can earn a greater yield on capital from the property income than the cost of financing.
83
Fill in the blank: The constant for the demand rate at 14 percent for a mortgage term of 15 years is ______.
16.326.
84
What is a factor if the buyer does not have 100 percent cash available for a purchase?
The buyer must consider financing options and assumptions about the benefits of using terms.
85
What are the two major assumptions regarding financing for a buyer?
* The buyer can earn a greater yield on capital from property income than the financing cost.
* The buyer qualifies for financing available either through the market or the seller.
86
What happens if the buyer wants to pay cash for a property?
The discounted mortgage aspect does not apply.
87
How can a seller create a market for a property that is difficult to sell?
By offering reasonable financing options.
88
What was the original asking price for Robinson's 50-acre tract of land?
$1,000,000 ($20,000 per acre).
89
What financing terms did Robinson initially want for his property?
50 percent down and short payout.
90
What price did Robinson agree to reduce his property to in order to move it?
$900,000 ($18,000 per acre).
91
What was the structure of the financing proposed by the broker for Robinson's property?
* 10 percent down payment
* First mortgage of $500,000 at 8 percent, fully amortized
* Second mortgage of $400,000 at 10 percent, interest-only payments
92
What is the monthly payment for the first mortgage in Robinson's financing?
$4,778.33.
93
What is a key provision in the second mortgage for Robinson's property?
The mortgagor must pay off the loan if the property is sold or subdivided.
94
What discount did the broker suggest for the first mortgage to generate cash?
$50,000.
95
What yield did the buyer want for the discounted mortgage?
10.25 percent.
96
How did Sterling determine the selling price for the mortgage?
By using a constant from a table for the required yield.
97
What was the calculated selling price of the mortgage for Sterling to achieve a 10.25 percent yield?
$438,613.63.
98
What is one alternative Sterling could have used to reach his goal of acquiring the 300-acre farm?
Creative financing strategies.
99
What are some sources that will buy discounted mortgages?
* Mortgage brokers
* Trust funds and pension funds
* Private investors
* Real estate brokers
* The mortgagor
100
What is a primary source for discounted mortgages?
Mortgage brokers.
101
Why is establishing rapport with a bank president important?
It can facilitate introductions to key personnel like trust officers.
102
What is the advantage of realty as a security for mortgage investors?
It provides a lower yield at reduced risk.
103
Who may be a prime buyer for a discounted mortgage?
The mortgagor making payments on that mortgage.
104
What was Emory's second mortgage amount?
$45,000.
105
What was the interest rate on Emory's second mortgage?
8.5 percent.
106
What payment reduction did Emory offer the mortgagor to prepay part of the mortgage?
Reducing the interest rate to 6.5 percent.
107
What was the cost to Emory due to the interest rate reduction?
He saved $6,165 over the balance of the term.
108
What should be checked prior to lending or buying existing debt?
The title to ensure no unrecorded mortgages exist.
109
What is an important consideration in the life span of mortgages?
Early retirement of a mortgage boosts yield to the holder.
110
What happens to the yield on a discounted mortgage when it is paid off early?
The yield can be significantly higher in the first year.
111
What should you check before lending or buying existing debt?
The title of the property
## Footnote
It is advisable to let your lawyer handle the title check.
112
Where can you often check the title yourself?
County property records office
## Footnote
Clerks at these offices can help you learn how to check titles.
113
What is a potential opportunity when dealing with mortgages?
A discounted second mortgage behind a low-interest rate first mortgage
## Footnote
Such mortgages can be prime candidates for refinancing.
114
Why might a constant rate be more important than the interest rate for income property?
Because it provides stability despite potential increases in the new interest rate
## Footnote
This is especially true when refinancing.
115
What can affect the motivation of the mortgagor?
Their history of early prepayment
## Footnote
This information is valuable for identifying discounted mortgages.
116
Fill in the blank: The face amount of the mortgage is the ______.
Present balance owed
117
What is the contract rate on a mortgage note?
The interest rate specified in the mortgage agreement
## Footnote
This is typically expressed as a percentage.
118
Fill in the blank: The total annual payment can be calculated as monthly ______.
Payment
119
What is a constant annual percent adjustment?
The adjustment calculated by dividing total annual payment by face amount of mortgage
## Footnote
This is expressed as a percentage.
120
How is the constant at demand rate found?
By looking in the demand rate column for the number of years
## Footnote
The demand rate is shown in the corresponding line.
121
What is the discounted price calculated by?
Multiplying the face amount of the mortgage by the discounted value
## Footnote
This reflects the present value of future cash flows.
