Chapter 19 Residential Real Estate Finance: Mortgage Choices, Pricing and Risks - PowerPoint PPT Presentation

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Chapter 19 Residential Real Estate Finance: Mortgage Choices, Pricing and Risks

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Title: Chapter 19 Residential Real Estate Finance: Mortgage Choices, Pricing and Risks


1
Chapter 19Residential Real Estate Finance
Mortgage Choices, Pricing and Risks
2
Major Topics
  • Primary and secondary mortgage markets
  • FRMs and ARMs
  • Conventional, FHA and VA mortgages
  • The Effect of Points on Mortgage Choice
  • Tax Effects of Mortgage Deductions
  • Mortgage Underwriting Criteria
  • Impact of the Internet on Residential Finance


3
Introduction
  • Home ownership is a national policy in the United
    States
  • Instruments such as the adjustable rate mortgage
    which reduce interest rate risk for lenders and
    increase this risk for borrowers are a common
    alternative to fixed rate loans
  • Another major development impacting the way home
    purchases are financed today is the emergence of
    a dominant secondary market for home mortgage
    loans and the securitization of these loans


4
Residential Financing
  • The fully amortizing fixed rate loan or FRM is
    the most traditional loan format for residential
    mortgages
  • It is characterized by loan payments (usually
    paid monthly) that are constant throughout the
    term of the mortgage
  • The typical loan classifications are conventional
    loans, FHA loans, and VA loans
  • There are also jumbo loans that are based on
    the mortgage limit for secondary market sale to
    Freddie Mac


5
Loan Fees and Costs
  • In addition to the interest charged on the money
    borrowed and any insurance premiums for loan
    guarantees, the financial institution typically
    charges the borrower points, which are prepaid
    interest, and out of pocket costs for
    administrative and third party closing costs
  • Out of pocket costs include the cost of the
    appraisal, credit report, title insurance,
    surveys if required, environmental phase one
    reports if required, and other loan processing
    fees


6
The True Cost of Borrowing
  • The table below compares two loans of 240,000
    where the APR is not the best indicator of the
    best consumer choice if the loan is to be held 5
    years or less
  • The quicker the loan is to be repaid the better
    choice A becomes even though the initial contract
    rate is higher


7
Tax Benefits of Mortgage Interest Rate Deductions
  • One of the key advantages of US home ownership is
    that interest on the mortgage loan is fully tax
    deductible
  • This is one of the remaining few tax shelters
    available to the typical consumer
  • In addition, any points paid in connection with
    the loan may also be tax deductible in the year
    points are paid
  • These tax deductions create a cash benefit to the
    borrower which directly impacts the effective
    borrowing cost


8
Mortgage Buy Downs
  • When mortgage lending environments are
    competitive, lenders offer borrowers many choices
    in terms of points and interest rate combinations
  • Often, the borrower may buy down the interest
    rate by paying lender more points
  • Example What is the max points needed to pay to
    buy down rate to 7.5 on a No points loan _at_ 8.5,
    30 yr amortization. Assume they plan to hold loan
    to maturity


9
Mortgage Buy Down Example
10
Residential Mortgage loan Underwriting
  • Borrower defaults on a loan can occur if the
    borrower may lose the ability to make the
    required loan payments or when a borrower is in a
    negative equity situation
  • Regardless, however, of who bears the risk of
    default, the loan originator must adhere to
    underwriting standards that seek to minimize the
    likelihood of default
  • Underwriting is the lenders process of
    evaluating the borrower and the property offered
    as security for the mortgage to determine the
    transactions level of default and foreclosure
    loss risk

11
Assessing the probability of default
  • There are five major criteria to assess this
  • Income
  • Other Debt Obligations
  • Housing Expenses
  • Credit Evaluation
  • Net Worth

12
Mortgage Buy Downs
  • In evaluating the property, the lender wants to
    determine that the property provides adequate
    security for the debt
  • The value of the security is established by an
    appraisal on the property which includes market
    data on comparable sales
  • Acceptable loan to value ratios for conventional
    loans are typically 75 or 80 for non-insured
    mortgages and up to 95 for private insured
    mortgages
  • In the property evaluation process, the practice
    of redlining is prohibited, i.e. the lender is
    not permitted to make blanket designations of
    geographic areas that are considered to be
    unacceptable loan risks


13
Future of Residential Finance
  • Efficiency and speed of processing loans will
    play a greater role in attracting business in a
    market that is already very thin on margins
  • Loan applications can actually be taken online
    using pre-formatted forms
  • Credit checks can be ordered on line, employment
    verified or financial reports accessed
  • An appraisal can be ordered on line and in some
    cases performed without the need for physical
    inspections using fully computerized data bases,
    geographic information systems or GIS and
    property address electronic photo banks


14
END
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