19.2 - Mortgage Math III & Real Estate Borrowing - slides Flashcards
(18 cards)
Name the three common types of real-estate borrowing other than taking out a purchase mortgage.
1️⃣ Mortgage refinancing
2️⃣ Home-equity loan (a.k.a. “second mortgage”)
3️⃣ Reverse mortgage
What is mortgage refinancing?
Taking out a new mortgage on the same property to pay off (replace) the existing mortgage.
Primary reasons a homeowner might refinance.
- Lock in a lower interest rate
- Shorten or lengthen the term
- Switch between FRM/ARM
- Cash-out equity
- Consolidate debt.
If you hold a fixed-rate mortgage (FRM) and market rates fall—with no pre-payment penalty—what’s the financial benefit of refinancing?
You can swap the older, more expensive FRM for a new, cheaper one at no cost, instantly lowering the payment stream.
mortgage refinincing
What if you have a FRM, and interest rates fall?
– If you don’t face prepayment penalties, then you can replace the older more expensive mortgage with a newer cheaper one, at no cost.
Define a home-equity loan.
Borrowing against the equity you already own in your home; your house serves as collateral for this second loan.
Why does property appreciation create new, borrowable equity?
The lender’s claim is limited to the outstanding debt. Any increase in market value above the loan balance becomes unencumbered equity you can pledge.
- Lender is only entitled to value of
outstanding debt.
– There is additional equity you can use as
collateral for a loan.
Difference between a closed-end home-equity loan and an open-end line of credit (HELOC).
- Closed-end: one-time lump-sum disbursement, fixed amortization.
- Open-end (HELOC): revolving credit line—borrow, repay, re-borrow like a credit card.
Home equity loans can either be
closed-end loans (i.e. typical lump
sum), or open-end lines of credit
(i.e. like a credit card)
Tax treatment of interest on home-equity loans (U.S.).
In certain situations the interest may be tax-deductible (subject to IRS limits), unlike most consumer debt interest.
Equity-via-appreciation example: Purchased at $500 k with $100 k down. After 1 year home is worth $700 k. Roughly how much equity?
Equity ≈ $300 k ⇒ $700 k (value) – $400 k (outstanding loan) = $300 k.
What does the $300 k in the previous example represent?
Unpledged equity that can be tapped—for example, as collateral for a new home-equity loan.
Equity-via-amortization example: $500 k purchase, $100 k down, after 25 years loan balance is $80 k (no appreciation). What is the owner’s equity?
Equity ≈ $420 k ⇒ $500 k (value) – $80 k (remaining debt).
Key insight from the 25-year amortization example.
Even without price growth, paying down principal builds equity, which can later be borrowed against.
Define a reverse mortgage.
A loan in which the lender makes regular payments to the homeowner, to be repaid (usually in one lump sum) when the home is sold or the borrower moves/dies.
How do cash flows in a reverse mortgage differ from a traditional mortgage?
They are reversed: lender → homeowner (periodic payments) now; homeowner → lender (lump-sum payoff) later.
Why are reverse mortgages popular with retirees?
They let retirees with low cash income but high home equity stay in their house and convert equity to cash without selling.
Economic interpretation of a reverse mortgage.
It’s like gradually selling your home equity back to the lender over time while retaining occupancy rights.
Main risk the lender faces in a reverse mortgage.
Mortality (longevity) risk: if the borrower lives much longer than expected, sale proceeds may not fully repay the accumulated loan balance plus interest.
What secures the lender’s payments in a reverse mortgage?
The home itself—the loan is repaid from sale proceeds when occupancy ends (death, move-out, or sale).
