Module 2.2

Question 1

Definition of interest

Answer 1

is a fee or price paid by someone to a lender for the use of borrowed money

Question 2

Definition of simple interest

Answer 2

most basic type of interest and is calculated on a set loan amount over a set period of time. at the end of that time period, the loan amount plus all accrued interest is paid back in one lump sum to clear the debt

Question 3

what is compound interest

Answer 3

when the simple interest accrued over the initial term of a loan is added to the principal, after which interest is charged on the total of both(principal plus interest). compounding is charging interest on the interest

Question 4

What is mortgage interest

Answer 4

special type of compound interest. it is the fee charged by a lender for the use of money loaned for the purpose of owning real property and is typically a % of the total loan amount, charged per year.

Question 5

what is meaning of letters

P- principal
R- rate of interest
T-term
I-amount of interest owing

Question 6

What is fee simple interest formula

Answer 6

I=PxRxT

Question 7

Mortgage interest: nominal rate versus effective annual rate

Answer 7

Mortgage interest is complicated because the compounding frequency and the payment frequency are not the same. Recall that the Fair Trading Act (Note: information about the Fair Trading Act was provided in the Fundamentals course, Unit 5 Session 3) states that interest must be calculated annually or semi-annually and not in advance.

Question 8

Definition of term

Answer 8

Is the length of time for which a particular interest rate and other mortgage details are in place as a contract between a lender and a borrower

Question 9

Amortization period

Answer 9

life of a mortgage loan. Is the length of time over which equal, regularly spaced payments to completely repay a loan are distributed. typically divided up into several separate but consective terms.

Question 10

Repayment schedule

Answer 10

defines the dollar value of each of the borrowers mortgage payments, how often the payments will occur, and for how long. actually related to the amortiz. period, but related to a particular term not several.

Question 11

Prepayment options and penalties

Answer 11

realted to the loans repayment schedule. define when and how much a borrower can pay against the principal of the loan in addition to his or her scheduled repayments and what penalties will apply if he breaks the term or pays out the mortgage early.

Question 12

Down payment and mortgage default insurance

Answer 12

A down payment is a cash payment from a borrower’s own resources, that can as well be gifted or borrowed funds, that is applied toward the purchase price of a property. When the down payment represents more than 20% of the purchase price of the property, it may release the borrower from the requirement to purchase mortgage default insurance depending on the lender submitted through. Mortgage default insurance is an insurance product that protects the lender in the event should the borrower defaults on the loan. Please also reference the definitions for insured and insurable loans.

Question 13

Effect of compounding frequency on interest costs

Answer 13

Changing the frequency of compounding also has an effect on interest over time. As illustrated by the graph below, the more frequently interest is compounded, the higher the dollar amount of interest accrued will be.

Question 14

Effect of compounding frequency on effective annual interest rate

Answer 14

Because it is true that the more frequently interest is compounded, the more interest is accrued, it is also true that the more frequently interest is compounded, the higher the effective annual interest rate will be

Question 15

Effect of term length on interest rate

Answer 15

Longer term mortgages have higher interest rates in order to compensate lenders for the possibility that interest rates may rise during the term, and they will only receive interest at the rate for which the borrower has locked in.

The interest rate is lower on shorter term mortgages because they have to be renewed often, at whatever rates prevail at the time. With a short-term loan, therefore, lenders are less concerned that they will lose out on interest income should interest rates rise during the term.

Question 16

Effect of rate type on interest rate

Answer 16

A fixed-rate mortgage is one with an interest rate that remains constant for the duration of the mortgage term. A variable-rate mortgage is one with an interest rate that fluctuates according to the bank’s prime rate throughout the duration of the mortgage term.

Fixed-rate mortgages generally have higher interest rates than variable-rate mortgages. This is done to compensate lenders for the possibility that interest rates may rise during the term. With a fixed-rate mortgage, the lender stands to lose interest income if interest rates rise during the term while with a variable rate mortgage, the lender benefits when rates rise and the borrower benefits when rates decline.

Question 17

Effect of term type on interest rate

Answer 17

An open-term mortgage is one in which the borrower can pay off a portion or the entire mortgage loan before the end of the term without penalty. A closed-term mortgage is one in which the borrower cannot pay off the mortgage loan before the end of the term without having to pay a penalty.

Open-term mortgages tend to have higher interest rates because lenders cannot predict whether a borrower might suddenly pay off the entire mortgage or lock into a new term and rate. Because the lender stands to lose out on interest income, a higher interest rate helps to compensate for that possibility.

Closed-term mortgages, because they are more restrictive and do not allow for renegotiation without penalties, tend to carry a lower interest rate because the lender can be certain of being compensated for any unexpected loss of interest income through penalties.

Question 18

Effects of extending amortization

Answer 18

Extending the amortization period

lowers monthly payments by giving the borrower more time to pay off the loan; and
significantly increases the amount of interest to be paid over the lifetime of the loan (in fact, increases the effective annual interest rate).
You must be sure to explain the disadvantages in terms of significantly increased interest costs (and increased insurance premiums, if applicable) over the life of the mortgage.

Question 19

Effects of shortening amortization

Answer 19

For borrowers who want to pay off their mortgages faster, shortening the amortization period is an option that results in the following:

larger payments
less interest costs over the lifetime of the loan
The potential downside of this approach is that the borrower will be locked into the new amortization and payment amount until the next renewal, so s/he must be certain that the larger payments are manageable for that length of time.

Question 20

Advantages to changing amortization

Answer 20

Looking at changing the amortization period is useful when your client’s top priority is either

to reduce his or her monthly payment amount; or
to pay off his or her mortgage faster.

Question 21

Benefits vs costs to changing amortization

Answer 21

• can help when a borrower has lost their job, through lower payments.
• for someone with stable or high income, can take advantage of lower interest costs by shortening am.

Question 22

Blended payments (principal plus interest)

Answer 22

• borrower pays the same amount every month, but part of the payment is applied to paying down the principal loan amount and part of the payment is applied to paying down the interest on the principal amount. Also called PI payments or principal plus interest payments.

Question 23

Using an amortization schedule

Answer 23

useful tool that shows each and every mortgage payment for a time period.
- breakdown between the principal and interest for either the term or for the entire am period.

Question 24

what info is required to calculate blended payments

Answer 24

• loan amount
• mortgage term
• interest rate
• amortization period

Question 25

How do mortgage payment frequency differ

Answer 25

• timing for and number of payments per year
• dollar amount (size) of the payments
• Resulting annual paydown of principal

Question 26

Example of payment previliges

Answer 26

• Lump sum payments
• increased or double up payments
• anniversary payments
• paydowns at renewal

Question 27

Effects of prepayment options on amortization and interest costs

Answer 27

• shortening the am period of the loan
• reducing the total amount if interest accrued over the lifetime of the loan (reduces the effective annual interest rate)

Question 28

What is a payout penalty

Answer 28

penalty or fine levied for paying out or breaking a mortgage term before its maturity or renewal date.

Question 29

When to let the borrower know about payout penalties

Answer 29

In circumstances when they will apply, you must inform the borrower of the added cost of the penalty. This may affect their decision about whether or how to fefinance the mortgage. If they stay with the same lender you may be able to bypass the penalty.

Question 30

What 2 ways are payout penalties charged

Answer 30

1. Three Months interest
2. Interest Rate Differential (IRD)

Question 31

Explain three months interest penalty

Answer 31

A payment equal to three months (simple) Interest on the outstanding loan amount

Question 32

Explain Interest rate differential

Answer 32

The Difference between the original interest rate and the rate at the time of payout, calculated over the remainder of the term. The IRD represents the amount of interest that the lender loses as a result of not continuing to receive the contracted interest amount for the term and having to re-invest those funds at a lower current rate.

Question 33

Can you determine the exact payout penalites and what is required to do so

Answer 33

No - can only be estimated
- Will require the outstanding balance of the loan, which only the lender will have . Only lenders calculation can be used.

Question 34

what situations will require payout penalties?

Answer 34

1. Exiting a closed term mortgage
2. Refinancing, or if borrower pays out mortgage early.
3. Restricted mortgages - Some lenders do not allow refinances or early payouts with penalty, know as a bonfide sales clause. Usually associated with deeply discounted mortgages, or sub prime mortgages.
4. Selling one property and buying another - may not receive penalty if staying with same lender but will receive if switching lenders.
5. Borrowing more money - May avoid if buying a higher priced property with same lender, but will pay if new lender.
6. Taking advantage of lower interest rate - Even if you are going with the same lender, exiting the term early for a lower rate will result in penalties as the lender will be losing interest.
7. Claw back penalty (on cashback)- If borrower receives funds in advance from lender for renos, and breaks early, a portion of the cash will have to be repaid.

Question 35

Effects of increasing downpayment

Answer 35

1. reduces loan amount
2. can determine if MDI is necessary
3. Reduces MDI premium
4. Reduces loan pmt and interest costs

Question 36

what is EAR

Answer 36

The effective annual rate (EAR) is the annual rate of interest when compounding occurs more frequently than once a year