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Finance 4713: Class Examples

Electronic Device Policy – DON’T!

Attendance Policy – Expected and rewarded with up to Fifty Extra Credit Points

Homework Policy – Due by 10 AM – lose 2 point per minute it is late until worth

zero. Ten percent bonus if turned in by 10 AM on day after material is covered in class.

Professional Development Minimums:

20 points REFD sponsored Events such as round table or site tour

20 points in Real Estate Related Service (example: Habitat for Humanity)

10 more points (can be more of the above)

Grade Bump – Must complete a 50 point portfolio of above events to qualify. Your

group must be approved via email by Prof. Thomson unless it’s one of the Professional

Real Estate Groups the REFD program partners with, or Investment Society, or Forum of

Finance. Must show you are a member and complete at least 3 events with this group,

and earn 100 points for total portfolio.

Must show proof of attendance at each event. Photo is expected. When a sign in sheet

is available, take a photo of your sign in.

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Course Syllabus Fall 2018

COURSE: FIN 4713 – Mortgage Banking and Real Estate Finance INSTRUCTOR: Dr. Thomas Thomson

OFFICE: BB 4.06.26

OFFICE HOURS: T H 3:45 – 5:15PM and by appointment, except Oct 23 and Nov 27

WWW Homepage: http://faculty.business.utsa.edu/tthomson

EMAIL: thomas.thomson@utsa.edu PHONE: 458-5306

TEXTBOOK Ling, D.C. and W. R. Archer. 2018. Real Estate Principles: A Value Approach, 5th edition.

McGraw Hill. 666 p. (ISBN-13 978-0-07-783636-8) Other readings may also be assigned

as announced in class. An HP 10bII+ is the recommended financial calculator. Any examples shown in class will use this

calculator. If you choose to use another, it is your responsibility to learn to use it.

LEARNING OBJECTIVES

This course provides an overview and analysis of mortgage banking and real estate

finance. Upon completion of this class you should understand the analytical issues of real estate

finance including analysis of types of real estate loans and a broad overview of the secondary

mortgage markets. You should understand how real estate lending is done. You will learn how

to calculate the payments, amount to principal, amount to interest and remaining balances from a

wide variety of mortgages and to measure the return to lender and the cost to borrower. You

should understand the legal environment and the forms and instruments used in real estate

finance. Guest speakers will present the current state of real estate lending.

PREREQUISITES

MGT 3003, FIN 3014,and FIN3433, or consent of instructor

COURSE OUTLINE

Week of Topics Reading (Chapters)

Aug 21 Introduction; Amortization and Calculator use “Handouts”

Aug 28 Mortgage Mechanics “Handouts”

Sep 4 Fixed Rate Mortgages 15

Sep 11 Adjustable Rate Mortgages “Handouts”

Sep 18 Other Mortgages “Handouts”

Sep 25 Real Estate Finance Law 9

Oct 2 Exam 1 N/A

Oct 9 Development Financing 23

Oct 16 Development Financing – Pro forma 23

Oct 23 Commercial RE Mortgages 16

Oct 30 Residential Mortgage Types 10

Nov 6 Exam 2

Nov 13 Secondary Mortgage Markets 11

Nov 20 Mortgage Underwriting – Recent Mortgage Form 11

Nov 27 Guest Speakers N/A

Dec 4 Review (time permitting) N/A

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EVALUATION Your success in this course will be measured using homework, professional development, two

midterm examinations, and a comprehensive final exam. iClicker questions will be posted before and

during class to determine your participation bonus points. With the exception of your financial calculator

and iCliker, this is an electronics free class. Students are not permitted to use a cellphone, tablet, laptop

computer, or similar devices during class. Students using such devices will be docked iClicker bonus

points for that day, and may be asked to leave. Homework will be received as a single pdf or an excel file

for each assignment via Blackboard Learn, and it must be successfully submitted by 10 AM on the day

noted on Blackboard. Homework that is not received by the cutoff time in Blackboard will be docked 2

points per minute until it receives the grade of zero). The course website

(http://faculty.business.utsa.edu/tthomson/Fin4713.htm) and Blackboard Learn provide additional details

for earning a grade bump by participating in an approved professional association. The proposed exam

dates are shown below. If you cannot be present at an exam, you must discuss your situation with the

instructor before the scheduled exam date to determine if a makeup exam will be permitted; otherwise you

will receive a grade of zero for that exam. Any revision announced in class supersedes the schedule below.

The points which will be applied to the exams and other measures are:

Item Points Date Chapters

Homework 150 Ongoing N/A

Participation Bonus 50 Daily N/A

Prof Development 50 Ongoing N/A

Exam 1 175 Oct 2 9,15

Exam 2 175 Nov 6 10, 16, 23

Final Exam 450 Dec 13 (12:30 PM) 9-11, 15, 16, 23

Though subject to a downward revision in cutoff scores (i.e. a “curve”), grades will be assigned to the point

achievements noted in the Table below.

A+ 970-1000 B+ 870-899 C+ 770-799 D+ 670-699

A 930-969 B 830-869 C 730-769 D 630-669

A- 900-929 B- 800-829 C- 700-729 D- 600-629

Exams The proposed exam dates are noted above. The Chapters included on each exam will be announced during

class. In addition to the text materials, exams will test materials covered in class by the instructor and guest

lecturers. Unless revisions are announced in class, the exam dates will be as noted above. The exam

questions will be taken from the end of chapter questions, online quizzes, homework, examples covered in

class, presentations by guest speakers and assigned readings. The Final Exam will be comprehensive. To

each exam bring a financial calculator, No 2 pencil, and a SCANTRON form. All exams and all your

work on exams are the property of the instructor. You are encouraged to review your exams during

office hours.

Student Conduct in Class: Class Attendance: This class follows HOP 5.09 which can be found at:

http://www.utsa.edu/hop/chapter5/5-9.html. Attendance at lecture is expected. All students are expected

to exercise self-discipline and a respect for the rights of others at all times. Students acting in a disruptive

manner will be asked to leave the classroom. All students are expected to uphold the UTSA Creed:

http://www.utsa.edu/about/creed/, and the Student Code of Conduct,

http://www.utsa.edu/infoguide/appendices/b.html. Any student suspected of participating in any academic

dishonesty will be reported to Office of Student Judicial Affairs, and the Instructor will recommend an

automatic F for the course grade. Full details on Common Syllabus Information, which this class adhers to,

is provide at the following link; http://provost.utsa.edu/syllabus.asp

Course Revisions: Any revisions to this syllabus will be announced in class.

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Chapter 15: Introduction to Mortgage Mechanics

Mortgage Interest Rate

Periodic Mortgage Interest Rate

Interest Due

You borrowed $250,000 last month at 5 3/8%. How much interest is due

now?

What is your balance if you make a payment of $1500?

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Mortgage Amortization What is mortgage amortization? For the following interest rates and payment amounts, compute the loan amortization. The note requires a minimum payment of $1800 per month, but the borrower is allowed to pay additional if desired. The note rate (APR) may change each month.

Date Payment APR Int Due (APR/1200

Balt-1)

Principal Paid

(PMT – Int)

Balance (Balt-1 – Print)

Jan 1 0 250,000.00

Feb 1 1800.00 7.000%

Mar 1 2000.00 7.500%

Apr 1 1800.00 9.375%

May 1 1900.00 7.125%

What if the payment and the interest rate are the same each period?

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Solving mortgage problems with a financial calculator

Professor Thomson calculator notation

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Solving for the mortgage payment on a FRM mortgage. What will your loan payment (PMT) be for a $270,000 loan at 6% amortized over a 15 year period

For the previous example, how much principal and how much interest will be paid in the second year? What is your loan balance after 2 years?

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Let’s get some insight from solving a series of problems

Unless stated otherwise, assume mortgage payments are made monthly. 1. Complete the following table, assuming monthly payments.

Interest Rate

Loan Amount

Term (years)

Monthly. Payment

Yr 1 Interest. Amount

Year 1 Principal

Balance after 1 Year.

14% 180000 30

7% 180000 30

3% 180000 30

14% 180000 15

7% 180000 15

3% 180000 15

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2. How much interest will you pay in the 14th year of a $105,000, 5.5%, 20-year mortgage?

3. How much will you pay into principal on a 7 5/8%, $155,000, 15 year mortgage in the final 3 years of the mortgage?

Other ways to solve?

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4. Compute the balance, at 13 3/4 years, on a $125,000, 6.75%, 20 year mortgage.

5. You need a loan of $175,000, but want to pay it off as soon as possible. For a 7.25% rate, and 30-year term, what will your required monthly payment be? If you choose to pay $1675 per month on this loan, how fast will you be able to pay if off?

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6. With a graduated payment mortgage, your initial payments are too low to amortize your loan at the standard rate. Consider a $155,000, 8% interest rate mortgage with a required payment of $800 per month for the first year. How much interest is due in the first month? What will the balance be after the first year? How much will you have paid into interest in the first year?

7. You have acquired a $155,000 mortgage at 6.125%, for 30 years. If you make a quadruple payment on the first anniversary of the mortgage, and then make the required payments from then on, how many fewer mortgage payments will you make than if you just paid your required amount for the life of the loan?

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8. A reset mortgage allows for one interest rate reset during the life of the loan. If you have a 3/17, the mortgage rate will be reset after 3 years, to fully amortize at the end of the original 20 year period (i.e. after 17 more years). For a 6 3/8%, $150,000, mortgage, compute the reset payment if the new rate resets to 8 5/8%.

End of Quiz (i.e. you can now finish HW)

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Example: What will your loan payment (P&I) be for a $270,000 loan at 6% amortized over a 15 year period How much will you pay into principal in the second year? How much will you pay into interest in the second year? What will you loan balance be at the end of the second year?

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FRM Example: You have applied for a $200,000, 30 yr, FRM, at 4.75%, with three points in lender fees. What is your payment?

How much do you pay in principal in the 14th month? How much do you pay in interest in the 14th month? What is your loan balance after your 14th payment? How much do you pay in principal in the 4th year?

How much do you pay in interest in the 4th year? What is your balance after 4 years?

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Lender’s Yield – Holding for term of loan. You have applied for a $200,000, 30-year, FRM, at 4.75%, with three points in lender fees. What is Lender’s Yield? What is a point? How do points affect Lender’s Yield? What is the dollar amount of the points in this example? What are the net loan proceeds? Assuming you keep the loan 360 months, what is the lender’s yield (as an APR)?

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In words, what is the Cost to Borrower or Effective Borrower Cost (EBC)? You have applied for a $200,000, 30-year, FRM, at 4.75%, with three points in lender fees. This loan has 3rd party charges of $1250 and you keep the loan for 30 years? What effective amount of upfront cash do you receive from this loan?

Assuming you keep the loan 360 months, what is the EBC (as an APR)? How does the computation of EBC differ from the Lender’s Yield computation?

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FTLAPR computation for FRM. You have applied for a $200,000, 30-year, FRM, at 4.75%, with three points in lender fees. Note: FTLAPR assumes borrower keeps loan for its entire term.

Must be accurate to 1/8%. What is the FTLAPR (to the closest 1/8%)?

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Lender’s Yield/EBC – Early Payoff You have applied for a $200,000, 30 yr, FRM, at 4.75%, with three points in lender fees and $1250 in 3rd party charges.

Assuming you keep the loan 48 months, what is the lender’s yield (as an APR)? Assuming you keep the loan 48 months, what is your EBC (as an APR)? What is the only input that changes in doing these computations?

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What is a bullet (I/O) loan Bullet (I/O) Loan Example: You are purchasing an apartment building for 10,000,000 and have been approved for a 5-year bullet loan at 4.125% in the amount of 7,000,000?

What is your monthly payment?

How much will you repay at the end of 5 years?

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What is a partially amortizing loan? Partially Amortizing Loan Example: You purchased a small shopping center for $5,000,000 and have obtained a 4.625% loan that amortizes over a 25-year period, with a balloon payment due on after 6 years. The loan amount is 3,000,000

What is your monthly payment? What is amount of your balloon payment?

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Working backward to determine the points a lender must charge to achieve a desired yield. How many points must a lender charge on a 6%, 15-year note to achieve a yield of 6.5%? (Though the loan amount does not matter, assume a $100,000 loan for computations) A. Assume the borrower holds the note for the entire term

B. Assume the borrower holds the note for 3-years

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Example – Effects of points on short term loans: Short term bullet loan with points. You are offered a bullet loan at Prime plus 3 for 6 months, with 3 points. Prime is currently at 4% and we will assume it will remain stable. What is your expected financing cost expressed as an EAR assuming you make monthly interest only payments and you draw the entire line at the start of the loan?

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Example: Hybrid Loan: To buy your dream home you use a 3/12 reset loan that pays interest only (bullet loan) for the first 3 years, followed with a reset payment to amortize over the remaining 12 years. The loan amount is $180,000 at 6.5%, with 3 discount points (to the lender) and $950 in third party closing costs which the borrower must pay.

What net amount does the lender disburse?

What net amount do you as a borrower receive?

What is your monthly payment during the first 3 years?

What is your monthly payment during the remaining 12 years?

What is the FTLAPR on this loan?

What is your balance after 4 years

If you repay this loan after 4 years, what is the effective yield for the lender?

If you repay this loan after 4 years, what is the effective cost to you, the borrower?

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What is a “bankers” year? Loan Payoff Mid-Month: On March 1, 2015 you took out a loan for $180,000 that was a 30-year FRM, with an interest rate of 5.25%. What would your loan payoff be on June 21, 2021?

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ARM Example 1. You are seeking a loan for your $250,000 house and have determined that you would like to choose an ARM because you expect to keep the house for just 3 years. Assume you make a 20% down payment and pay 3 points. You will also incur $1350 in third party closing costs. What are your CF’s, the yield to lender and cost to borrower? What do you pay each year in interest?

Initial rate 3.25% Annual adjustments – Tbill + 2.25% (rounded to 1/8%) No payment or interest rate caps Index, now at 4.21, then changes annually to: 3.67, 6.23, 8.33

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ARM Example 2. You are seeking a loan for your $250,000 house and have determined that you would like to choose an ARM because you expect to keep the house for just 3 years. Assume you make a 20% down payment and pay 2 points. What are your CF’s and the yield to lender? What do you pay each year in interest?

Initial rate 3.5% Annual adjustments – Tbill + 2.75% (rounded to 1/8%) Max change of 2% per year interest rate Max interest of 5% above initial rate Index, now at 4.21, then changes annually to: 3.67, 6.23, 8.33

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Example: Interest Paid during 12 month period

The lowest prior balance on your fixed rate 6% note was $94,000. The current balance, including accrued interest is $96,000 (i.e. there is $2000 of accrued interest currently due on this loan). What amount will you pay in interest over the next 12 months if: Payment is $450 per month

Payment is $550 per month

Payment is $750 per month

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ARM Example 3. You are seeking a loan for your $250,000 house and have determined that you would like to choose an ARM because you expect to keep the house for just 3 years. Assume you make a 20% down payment and pay 1 point. What are your CF’s and the yield to lender? What do you pay each year in interest?

Initial rate 3.75% Annual adjustments – Tbill + 2.75% (rounded to 1/8%) Max payment change of 7.5% per year (negative amortization

allowed) Max interest of rate 6% above initial rate Index, now at 4.21, then changes annually to: 3.67, 6.23, 8.33

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FTLAPR for ARM. How is this computed? A 15-year ARM with 3 points ($100,000 note amount) is offered with an initial interest rate of 3% based on the 1 year Treasury Index that is currently at 5.82. The margin is 275 bp, and the composite rate will be rounded to the closest 1/8%. Annual interest rate cap is 2%, with a 6% lifetime ceiling (increase). What is the FTLAPR?

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What is a Price Level Adjusted Mortgage (PLAM)? Consider a $100,000 loan offered at a 3% real rate of interest over 20 years, with 6 points payable upfront. Payments and loan balance will be adjusted annually. Assuming inflation over then next three years is 18%, 11%, and 15% respectively, what are the loan payments, and final payoff required at the end of year 3? What is the yield to lender?

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What is a Shared Appreciation Mortgage (SAM) Example. You have a building currently valued at $1,200,000 for which you seek a $1,000,000 mortgage (30-year term with 5 year balloon). You are offered a SAM at 7%, where you must also pay the lender 50% of the appreciation after 5 years. For an 8% annual inflation rate for the building, and assuming you hold the building for 5 years, what are your cash flows on the loan. What is the yield to the lender? How does the IRS treat the lump sum payment to the lender?

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Chapter 9 – Real Estate Finance: The Laws and Contracts

Why use a mortgage?

What is a mortgage?

The two instruments

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Payments

Prepayment

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Recourse

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Title v. Lien Theory

Some Important Mortgage (DOT) Clauses

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Default

Non foreclosure remedies to Default

Potential Disadvantages

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Foreclosure

Recourses to the Borrower

Judicial Foreclosure v. Power of Sale

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Bankruptcy

Acquiring Property with existing Debt

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Nonmortgage way to acquire property

Mortgage Regulation

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RESPA – Real Estate Settlement Procedures Act

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Adjustable Rate Mortgages (ARM’s)

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Chapter 23 (Partial – Development Financing)

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Development Finance – Interest calculation A simplified starting example point. Consider the following construction loan with the noted monthly draws. The interest rate (APR) is 6.00%. No payments are made during the construction period. How much interest will be paid on this loan?

Month Draw Amount

Interest Due

EOM Balance

0 0

1 100,000

2 150,000

3 300,000

4 300,000

5 450,000

6 200,000

Totals 1,500,000

What if there were points charged on this loan? Hmm - this looks like a spreadsheet . . . .

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Example: Measuring Leverage Effect via MM equation. You buy a building for $5,000,000 that has an NOI of $400,000. You can sell this building for $5,000,000. What is the IRR from this investment? You can get a bullet loan of 65% LTV at 5% for this building. What is the levered return for this building? By solving for Cash Flows By solving with MM equation From examination of the MM equation, what is required for positive leverage?

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Potential Gross Income

NOI

Before Tax Cash Flow

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DY CAP rate Cash on Cash OpEx Ratio Break Even Occupancy Ratio

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DCR Maximum Available Loan for target DCR What is the Maximum Loan for a DCR=1.35?

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What is the NPV and IRR rule, for evaluating investment desirability? What is the relationship between NPV and IRR?

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Chapter 10 – Residential Mortgage Types – Some highlights

A Mortgage Taxonomy

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FHA Mortgages

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Veterans Affairs Guarantees

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Private Mortgage Insurance

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Example: When must PMI be automatically be cancelled? How do you determine when is the loan at 78% of the original purchase price?

For a 30-year 4.75% loan with $10,000 down for a $200,000 house, in what month will the PMI be cancelled?

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Other Mortgage Types

Purchase Money Mortgage

Piggyback Loan

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Home Equity Lending

Reverse Mortgages

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Some more recent mortgage forms

IO mortgages

Hybrid ARM

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Option ARM

Subprime Loans

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If the loans are prepaid after 6 years, what are the yields to the lender?

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Chapter 11 – Sources of Funds for Residential Mortgages -

Highlights

Portfolio and Non Portfolio Lending

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Fannie Mae

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Freddie Mac

Importance of Fannie and Freddie

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Lender Underwriting.

The three C’s

What is the “Front End” (Housing Expense) ratio?

Example: Your household income is $75,000 and your proposed loan has a

PITI of $1,863.50 per month. What is your front-end ratio?

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What is the “Backend” (Total Debt) ratio?

If you have $925 in LTO, what is your backend ratio?

Should you qualify for your proposed loan based on these ratios?

How much in come do you need to qualify for this loan using a front-end

ratio of 28% and a backend ratio of 36%?

What if the only ratio that is used is a 43% backend ratio?

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Why is a high credit score important in today’s economy?

What are 4 things that affect your credit score?

How can you achieve and maintain a high credit score?

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Subprime Lending – some further points

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Qualified Mortgage

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Example: How much house can I afford? You have an income of $84,000 per year. You are applying for a 5%, 30-year FRM. Property Taxes are 2.5% of the house value, and insurance is 1% of the house value. Your LTO are $650 per month. You will be qualified on a 43% back end ratio. Hints: What is the maximum PITI you qualify for? What is your PITI for a $100,000 loan? Yay – algebra! How much money will you need to bring to closing if closing costs are 5% of the house value and you will have a 20% down payment?

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The examples below depend on the pacing of the class. Refinance Example 1: You currently have an 8%, 30-year loan you took out 2 years ago. You can refinance this at 6.5% with 3 points in fees to a new 28 year loan. You expect to keep this new loan for 2 years. Your original note was for $80,000 and you will take the closing costs from your savings account that is currently paying 5%. Is this a good choice? Does your tax situation affect your decision?

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Refinance Example 2: You currently have an 8%, 30-year loan you took out 2 years ago. You can refinance this at 6.5% with 3 points in fees to a new 30-year loan. You expect to keep this new loan for 2 years. Your original note was for $80,000 and you will add the closing costs to your existing loan balance. Is this a good choice?

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Example: Market Value of Existing Loan. You took out a 9%, 30-year mortgage for $160,000, four years ago. Current rates are 6.5%. What is the market value of this loan if: You keep the loan until maturity You payoff the loan 4 years from now What if the current market rate is 10%?

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Example: Builder Buydown. To move inventory a builder is offering either a mortgage at 6% when rates are 6.5%, or a 2/1 buy down (2% lower interest rate the first year followed by a 1% buy down the second year. What are the values of these alternative financing alternatives (160,000 note amount) assuming you will keep the loan for a) 3 years, or b) 8 years?

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Example: Value of Assuming an Existing Loan. Five years ago you purchased a new home for 100,000 (with a 20% down payment). You now have an offer in hand from a buyer for $150,000, subject to the buyer assuming your 5.5% loan. The buyer can get a 25-year second mortgage at 7.5% as long as he puts 20% equity into the deal. New 80%-LTV, 25-year mortgages are available at 6.5%. What is the apparent value of the note assumability (assume a 7 year horizon for the purchaser).

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Solution: As usual, first we compute the payment, in this case starting with the PMT on the original note. P/YR=12 PMT(PV=-80000, N=360, I/YR=5.5) = 454.23 Compute Bal month 60 (today) and month 144 (7 years from now) for use later 1 INPUT 60 AMORT Bal60 = 73,968.57 1 INPUT 144 AMORT Bal144 = 62,196.82 Buyer needs $120,000 financing for 80% LTV 120000 – 73968.57 (assume) = 46031.43 needed as a second mortgage. PMT on 2nd mortgage PMT(PV=-46031.43, N=300, I/YR=7.5) = 340.17 Compute balance after 7 years when you repay 1 INPUT 84 AMORT Bal84 = 40257.65 Total Pmt of assumed plus 2nd : 454.23 + 340.17 = 794.40 Total Balance owed after 7 years: 62196.82+40257.65 = 102454.47 Or: Take out a new 1st mortgage for 120000 (25 yr) PMT(PV=-120000, I/YR=6.5, N=300)=810.25 1 INPUT 84 AMORT Bal84 = 103011.36 PMT = 810.25 – 794.40 = 15.85 BAL = 103011.36 – 102454.47 = 556.89 Value of the assumption is the present value of savings PV(PMT=15.85, FV=556.89,N=84, I/YR=6.5) = 1421.13

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Example: FTLAPR disclosure. A customer is offered a 6.75%, 30 yr FRM loan for $160000 (80% LTV) with 3 points and no other financing fees. This loan will close on the first of the month.

What is the FTLAPR? What is the Finance Charge? What is the Amount Financed? What is the Total of Payments?