Transcript Slide 1

Adjustable Rate Mortgages
 Definition –
 Characteristics:
 Riskiness Relative to Fixed-rate Mortgages

Index Rate

Rate Resetting Restrictions
 Why Do Borrowers Select ARMS???
 Advantages:
 Disadvantages:
David M. Harrison, Ph.D.
Real Estate Finance
Texas Tech University
ARM Example
 Suppose you are considering an ARM with the
following characteristics:
Mortgage Amount:
 Index:
 Margin:
 Annual Cap:
 Lifetime Cap:
 Discount Points:
 Loan Term:

David M. Harrison, Ph.D.
Real Estate Finance
Texas Tech University
$200,000
1-year Treasury bill yield
2.50%
2.00%
6.00%
2.00
30 Years
ARM Example, cont.
 If the Treasury Bill yield is currently 6%, what is the
monthly payment for the first year?
 If the index moves to 7.50% at the end of the first
year, what is the monthly payment for year 2?
 If the loan is paid off at the end of year 2, what is the
effective cost (yield)?
David M. Harrison, Ph.D.
Real Estate Finance
Texas Tech University
Price-level Adjusted Mortgage (PLAM)
 Definition –
 Role of Inflation
 Complications:


 Potential Problem:
David M. Harrison, Ph.D.
Real Estate Finance
Texas Tech University
PLAM Example
 Consider a PLAM with the following features:
Mortgage Amount:
 Mortgage Term:
 Current Real Rate:
 Inflation for years 1-3:

$90,000
30 years
5%
2%, 3%, and 5%
 Note: Mortgage Payments are adjusted annually

What are the monthly payments for each of the
first 3 years?
David M. Harrison, Ph.D.
Real Estate Finance
Texas Tech University
PLAM Example, cont.

What is the effective cost if the loan is repaid
at the end of year 3?

What is the effective cost if the loan is repaid
at the end of year 3 and the lender charges 2
discount points up front?
David M. Harrison, Ph.D.
Real Estate Finance
Texas Tech University
Shared-Appreciation Mortgage (SAM)
 Definition
 Contingent Interest:

NAV =
 Problems:



David M. Harrison, Ph.D.
Real Estate Finance
Texas Tech University
SAM Example
 Determine the share of appreciation the lender
should receive on the following SAM loan:
Loan-to-value ratio:
 Market rate:
 Rate on loan:
 Lender’s tax bracket:

David M. Harrison, Ph.D.
Real Estate Finance
Texas Tech University
90%
12%
10%
30%
Graduated Payment Mortgage (GPM)
 Definition  Motivation
 Concerns:



David M. Harrison, Ph.D.
Real Estate Finance
Texas Tech University
GPM Example
 Given the following data, determine the first monthly
payment for a graduated payment mortgage:





David M. Harrison, Ph.D.
Real Estate Finance
Texas Tech University
Market Rate = 10%
Real Rate = 3%
Mortgage Amount = $200,000
Maturity = 30 years
Payment growth rate = 7.5% for 5 years
Reverse Annuity Mortgage (RAM)
 Definition –
 Fixed Term vs. Life of Borrower
 Forced Sale?
 Income Stream vs. Insurance Purchase

David M. Harrison, Ph.D.
Real Estate Finance
Texas Tech University
Implications
RAM Example
 Suppose a widow wishes to take out a
reverse annuity mortgage on her house.
What annual payment can she get if she
decides on a $200,000 debt at the end of 10
years and the current rate is 7 percent?
David M. Harrison, Ph.D.
Real Estate Finance
Texas Tech University
Balloon Notes
 Definition –
 Satisfying the Balloon Payment



 Usage



David M. Harrison, Ph.D.
Real Estate Finance
Texas Tech University
Balloon Note Example
 Suppose you wish to purchase a $250,000 house, have
sufficient resources to make a 20% down payment, but have
short-term cash flow concerns. Your lender, recognizing your
long-term creditworthiness offers you the option of a 15-year
balloon loan, in which the payments will be amortized over 30years. Assuming the market rate is 7%, what is your monthly
payment on this balloon loan, and what will be your final, balloon
payment at maturity?
David M. Harrison, Ph.D.
Real Estate Finance
Texas Tech University
Pledged-Account Mortgage
 Suppose upon graduating from college you receive a sizable
gift/signing bonus of $60,000. Being a TTU grad, you also land a
lucrative entry-level position, with the expectation of rapid
advancement through the organization. In order to both put your
money to work and to maximize the home you can purchase, you
decide to undertake a pledged-account (or FLIP) mortgage. The
home you want to buy costs $300,000. You plan to make a 10%
down payment, deposit sufficient cash in a pledged account to lower
your monthly mortgage payments in the early years of the (30-yr.)
loan, and use the remainder to buy something nice (an engagement
ring for your college sweetheart/a new sports car). If the underlying
mortgage rate is 8%, the deposit rate is 5%, and you want your
payments to increase by 4% per year for the next five years, set up
a PAM/FLIP amortization schedule. How much cash can you retain
to spend on something “nice”?
David M. Harrison, Ph.D.
Real Estate Finance
Texas Tech University
PAM/FLIP Example
Year
Beginning
Deposit
Balance
1
2
3
4
5
6-30
David M. Harrison, Ph.D.
Real Estate Finance
Texas Tech University
Reduction
in Principal
Buyer’s
Interest
Ending
Payment
Total
Balance