Real Estate Finance Exam 2

Teaser rate

A below-market rate of interest for an initial period of time only on an adjustable rate mortgage.

Reverse annuity mortgage (RAM)

The borrower receives a series of monthly payments and @ the end makes a large cash repayment (rising debt, falling equity) Borrower NEVER owes more than the house is worth, becomes due when the last surviving borrower dies, sells the home, or permanently moves. Loan advances are not taxable, interest is deductible when paid, designed for senior home owners with little to know mortgage debt

11th District Cost of Funds Index

The cost of financial institutions in the 11th district to obtain funds from depositors. An example would be the rate of interest financial institutions pay on one year certificates of deposit.

Life-of-loan rate cap

The maximum rate of interest allowed under the terms of an adjustable rate mortgage.

Margin

The number of basis points a lender adds to an index to determine the contract rate of an adjustable rate mortgage.

Adjustment rate cap

A cap (usually one or two percent) on the change in the interest rate on an adjustable rate mortgage.

Rate cap

A limit on the contract rate of interest (for a particular adjustment period) on an adjustable rate mortgage.

Interest rate caps

A provision in an adjustable rate mortgage that limits the increase in the rate of interest at each anniversary date of the rate change.

Index

A rate of interest, such as a T-bill rate, used to measure periodic interest rate adjustments for an adjustable rate mortgage.

Adjustable-rate mortgage (ARM)

A type of mortgage in which the interest rate adjusts periodically according to a preselected index, such as Treasury Bill rates, and a margin. This adjustment results in the mortgage payment either increasing or decreasing. Solves interest rate risk

London Inter-Bank Offered Rate (LIBOR)

An average of daily lending rates from several major London banks, used as a common international interest rate index. (An index that reflects the rate most major international banks charge each other for large loans)

Negative Amortization

An increase in the loan balance (PV) as a result of payments that are less than the full amount of interest charged (tacks on what you owe to the balance) Usually caps at 110%-125% before the loans payments are automatically changed to fully amortizing

GPM

Designed to offset the tilt effect by lowering the payments on an FRM in early periods (First 5 yrs) and gradually increasing them over time until the PMTs level off for the remainder. Simply rearranges the payments on a FRM so that they are lower @ the beginning and higher @ the end, smooths out the tilt effect like a puzzle piece. Generally experience negative amortization in early years. Eliminating Tilt Effect allows borrowers to qualify for more funds. Most popular amongst first time home buyers, get established with low payments first

Option ARMS

Give you the choice to make varying payments; either a set "minimum payment", interest only payment, 30 yr amortizing PMT, or 15 yr amortizing PMT. You chose, but every 5-10 years the pmt is recast to be fully amortizing which can result in negative amortization or payment shock

Frequency of rate change

How often the rate of interest on an adjustable rate mortgage can change. Longer the time b/w adjustments, the greater the risk to the lender

Cost of Funds Index (COFI)

Index for an adjustable rate mortgage based on the average of interest rates paid by thrifts to their depositors (based on the rate that is paid on savings deposits or their cost of funds because a banks funds comes from its savings deposits) Determined by a federal regulatory agency

SAM

Low initial contract rate w/ inflation premium collected later in a lump sum based on house price appreciation @ sale or through appraisal 15 yrs in. Lender gets a percentage of the appreciation value. Works the same as a PLAM but with no annual adjustments. Lender must decide what share in appreciation will compensate for the reduction in initial interest rate. The greater the reduction in rate, the larger the percentage of appreciation required.

Reverse mortgage

Refers to a mortgage with falling equity, rising debt, in which the lender makes payments to the borrower for a stipulated time.

Regulation and negative amortization

Regulations that address whether a mortgage can incur negative amortization.

Refinancing

Repaying one or more existing mortgage loans by simultaneously borrowing funds through another mortgage loan.

Graduated-payment mortgage (GPM)

Residential mortgage designed to overcome the tilt effect. Monthly mortgage payments that start at a level below that on a FRM and increase at a predetermined rate with later payments above that on a FRM. They may level off at some predetermined point.

Review appraiser/Underwriter

Reviews the appraisal report for acceptability. If its done only in the office (not the field) its called a desk review

PLAM

Solves BOTH the tilt effect and interest rate risk problems of FRMs. Seperates the return to the lender into 1) The real return and 2) compensation for inflation. The inflation is determined after it has ocured usually at the end of the year and is equal to the exact amount. The contract rate is the real rate, about 3%, then the balance (PV) of loan is adjusted annually for the amount of the previous years inflation

Pricing ARMs

The process of determining the effect of value and other factors such as interest rate risk of an ARM by changing one or more of its terms. (The trade off and effect on value of changing one or more terms of a loan) ex. Adding a rate change cap ups the lenders interest rate risk and devalues the loan so the lender will have to charge more discount pts or add basis pts to the margin to maintain an ideal "value"

Fully indexed rate

The rate of interest on an adjustable rate mortgage when no discount or teaser rate applies. Also when the contract rate is equal to the index + the margin

Tilt Effect

When current payments reflect future expected inflation (adjusting payments to compensate for future interest risk) This results in very burdensome payments at the start of the loan and easy ones toward the end