Chapter 10 (plus 11)

Question 1

What are the four types of residential mortgage loans? Two most popular?

Answer 1

Conventional mortgage loans (POPULAR)
FHA and VA gov. mortgages (POPULAR)
Home equity loans
Reverse mortgages

Question 2

Conventional mortgage loan

Answer 2

Any loan that’s not a government loan (FHA and VA)

Question 3

Conforming conventional loan

Answer 3

Form of conforming loan that Meets the requirement for purchase by the GSEs (ex. Fannie Mae and Freddie Mac)

Question 4

What is typical of a non-conforming loan relative to conforming?

Answer 4

Non-conforming is generally riskier, lower liquidity, higher rate. Ex. subprime mortgages are non-conforming.

Question 5

Private mortgage insurance (PMI)

Answer 5

Protects lender against loss due to borrower default. Think “deficiency insurance”

Question 6

When is PMI required and how can this be circumvented?

Answer 6

PMI required when LTV > 80%. Borrowers can piggyback two loans (ex. 80% LTV loan and 15% LTV loan) to avoid paying PMI.

Question 7

How much of the loan amount will PMI insure and why?

Answer 7

Up to 30%, generally the “top 30%” of the loan amount. This is because the property is collateral and covers the rest.

Question 8

Mortgage insurance premium (MIP)

Answer 8

Pay down payment on the PMI and then pay monthly.

Question 9

How long does PMI last?

Answer 9

Until the loan gets down to 80% LTV, then you can cancel PMI. Value = original value at purchase or current market value.

Question 10

How does PMI differ from piggyback mortgage?

Answer 10

PMI is insuring up to 30% of the loan amount. Second piggyback mortgage (ex. 15% LTV if first is 80% LTV) will have a higher rate and shorter term, but this higher rate is only on 15% of the loan!

Question 11

FHA mortgage

Answer 11

FHA is a government loan insurance program, gives borrowers who can’t get a conventional loan to receive a loan. FHA loans through PRIVATE sellers.

Question 12

How much of the loan does FHA insure, and who are they insuring?

Answer 12

FHA insures 100% of loan (cf. PMI 6-30%). It’s impossible for a lender to lose money on an FHA loan.

Question 13

What is the maximum LTV for an FHA loan?

Answer 13

96.5% LTV

Question 14

How does an FHA loan differ from a conventional loan in terms of insurance paid?

Answer 14

Conventional: Borrower stops paying MIP once loan reaches 80% LTV.
FHA: Ongoing MIP, more expensive! Upfront premium is added to loan.

Question 15

Equity = ???

Answer 15

Home value - loan balance

Question 16

HELOC

Answer 16

Home equity line of credit. It’s open-end and revolving, so it goes up and down like credit card debt.

Question 17

How do rates for mortgages compare to consumer loans?

Answer 17

Home equity loans have better rates. Home as collateral is very secure!

Question 18

Reverse mortgage

Answer 18

Convert home equity to income as payments without requiring borrower to sell more. Restricted to 62+ year old.

Question 19

When is a reverse mortgage paid back?

Answer 19

The earlier date between death and moving out of the house.

Question 20

What are the two types of reverse mortgages?

Answer 20

Term: Equal monthly payments for fixed period/occupancy. RARE! Ex. $1000 monthly payments for 60 mo. At mo. 61, you won’t receive $1000 but interest will continue to add to loan amt.
Tenure: Equal monthly payments for life/occupancy. Loan amount determined by borrower’s age, int rate, and home val.

Question 21

FHA’s Home Equity Conversion mortgage

Answer 21

Non-recourse reverse mortgage. Insurance pays any deficiency if balance exceeds value of home at time of repayment. MIP like FHA mortgages, which are expensive!

Question 22

Interest-only mortgage

Answer 22

Bullet loan! Typically adjustable rate and short term. Common for development/construction.

Question 23

Interest only amortizing loan

Answer 23

Pay interest-only for some period (ex. 5 years). At the end the loan converts to a fully amortizing LPL.

Question 24

Hybrid ARM

Answer 24

A loan that adjusts after some fixed period. Fully amortizing over life of loan. Lower rates than fully amortizing LPL.

Question 25

Define a 5-1 hybrid ARM

Answer 25

Loan is fixed for 5 years. Adjusts 1 time/year thereafter.

Question 26

Option ARM

Answer 26

Borrowers select from several initial payment options. Arbitrarily low start rate (as low as 1%), rate adjusts monthly. At end of initial period (ex. 5 yrs) or max loan amt (ex. 120% of original loan) it converts to a fully amortizing LPL. HUGE payment increases.

Question 27

Which type of ARM is negative amortizing?

Answer 27

Subprime loans and Option ARM. Payment caps so negatively amortizes.

Question 28

What is the only way a negatively amortizing loan would be viable?

Answer 28

If the property appreciates in value faster than the negative amortization. Then borrower could refinance after initial period.

Question 29

APR

Answer 29

Annual Percentage Rate. A standardized way of stating the REAL costs of a loan (interest + costs)

Question 30

What's the flaw with APR?

Answer 30

Assumes that up-front costs are spread over full life of loan. If you only hold a 30-year loan for 7 years, the borrowing rate will be HIGHER than APR.

Question 31

Net benefit

Answer 31

Benefit - Cost Benefit: Sum of savings in future interest payments over remaining holding period Cost: Up-front costs associated with refinancing

Question 32

Interest rate spread rule

Answer 32

Refinance if spread between old and new rate is greater than 2%. TERRIBLE!

Question 33

Payback period rule

Answer 33

(Cost of switching. Think upfront) / (total monthly savings between two loans) = payback period. Ex. If cost of switching is $20,000 and total monthly savings is $2000, the payback period is 10 months. If we expect to hold prop longer than 10 months, refinance!

Question 34

Net benefit rule

Answer 34

Sum of savings over holding - cost

Question 35

What is the issue with the int rate spread rule, payback period rule, and net benefit rule?

Answer 35

We are paying the cost up-front but enjoying benefits over time. We need to adjust those future cash flows to PV and these methods don't do that.

Question 36

Loan underwriting

Answer 36

Determining whether to approve a particular loan for a particular borrower.

Question 37

What are the three C's of traditional underwriting

Answer 37

1. Collateral. This is the HOUSE, value determined by appraisal. 2. Creditworthiness. Determined by FICO score. 3. Capacity. Ability to repay, may look at income.

Question 38

What is the difference between approvals for residential and commercial loans?

Answer 38

For commercial, appraisal will also make thorough estimations of cash flows (CF). Lender gets paid back from CF, so personal financial stability isn't taken into account.

Question 39

PITI

Answer 39

Principal, interest, taxes, and insurance. These are the four components of a mortgage payment.

Question 40

GMI

Answer 40

Gross monthly income.

Question 41

Housing expense ratio ("front-end")

Answer 41

= PITI/GMI. Can I pay the mortgage payment with my monthly income?

Question 42

What is the max housing expense ratio for conventional and FHA loans?

Answer 42

Conventional: 28% FHA: 31%

Question 43

Total debt ratio (“back-end”)

Answer 43

= (PITI + LTO) / GMI. LTO is long-term obligations such as child support or car loans.

Question 44

What is the max total debt ratio for conventional and FHA loans?

Answer 44

Conventional: 36% FHA: 43%