History of Real Estate Finance and the

1
Chapter 4

• History of Real Estate Finance and the
• Fixed-Rate Mortgage

2
Chapter 4Learning Objectives
4-1

• Understand how residential lending evolved from
  the earliest of times through World War II
• Understand the mechanics of the standard
  fixed-rate mortgage

3
History Of Real Estate Finance
4-2

• ROMAN LAW
• Transfer Of Title And Possession Until Repayment
• No Transfer Of Title Or Possession. Lender Could
  Take Title And Possession Under Suspicion Of
  Default
• No Transfer Of Title Or Possession. Lender Could
  Take Title Under Actual Default

4
History Of Real Estate Finance Cont
4-3

• GERMAN LAW
• Gage Is A Deposit Made To Fulfill An Agreement
• Mort Is French For Dead. Real Property (Not
  Transportable) Was A Dead Gage
• In Default The Lender Could Take Title But Could
  Not Look Further For Relief

5
History Of Real Estate Finance Con't
4-4

• ENGLISH LAW
• Concept Of Usury In That Charging Interest Was
  Sinful
• Equitable Right Of Redemption Allowing Borrower
  To Redeem The Property After Default

6
History Of Real Estate Finance Cont
4-5

• U.S. Law Is A Mix Of Roman, German, And English
  Law
• EARLY EXPANSION
• Little Need For Lending
• Some Building Societies Formed To Consolidate
  Funds For Home Buying
• POST-CIVIL WAR
• Increased Mortgage Lending To Finance Westward
  Expansion
• Typical Loan Was Short-term, Interest Only

7
History Of Real Estate Finance Cont
4-6

• 1920s BOOM
• SLs Expanded Rapidly
• Real Estate Prices Rose Rapidly
• 1930s DEPRESSION
• Banking System Collapsed, Money Supply Plummeted
• Short-term, Non-Amortizing Loans Became A Problem
• A Number Of Federal Agencies Created Including
  FSLIC, FHA, And Fannie Mae

8
Fixed-rate Mortgages
4-7

• PRESENT VALUE OF AN ANNUITY
• PVANN (1i)n 1
• (i) (1i)n
• MORTGAGE CONSTANT
• MCi (i) (1i)n
• (1i)n - 1

9
Fixed-rate Mortgages
4-8

• IMPORTANT VARIABLES
• Amount Borrowed
• Contract Interest Rate
• Maturity (Term)
• Outstanding Balance
• Amortization
• Payment
• Financing Costs Including Discount Points
• Annual Percentage Rate (APR)

10
Fixed-rate Mortgages
4-8

• Suppose You Borrow 100,000 _at_ 7.50 For 30 Years,
  Monthly Payments
• What Is Your Monthly Payment To Fully Amortize
  The Loan Over Its Term?

11
Fixed-rate Mortgages
4-9

• PMT AMT. BORROWED (MCi,n)
• PMT 100,000 (MC7.5,30)
• PMT 100,000 x
• (.075/12) (1.075/12)360
  (1.075/12)360 1
• 100,000 (.0069921)
• 699.21

12
Fixed-rate Mortgages
4-10

• LOAN AMORTIZATION
• Payment Consists Of Interest And Repayment Of
  Principal
• AMORTIZATION FOR MONTH ONE
• Payment Is 699.21
• Interest Portion Is 100,000 (.075/12) 625
• Repayment Of Principal Portion Is Remainder,
  699.21 - 625 74.21
• Each Months Interest Is Calculated As The Loan
  Balance At The Beginning Of The Month Times The
  Monthly Interest Rate

13
Fixed-rate Mortgages
4-11

• OUTSTANDING BALANCE
• Present Value Of The Remaining Stream Of Payments
  Discounted At The Contract Rate
• FOR OUR EXAMPLE AT THE EOY 5
• Enter The Payment (699.21)
• Enter The Contract Rate (.075/12)
• Enter The Number Of Remaining Payments (300)
• Solve For Present Value (PV) (94,617)

14
Fixed-rate Mortgages
4-12

• KEYSTROKES FOR PAYMENT CALCULATION
• Enter Amount Borrowed As Negative PV
• Enter The Contract Rate (Adjusted Monthly)
• Enter The Number Of Payments
• Solve For Payment (PMT)
• Caution If Your Calculator Is Set On One
  Payment Per Year, You Must Divide The Interest
  Rate By 12 And Multiply The Years By 12.

15
Fixed-rate Mortgages
4-13

• APR
• The Effective Cost Of The Loan Assuming It Is
  Held For Its Full Term
• Some Items Included In APR Calculation
• Origination Fee, Lender Inspection Fee,
  Assumption Fee, Underwriting Fee, Tax Service
  Fee, Document Prep Fee, Prepaid Interest,
  Mortgage Insurance Premium, Discount Points

16
Fixed-rate Mortgages
4-14
17
Fixed-rate Mortgages
4-15
18
Trade Off Between Contract Rate and Discount
Points
4-16

• Contract Rate
• 7
• 6.75
• 6.50
• 6.25

• Discount Points
• 0
• 1.00
• 2.875
• 3.00

19
Calculating The APR
4-17

• Assumption Borrow 100,000 for 30 years,
  monthly payments
• 7 O pts
• 100,000 - 0 665.30 (PVAFi/12,360) i 7
• 6.75 1 pt
• 100,000 - 1,000 648.60 (PVAFi/12,360)
• i 6.85

20
Calculating The APR Cont.
4-18

• 6.50 2.875 pts
• 100,000-2,875 632.07 (PVAFi/12,360) i 6.78
• 6.25 3 pts
• 100,000-3,000 615.72(PVAFi/12,360) i 6.54

21
Calculating the Effective Cost Under Shortened
Holding Period
4-19

• Assumption Borrow 100,000 for 30 years, monthly
  payments, hold for five years
• 7 0 pts 100,000 - 0
• 665.30 (PVAFi/12,60) 94,132 (PVFi/12,60)
• i 7
• 6.75 1 pt 100,000 - 1,000
• 648.60 (PVAFi/12,60) 93,876 (PVFi/12,60)
• i 6.99

22
Calculating the Effective Cost Under Shortened
Holding Period
4-20

• 6.50 2.875 pts 100,000 - 2,875
• 632.07(PVAFi/12,60) 93,611(PVFi/12,60)
• i 7.2
• 6.25 3 pts 100,000 - 3,000
  615.72(PVAFi/12,60) 93,337(PVFi/12,60)
• i 6.98

23
Summary of Effective Costs
4-21

• Option APR 5 Years
• 7 0 pts 7 7
• 6.75 1 pt 6.85 6.99
• 6.50 2.875 pts 6.78 7.21
• 6.25 3 pts 6.54 6.98

24
Prepayment Penalty
4-22

• Assumptions 100,000 at 7.5 for 30 years,
  monthly payments. Five percent prepayment
  penalty over entire term. Repay at the end of
  year 5
• PMT 699.21
• BalanceEOY5 94,617
• Effective cost with no points
• 100,000 - 0 699.21(PVAFi/12,60)94,617(1.05)(
  PVFi/12,60)
• i 8.28

25
Fifteen Year Mortgage
4-23

• Borrow 100,000 at 7.50 for 15 years, monthly
  payments
• PMT15 100,000( MC7.5,15) 927.01
• PMT30 100,000 (MC7.5,30) 699.21
• Total interest over 15 year term
• 927.01(180) - 100,000 66,862
• Total interest over 30 year term
• 699.21(360) - 100,000151,716
• Difference in Interest Paid
• 151,716 - 66,862 84,854

26
Extra Payment Monthly
4-24

• PMT 100,000 (MC7.5,30) 699.21
• 699.21/12 58.27 Extra Paid Monthly
• New PMT 699.21 58.27 757.48
• Number of Payments at New Payment Amount
• 100,000 757.48 (PVAF7.5/12, n)
• n 279.84, approximately 23 years
• Amount Saved
• 699.21 ( 80.16) - 58.27 (279.84)
• 56,049 - 16,306 39, 743

27
Extra Payment-Lump Sum
4-25

• PMT 100,000 ( MC7.5,30) 699.21
• 10,000 Extra Paid at the end of year 3
• BALEOY3 97,014
• Minus Extra Payment 10,000
• New BalanceEOY3 87,014
• Number of Payments Remaining After Extra Payment
• 87,014 699.21 ( PVAF7.5/12, n)
• n 241.41
• Amount Saved
• 699.21 (82.59) - 10,000 47,748