chapter 10

suppose you have computed the benefit of refinancing using the ling-archer net benefit approach, and have found a gross benefit (before costs) of $15,000. further, assume that you can deduct for income taxes all the mortgage interest you pay, and that your tax rate on additional income (marginal tax rate) is 25 percent. what is your gross benefit of refinancing after taxes? _____ if the cost of refinancing is $10,000, what is your after tax net benefit? _____

$11,250; $1,250

characteristics of qualified mortgages include:

- ARM loans must be underwritten to highest rate in first five years - term no longer than 30 years - fully amortizing, with level payments - fees no greater than 3 percent

important programs and contributions of FHA include:

- FHA insurance made possible the first long-term level-payment home loan - an important emerging program of FHA is the home equity conversion mortgage (HECM) program for elder homeowners - the main FHA insurance program for home loans is the section 203 program

variations of the I-O mortgage include:

- a standard I-O but with lender's promise to fund pay off in 5-7 years with a fully amortizing loan - a loan that is I-O for 15 years and then converts to fully amortizing level payment for the remaining term

home buyers usually chose to finance their home with substantial mortgage debt. reasons for this include:

- better diversification of assets - lack of sufficient equity funds - opportunity for beneficial financial leverage

if a refinance decision involves replacing multiple loans with an increased first mortgage loan the solution involves:

- compute the difference between all old payments and all revised payments and proceed as with a single loan replacement - for each old loan, compute the reduction in payment with the new interest rate, keeping all other terms as they were - compute the "old" payment as the sum of all the payments to be replaced

reasons why both net benefit and net present value analysis of refinancing tend to overstate actual benefits include:

- cost of personal time and hassle - income tax effect - risk that rates could decline further

most subprime loans were:

- interest only - 2-28 hybrid - option ARM

the option ARM typically allowed the borrower to select among several choices of payments, including:

- interest only payment - fully amortizing payment - minimum payment resulting is significant negative amortization

some factors that affect the premium charged for PMI include:

- loan-to-value ratio - length of loan term - use of property (owner occupied, rental, second home) - borrower's credit record

home equity credit lines can offer homeowners several advantages over other consumer loans, including:

- longer term - lower interest rate - tax deductible interest

originators of mortgage loans include:

- mortgage brokers - savings and loan associations and credit unions - mortgage banking companies - commercial banks

as the loan-to-value (LTV) of a loan is higher the effective interest cost increases. this can result from multiple factors, including:

- required mortgage insurance above 80 percent LTV - higher cost of a "piggyback" second mortgage - higher interest rate on the first mortgage due to higher risk classification

valid aspects of housing assistance programs include:

- state and local housing agencies make low interest loans to qualified households - the federal housing administration insures home loans for qualified borrowers - the USDA rural housing services makes direct home loans to qualified rural households - the veterans administration guarantees home loans for qualified veterans

characteristics of an interest-only mortgage include:

- the full balance must be paid off at maturity - the regular payment is significantly lower than with the level payment mortgage - payments are strictly interest - the interest rate can be fixed or adjustable

attractions of the hybrid mortgage include:

- the lender faces much lower interest rate risk than with a fixed rate loan - the borrower can expect a rate lower than a standard fixed rate since the fixed term is shorter - the borrower has fixed payments during the early, most budget-sensitive years

factors in the population that compel interest in reverse mortgages include:

- the population of elderly homeowners is growing - a large percentage of elderly homeowners own a house outright, but have low income - most elderly homeowners want to stay in their home as long as possible

initially, qualified mortgages include mainly:

- those meeting the requirement specified in the dodd-frank act - all FHA and VA loans - all conforming conventional loans

two conditions that generally appear to be required before a "trigger event" causes home mortgage defaults are:

- value of housing services falling below the monthly cost - negative equity

whether you should conduct refinancing analysis on a before tax basis or after tax basis depends on two considerations in US income tax law. you should use before tax analysis if:

- you use a standard deduction rather than itemizing deductions - you itemize deductions, but your total deductions, including interest, are little more than the standard deduction

ling and archer offer net benefit analysis, a "short cut" approach to refinance analysis. if the result is positive, refinancing may be beneficial. if it is negative, refinancing is not beneficial. what is the order of the steps involved?

1. determine your current loan payment and how many more months you expect to make the payment 2. recompute your loan payment as if it were at the current market interest rate available to you (change only the interest rate on your loan) 3. find the resulting reduction in your payment and multiply the difference by the number of months you expect to retain the loan 4. compute the costs of refinancing 5. find the difference between the sum of payment reductions and the cost of refinancing

private mortgage insurance commonly protects the lender against the first _____ to _____ percent of losses on a mortgage loan due to default.

25; 35

by far, the most important home equity conversion or reverse mortgage program is that of _____.

FHA

the interest rate on a home equity line of credit normally is _____, based on the prime rate as published in the wall street journal.

adjustable

a conventional home mortgage that meets all of the requirements to be purchased by fannie mae or freddie mac is called a _____ conventional mortgage.

conforming

any standard home loan that is not insured or guaranteed by an agency of the US government is a _____ mortgage loan.

conventional

alt-a loans were characterized mainly by high loan-to-value ratio, high interest rate and no _____ of borrower financial circumstances.

documentation

the existence of a well functioning secondary mortgage market makes the primary mortgage market more _____.

efficient

the main risk of a reverse mortgage, called mortality risk, is that the accumulating balance on the loan will _____ the value of the _____.

exceed; property

when a loan is paid off early it can change the effective interest cost of the loan because any upfront expenses are effectively spread over a shorter time span, causing them to equate to a _____ interest charge increment. so earlier the prepayment, the _____ the resulting effective interest cost.

higher; higher

a conventional mortgage loan that meets all the requirements of fannie mae and freddie mac except that it is too large is called a _____ conventional mortgage.

jumbo

in the FHA home equity conversion mortgage (HECM) program FHA commits to the lender that if the balance at sale exceeds the value of the house, FHA will pay the difference to the _____.

lender

the hybrid mortgage is interesting as a solution to a long-standing conflict between home mortgage borrowers and depository lenders. the _____ wants interest rates and payments to adjust as frequently as possible while the _____ wants as much payment predictability as possible.

lender; borrower

loans eligible for purchase by fannie mae and freddie mac are much more _____, resulting in a lower contract _____ _____, and more _____ terms across lenders and regions.

liquid; interest rate; uniform

the maximum guarantee on a VA loan is specified as _____ of the maximum allowable loan purchased by fannie mae or freddie mac.

one fourth

the premium on PMI is some combination of a lump sum payment at loan _____ or _____ installments.

origination; monthly

a second mortgage loan created at purchase along with a first mortgage of no more than 80 percent of value, can provide an alternative to mortgage insurance as a way to increase total financing above 80 percent of value. this kind of mortgage is called a _____ mortgage.

piggyback

subprime and alt-a loans were mostly distinguished not so much by their loan design but by lending _____ and borrower _____.

practices; circumstances

an event that enabled the long maturity and high loan-to-value ratio of modern prime conventional mortgages was the creation after world war II of _____ _____ _____.

private mortgage insurance

the variety of home mortgage loans offered by lenders tends to be those types of loans for which there is a _____ _____.

profitable market

while government agencies generally classify any mortgage that finances a home _____ as a purchase money mortgage, real estate brokers limit the term to any mortgage lien given from a _____ to the _____.

purchase; buyer; seller

with the option ARM, the minimum payment eventually reset to a fully amortizing level to pay off the now enlarged loan. the threat of the payment increase often forced the borrower to count on appreciation of the house and seek _____ to start the cycle over.

refinancing

the qualified mortgage created in the dodd-frank act of 2010 sets an ability-to-_____ standard for most home mortgages. loans meeting the standard receive "safe harbor" protection against legal defenses of the _____ in case of default.

repay; borrower

when interest rates became very volatile in the 1970s main home mortgage lenders, S&Ls and banks, faced a devastating maturity mismatch problem due to _____ term liabilities and _____ term home mortgage assets. they could reduce this problem by changing their mortgage loans to _____ _____ morgages.

short; long; prime rate

two refinance "rules of thumb" commonly offered in the media are a spread rule and a payback rule. between these two rules, the _____ rule is particularly deficient, amounting to an attempt to use a single dimension answer to a multi dimension problem?

spread

the long-term fixed-rate level-payment home mortgage works best in an environment of _____ (stable/unstable) and _____ (high/low) interest rates.

stable; low