Chapter 4: Fixed-Rate, ARM, & GPM

Most Common Amortization Types (3)

1. Fixed-rate 2. Adjustable rate mortgages (ARM) 3. Graduated payment mortgages (GPM)

Describe the (5) features of an ARM:

1. Initial Interest Rate and Payment: low introductory rate/payments for starting period (usually 1 month to a few years) 2. Adjustment Period: the period between rate changes (can change every month, year, etc) 3. Index: the measure of interest rates tied to the loan 4. Margin: extra amount the lender adds on top of the index rate 5. Caps: usually a limit for annual changes and lifetime cap for interest rate increases

Eurodollar

A dollar deposited in a bank in a country in which the currency is not the dollar

Purchase Money Loan

A loan that is used to purchase property

Hard Money Loan

A loan used to take cash out of the property by drawing on the equity in the property. Includes home equity loans, HELOCs, and swing loans

Assumable Feature

Allows a borrower to transfer the loan to another borrow if they qualify

Nontraditional Mortgage Product

Anything other than 30-year fixed

Certificate of Deposit Index (CODI)

Average secondary market rates on certificates of deposit. Reacts quickly to changes in the market

Closed-End Loan

Borrower receives all loan proceeds in one lump sum at closing

Convertible ARM

Can be converted to a fixed rate by the borrower at some point during the loan term for a fee

Common Indices For ARMs (5)

Constant Maturity Treasury (CMT) - leading - better for borrower when rates are declining 11th District Cost of Funds Index (COFI) - lagging - better for borrowers when rates are rising London Interbank Offering Rates (LIBOR) Certificate of Deposit Index (CODI) Bank Prime Loan (Prime Rate)

Maturity Date

Date the debt becomes due for payment. For fixed-rate loans, range from 10-40 years

Graduated Payment Mortgage (GPM)

Fixed-rate loan with initial payments lower than later payments. Difference between low initial payment and fully-amortized payment is added to the unpaid principal Good for buyers planning to have more money in the future Each year for 5 years, payments graduate from 7.5-12.5% of the previous year's payment Scheduled negative amortization More expensive to the borrower in the end

Fully Indexed Rate

Index + Margin

Basic Features of an ARM (5)

Initial interest rate and payment adjustment period index margin caps

Types of ARMs (3)

Interest-Only ARM Convertible ARM Payment-Option ARM

11th District Cost of Funds Index (COFI)

Lags behind market, slowest moving index. Used commonly for option ARMs

Straight Loan

Not amortized, borrower only pays periodic interest payments. Principal is due upon maturity

Discount Points

One-time charge paid to lower the interest rate on the loan. 1 point = 1% of loan amount

Ways to classify loans

Purpose: purchase, refinance, cash out Amortization: fixed-rate, ARM, GPM Priority: first, second, etc Occupancy: residence or investment

London Interbank Offering Rate (LIBOR)

Rate charged on eurodollars traded between banks in London. Similar to CMT and less stable than COFI. 6-month LIBOR is most common.

Cash-Out Refinancing

Refinancing the loan for a larger amount than the current loan

Fully Amortized Loan

Repaid fully at maturity by periodic reduction of the principal. Equal payments for the duration of the loan

Partially Amortized Loan

Repayment schedule is not sufficient to pay off the loan over its term, so there is a balloon payment at the end

Refinancing

Replaces the old loan with a new one

Payment Cap

Restricts a payment from increasing more than a certain % above the last year's payment

Interest-Only Fixed-Rate Loans

Short-term fixed-rate loans. Monthly payment usually based off 30-year fully amortizing schedule. Terms usually 3,5,7 years. Lower payments, but does not build equity

Payment Shock

Significant increase in monthly payment

Note Rate

The interest rate on the ARM loan at the time it is funded

Amortization

The liquidation of a financial obligation on an installment basis

Lifetime Cap

The maximum interest rate that may be charged over the life of the loan

Interest-Only ARM (IO)

allows payment of interest only for a set number of years (usually 3-10). After that, must repay principal and interest.

Option ARM

allows the borrower to choose among several payment options each month, which helps manage cash flow. Payments could be minimum payment (often negatively amortizes), 15- or 30-year amortized payment, interest only payment, etc

Recasting

automatic payment adjustment that re-amortizes the loan so it can be paid in full by the end of the term. Common with Option ARMs that negatively amortize. After a recast, the new payment is a fully amortizing payment

Hybrid ARM

combines fixed-rate and adjustable-rate features. Ex. 1: 3/1, 5/1, 7/1, 10/1 ARMs (first number is length of fixed-rate period, second number is how often rate adjusts after initial period) Usually lower initial interest than a fixed-rate loan Ex. 2: 2/28, 3/27 ARMs (first number is length of fixed-rate period, second number is number of years the rates will be adjustable)

What does an amortization schedule show

details each payment, the amount applied to interest and principal, and the remaining principal balance after each payment

Prepayment Penalty

fee charged when loan is paid off early. Usually ~3 years, and penalty is typically 6 months interest on the loan

Negative Amortization

increase in the principal balance when monthly payments are lower than the interest payment

Periodic Adjustment Cap

limits ARM rate changes in a single adjustment period

Teaser Rate

low, short-term introductory rate to entice a borrower to pick a loan and allow them to qualify for a larger loan. Common on Option ARMs

Constant Maturity Treasure (CMT)

most widely used index (~50% of ARMs). Annual rate adjustments, volatile leading index. Good when rates are declining