Final Study Guide
Final RES3200
Dervish Nivokazi
Fixed-Rate Mortgages
• What are the basic characteristics of mortgages that we will study? o Payments and pricing
§ Elements relating to the cost of borrowing o Structure
§ Innovations the payment patterns and allocation of risk and return among borrower and lender
• In a fixed-rate mortgage, the contract rate stated in the mortgage note is fixed for the term of the loan o Even if rates are fixed, payments may vary depending on the type of loan
§ Regular, fully amortizing loans (most common type)
§ Interest-only mortgages
§ Graduated payment mortgages o Mortgage Pricing
§ Lenders require returns sufficient to compensate them for the expected costs and risks associated with mortgage lending ú Components:
• Real interest rate
• Expected inflation
• Risk premium and Interest rates o Time to maturity
§ The yield curive
§ Credit Risk
§ Liquidity
The Cost of Borrowing
• The effective cost of borrowing represents the yield received by the lender including all costs incurred as part of issuing the loan o Borrower cost is the inverse of lender gain
• Does the interest rate on the mortgage reflect the true cost of borrowing? o Points/origination fees
§ Origination fees are payments made to the lender at the time of loan origination in exchange for a lower contract interest rate on the loan
One point is a payment equal to one percent of the outstanding loan balance ú Borrower pays points at origination ú Lender disburses the loan amount, less the value of the origination fee ú The borrower’s payments are based on the full loan amount ú Menu of contract rates versus the points to be paid at closing
• 7% with 0 points
• 6.5% with 2 points
§ Who benefits most from paying points? ú Origination fees are paid at origination, but the benefits accumulate throughout the life of the loan • Borrowers who expect to keep the same loan receive greater benefits from paying
Dervish Nivokazi
Fixed-Rate Mortgages
• What are the basic characteristics of mortgages that we will study? o Payments and pricing
§ Elements relating to the cost of borrowing o Structure
§ Innovations the payment patterns and allocation of risk and return among borrower and lender
• In a fixed-rate mortgage, the contract rate stated in the mortgage note is fixed for the term of the loan o Even if rates are fixed, payments may vary depending on the type of loan
§ Regular, fully amortizing loans (most common type)
§ Interest-only mortgages
§ Graduated payment mortgages o Mortgage Pricing
§ Lenders require returns sufficient to compensate them for the expected costs and risks associated with mortgage lending ú Components:
• Real interest rate
• Expected inflation
• Risk premium and Interest rates o Time to maturity
§ The yield curive
§ Credit Risk
§ Liquidity
The Cost of Borrowing
• The effective cost of borrowing represents the yield received by the lender including all costs incurred as part of issuing the loan o Borrower cost is the inverse of lender gain
• Does the interest rate on the mortgage reflect the true cost of borrowing? o Points/origination fees
§ Origination fees are payments made to the lender at the time of loan origination in exchange for a lower contract interest rate on the loan
One point is a payment equal to one percent of the outstanding loan balance ú Borrower pays points at origination ú Lender disburses the loan amount, less the value of the origination fee ú The borrower’s payments are based on the full loan amount ú Menu of contract rates versus the points to be paid at closing
• 7% with 0 points
• 6.5% with 2 points
§ Who benefits most from paying points? ú Origination fees are paid at origination, but the benefits accumulate throughout the life of the loan • Borrowers who expect to keep the same loan receive greater benefits from paying