katie schuberg and lisa shannon mortgage designs
TRANSCRIPT
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KATIE SCHUBERGAND
LISA SHANNON
Mortgage Designs
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Agenda
Fixed Rate Mortgage (FRMs) Two main issues with FRMs
Adjustable Rate Mortgage (ARMs) Interest Only
Balloon/Reset MortgageSub-Prime Mortgage
Subprime Meltdown
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Importance of Understanding Mortgage Designs
97% of houses purchased in 2001 were funded through loans Only 1.6% were purchased using cash As we have seen in recent events different mortgage designs
can cause a dramatic effect on the United States economy! “U.S. foreclosures reached 274,399 in January, the 10th
straight month in which more than a quarter-million filings were processed, RealtyTrac Inc., the Irvine, California-based provider of real estate data, said in a statement yesterday. Foreclosure filings soared to a record last year, surging 81 percent to 2.3 million, as home prices fell and mortgage standards tightened. “ http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aC7x_GWO2
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Fixed Rate Mortgage System
Pay interest and principal in equal installments over a determined period of time.
Most traditional mortgage design; though it is not the most popular.
Was the founding mortgage design; the following mortgages took off from the principals behind the FRM
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Two main issues of Fixed Rate Mortgages
Mismatch Problem Concept of borrowing short and lending long. Interest rate risk: Risk that depository institutions will
misjudge future interest rates and take positions that may create a negative spread when rates change.
Tilt Problem Fixed payments create a greater burden at the
beginning of mortgage.
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Mortgage Design Comparison
Mortgage Type Monthly Payment
Interest Rate Rate Changes Total Interest Paid
Build Equity
30-Year Fixed-Rate Mortgage
Average Average Never changes Average Average
40-Year Fixed-Rate Mortgage
Notably lower Slightly higher Never changes Higher Slower
15-Year Fixed-Rate Mortgage
Notably higher Notably lower Never changes Notably lower Notably faster
5/1 Adjustable-Rate Mortgage (ARM)
Lower for first 5 years, then may change each year
Lower Fixed for the first 5 years (then may change once a year)
Varies depending on interest rates
Average
3/1 ARM Lower for the first 3 years, then may change each year
Notably lower Fixed for the first 3 years (then may change once a year)
Varies depending on interest rates
Average
NET 5® (5/1 Initial Interest-Only Payment) ARM
Notably lower for first 5 years because only interest is required, then may adjust each year
Lower Fixed for the first 5 years (then may change once a year)
Varies depending on interest rates
Does not build equity for the first 5 years
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Adjustable-Rate Mortgage System (ARMs)
Most popular design in the United StatesInterest rates are reset every month, six
months, every year, two years, or longerShifts the interest rate risk from the lender to
the borrower Do not know how the interest rates are going to react
in the markets
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ARMs continued
Interest Rate Caps and Floors Rate Cap
Limits the amount that the interest rate may increase or decrease at the reset date (typically expressed in percentage points).
Rate Floors The lowest amounts charged on the lifetime of the loan
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Adjustable vs. Fixed Mortgages
Fixed Rate MortgageFixed Rate Mortgage
Amount of the loan: $ 250,000
Annual percentage rate of interest: 7%
Number of years: 30 Payment Information:
Your monthly mortgage payment will be: $ 1663.26
Adjustable Rate MortgageAdjustable Rate Mortgage
Per Beg. Bal.
Int. Pmt End Bal.
Int. Rate
1 $250,000
$1042
$1342
$249,700
5.00%
120 $210,468
$1272
$1660
$210,079
7.25%
146 $200,011 $1333
$1754
$199,590
8.00%
198 $175,003 1313 $1864
$174,452
9.00%
294 $100,752 924 $2019
$99,657
11.00%
360 $2032 20 $2053
0 12.00%
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Interest Only Loans
ARM design in where payments are comprised of just interest for the first period of the loan, typically five years.
In that first period no equity is earned besides the initial down-payment.
Enables payments to be notably lower than those of a traditional mortgage design.
Payment comparisonWhat issues can you foresee with a design
like this?
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Additional Mortgage Designs
Primarily deal with the tilt problem of the FRM
Payments account for inflation Graduated-payment mortgage- nominal payments
increase each month for portion of loan and then level off at fixed rate.
Price-level-adjusted mortgage- payments fixed at real rate opposed to nominal rate (price level measured on index)
Dual-rate mortgage- payments start very low then rise at rate of inflation( computed on floating short-term rate)
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Balloon/Reset Mortgages
Borrower is given a long term financing, but at the specified date (which is a while before the actual maturity date of the mortgage) the loan is paid off and the lender agrees to continue financing for the remainder of the term at a new mortgage rate. Lender and borrow figure out re-negotiation
periods at the time the contract is written up At the time of re-negotiation, they decide
what the new interest rates are going to be
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Sub-prime Mortgage System
For people with lower credit ratings (typically below 600)
Do not qualify for conventional design (FRM)These people did qualify for the non-traditional
mortgages Payment option ARMs Interest only mortgages Balloon mortgages
Because: Lenders lessened standards to subprime candidates
High default risk Affordable payments with record-low interest rates
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Sub-prime Meltdown
However, the historical low rates at time of issuance increased throughout the 3 to 5 year period.
Borrowers faced with much higher payments+ high default risk+ housing market depreciation= Sub-prime Meltdown
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Explain why someone would want to choose:
-Fixed rate mortgage-Adjustable rate mortgage-Interest only mortgage-Balloon/reset mortgage