L3 Financing Real Estate to Students

Borrower makes periodic payments which include both

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Unformatted text preview: rincipal and interest. At maturity the outstanding loan balance will be reduced to zero. The term of fully amortized residential mortgages generally varies from 15 to 30 years in the U.S. and from 5 to 20 years in Hong Kong. Classification of Mortgages by Repayment Method Partially Amortized Mortgages Interest + Remaining Balance | PMT PMT PMT PMT PMT PMT | | | | | | | | |_______|_______|_______|_______|_______|______....._________|______|_ 0 1 2 3 4 5...................... n This kind of mortgage provides for the gradual repayment of a part of the principal over the term of the loan. The borrower makes periodic payments that include both principal and interest, so that at maturity, only part of the principal is paid off. The balance of the principal, the balloon payment, is due at maturity. The periodic payments on the partially amortized mortgage are less than that of a fully amortized mortgage of the same amount with the same terms. These reduced payments toward the principal will necessarily leave a loan balance at maturity, however. Who would borrow this kind of mortgages?? Classification of Mortgages by Repayment Method Who would borrow this kind of mortgages?? Newly formed businesses with large start-up costs and cash flow problems are likely candidates for this kind of mortgages. The bank expects that the cash flow crisis experienced by the new firm is short term, and that within a few years when the loan has matured, the then more experienced firm will be in a position either to pay off or refinance the balance. Classification of Mortgages by Repayment Method Example: Consider a 10-year, 10% mortgage loan of $10,000 requiring monthly payments. Determine the mortgage payments for Term loan Fully amortized mortgages Partially amortized mortgages with monthly payments fixed at $90. Example Consider a 10-year, 10% mortgage loan of $10,000 requiring monthly payments. Determine the mortgage payments for term loan. Monthly interest payments = 10000*10%/12 = $83.33 There are 120 monthly interest payments Principal Payment at the end of year 10 = $10,000 Example Consider a 10-year, 10% mortgage loan of $10,000 requiring monthly payments. Determine the mortgage payments for fully amortized mortgage. 1 − (1 + r ) − n Loan = PMT r The present value of all future equal monthly payments must be equal to the mortgage loan. There are 120 equal monthly payments each of which includes interest payment and principal payment. 10% −120 1 − 1 + 12 10000 = PMT ⇒ PMT = 132.15 10% / 12 Example 1 − (1 + r ) − n Balloon Loan = PMT + (1 + r ) − n r Consider a 10-year, 10% mortgage loan of $10,000 requiring monthly payments of $90. Determine the mortgage payments for partially amortized mortgage. The present value of all future equal monthly payments of $90 and the balloon payment at the end must be equal to the mortgage loan. 10% −120 1 − 1 + Balloon 12 10000 = 90 + (1 + 10% / 12) −120 ⇒ Balloon = 8635.5 10% / 12 Question: What happens if the monthly payment is set at say $80 (less than the monthly interest $83.33 for...
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