1- Introduction to advanced Financing

1- Introduction to advanced Financing - Spring 2004 Spring...

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Unformatted text preview: Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 1 In This Class You Should In Become Familiar With How Become Loans are classified according to use Loans are classified according to risk Lenders are attracted to different loans Some lenders like high risk loans There are several types of loans Financial Calculators a necessity Clauses for loans Types of Interest Loan To Value Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 2 Classification of Loans Real Estate loans can most easily be Real classified According to what type of real property, or project, that they are financing. property, The most common loan for real estate The practitioners is the single family, owner occupied, loan. occupied, There are many others. Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 3 Look at some of the loans we may deal Look with according to their function; with Single Family/Owner Occupied Single Family Non-Owner Occupied Residential Income Loans 1 to 4 Units Residential Income 5 and more Construction Loans Permanent Loans - Take Out Loans – Fixed Loans Commercial Loans Industrial Loans Office Loans Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 4 Overview by Classification When we look at loans according to what is When securing the loan, i.e.; single family/owner occupied we quickly learn that the loans are made by different lenders. If you apply to a lender for a commercial loan on a shopping center, and that lender makes most of its loans on single family/owner occupied loans, they will not be a good source of funds for a commercial loan. commercial Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 5 Finding a Lender Different lenders specialize in certain loans. Different They think that those loans are the easiest to make and maintain with the greatest profitability. If a lender specializes in making loans on If strip shopping centers and you make or have a client make an application to that lender for a loan you probably won’t get it. loan Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 6 Lenders Specialize Lenders specialize, and they all think Lenders there area is the best area. there When you want a construction loan you When need to go to a lender who is used to making construction loans. If you want a residential income loan for a 30 unit building you have to go to a lender who makes loans for 30 unit buildings. makes Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 7 Specialists Take The Specialists Work Out of Your Loan Needs Work When you want a loan for a 30 Unit When building and you apply to a lender who is used to packaging loans for single family/owner occupied loans, you are not likely to get the loan. not This is because that lender lacks the This knowledge of packaging, and the money resources who will make the loan. resources Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 8 Building Loans Building Are Good Examples Are When you are getting construction financing for a When housing project, you are likely to get the construction loan from one lender. This will be a lender who specializes in construction loans. As the homes are sold you will likely be dealing with a lender who makes take out loans, or provides financing for single family homeowners who are going to occupy the homes. As these loans are made, the construction loan is paid off. made, Important here is that if you are the builder your Important salary is usually in the construction loan. Your profit is normally realized on the sale of the last 3 or 4 properties. properties. Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 9 Loans According To Risk Loans are made according to the risk Loans anticipated risk associated with the loan. anticipated A loan for a single family/owner occupied loan home is generally regarded as the lowest risk loan in real estate. loan This is because it is thought that a borrower This who falls on hard times will hold onto their personal residence long after commercial and income loan properties have been foreclosed on. on. Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 10 Risk is Spoken of as ? Paper Risk is spoken of as Paper in the Risk alphabet. With “A” paper being the least likely to be foreclosed on. “A” paper would normally have the lowest interest rate. interest “A” paper would normally have the A” greatest resale value on the secondary market. market. Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 11 The Alphabet Goes Down As the alphabet descends the interest rate As goes up, and the desirability of the paper declines. declines. “B” loans or paper would normally have a B” higher interest rate than “A” paper, and would normally be made to people who are less desirable borrowers. People who don’t pay their bills as promptly as “A” paper borrowers. borrowers. Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 12 The Picture Emerges You should have a picture emerging that says You the borrower has a lot to do with the loan. This picture should include the fact that This certain loans are made by certain lenders, or perhaps more accurately some lenders don’t make some loans. make The picture should also point to the fact that The some lenders want higher risk paper because of the greater returns. of Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 13 Some Lenders Like High Risk Some lenders only want high risk loans Some because this gives them the greatest return. because Some lenders only want low risk loans Some because this gives them the safest returns. because Some lenders only want certain types and Some sizes of property. sizes You have to know which lender to go to or You you’ll get the wrong loan and rate. you’ll Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 14 Loans Come in All Shapes & Loans Sizes Sizes We are more used to the fixed rate loan We with equal monthly payments that is fully amortized in 30 to 40 years. fully The consumer is more used to that loan The as well. Consequently more fixed rate, amortized loans are made. amortized Loans come in all shapes and sizes. Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 15 Look at Some of These Loans Look Fixed Rate Fully Amortized - Monthly Fixed Rate Partially Amortized – Monthly Interest Only – Monthly Payments Interest Only – Partial Monthly Payments Interest Only – Quarterly/Annual Payments Adjustable Rate Loans Adjustable Convertible Loans Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 16 Fixed Rate Fully Amortized Monthly Most loans that we use in real estate Most have a fixed monthly payment and are amortized over a period of time necessary to completely pay the loan off. off. These are desirable loans to the These consumer because they are predictable. consumer Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 17 Fixed Rate Fully Amortized Monthly 2 Fixed Let us say that you or a client purchase a home for Let $400,000, with $80,000 down (20% Down) and get a new 1st Trust Deed in the amount of $320,000 at new 5.5%, amortized for thirty years, and payable in equal monthly payments of $1,816.92. equal Your $1,816.92 payment of Principal and Interest, Your what we commonly call PI, will always be the same, $1,816.92. Your taxes and insurance will likely increase, so, Your what we often call the total payment PITI Principal, Interest, Taxes and Insurance will increase. Interest, Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 18 Fixed Rate Fully Amortized Monthly 3 Fixed These are good loans for the home buyer. These Without these loans we would not have the high rate of home ownership that we currently enjoy in the United States. currently In subsequent chapters we will learn that the In government, state and federal, reward the buyer by making the interest on most loans tax deductible. We will learn that we have an after tax interest rate. after Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 19 Fixed Rate Partially Amortized Some fixed rate loans are written like Some this, $320,000 at 5.5% interest, payable in equal monthly installments of $1,816.92, all due and payable ten years from conception. from These loans will fit some needs. They These are not acceptable to most minds. are Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 20 Fixed Rate Partial Fixed Payment Negative Loan 2 There are loans that from their inception There are negatively amortizing. There are many good reasons for these loans. You have to realize the virtue of them, then you can estimate the value and usefulness of such loans. usefulness How could a loan like this be profitable How to a borrower? to Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 21 Fixed Rate Partial Fixed Payment Negative Loan Payment As in our previous example we get, or have a As buyer get a $320,000 loan at 5.5% interest, amortized for thirty years, but payable in equal monthly installments of $1,200 for the first sixty months. The face value of the loan would have grown to $338,368.22 during the 1st five year period. Can you think of a situation where a loan like Can this would have value? this Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 22 Interest Only Monthly Interest Payment Loans Payment Many loans are interest only loans, that Many means that they don’t amortize. They just continue until they become due, or they are replaced by another loan. (Amortize means to die, amorti - ad to mors = add death Latin). Interest only loans are very popular with income properties. Can you give a situation where this would be a more desirable loan for the buyer, for the lender? buyer, Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 23 Interest Only Partial Monthly Payments There are times when it will be an There advantage to the lender and the borrower to have an interest only loan with partial monthly payments. In this instance the unpaid part of the payment accrues (adds to) the face value of the loan. The accrued interest may, or may not, bear interest. not, Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 24 Interest Only Partial Monthly Payments 2 Interest Use our previous loan, $320,000 at 5.5% Use interest only. This would generate $17,600 in interest in one year. If the borrower was required to pay all of the interest due, monthly, the monthly payment would be $1,466.67. If the borrower was to pay $1,200 a month, If and the balance was to accrue to the face of the loan we would have a $266.67 a month accrual. accrual. Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 25 Interest Only Partial Monthly Payments 3 Interest If this was the case, the unpaid balance at the end of If one year would be $323,200. one If on the other hand the unpaid interest was to If accrue to the loan and bear interest, we would have $323,281.91 due at the end of the first year. $323,281.91 This seems a small matter, but in five years at This $1,200 a month the loan balance would be $338,368.22. We were lacking $200 a month, multiply that by 60 months and you have $12,000, add that to $320,000 you get $332,000 and you can see the note will have earned $6,368.22 in interest. see Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 26 Interest Only Interest Quarterly/Annual Payment Loans Quarterly/Annual Interest only with quarterly payments are Interest very popular loans in business. These are used to purchase machinery, make payroll, build improvements. build Suppose you had this $320,000 loan at 5.5% Suppose monthly interest, paid quarterly. Your quarterly payment would be $4,400.00 – basically three interest only payments. basically If the monthly interest was earning interest If would that make a difference? would Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 27 Interest Only No Payment Loans Often, sellers or lenders will make interest only loans Often, with no payments, all due and payable in a certain period of time. period Suppose you sold an apartment building with a Suppose $500,000 2nd Trust Deed at 6% interest, compounded $500,000 annually, no monthly installments, all due and payable in ten years. In ten years, assuming the interest was bearing interest, the loan would have grown to $895,423.85 $895,423.85 IF you wrote this Trust Deed so that the interest did not IF bear interest, the payoff in ten years would be $800,000. Can you think of some reasons and situations you Can would want to know the effect of compounding? would Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 28 Financial Calculators You have probably figured out that if You you want to understand a lot of these concepts you should have a financial calculator. calculator. What kind do you think you should buy? Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 29 Adjustable Rate Loans Adjustable Rate Loans can be very powerful tools. Adjustable Rate Loans are normally made up of Adjustable Four Parts. Four Index Published Indicator used to Published adjust the monthly interest rate. rate. Margin A fixed percentage that will be fixed added to the index to determine the note rate. added Note Rate The rate of interest actually being The charged on the face amount of the funds charged Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 30 Adjustable Rate Loans Index - Margin - Note Rate - Published Indicator used to adjust the Published monthly interest rate. monthly A fixed percentage that will be added fixed to the index to determine the note rate. the The rate of interest actually being The charged on the current amount of the note. charged Rate Caps Lifetime Cap - The maximum allowable interest rate The over the life of the loan. over Per Adjustment Cap - Maximum allowable interest rate change at the Maximum change time of the adjustment. Payment Cap - The payment cap is normally limited Payment to 7 1/2% of the payment, up or down. to Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 31 Adjustable Rate Loans Have Many Advantages Adjustable Rate loans have many Adjustable advantages. Among them are the fact that a borrower can qualify to borrow more money. money. The payment on the larger amount of money The is a good deal less, particularly in the early years, than with a fixed rate loan. years, The borrower can usually make larger The payments without any pre-payment penalty. payments Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 32 Adjustable/Convertible Loans Due to the fact that adjustable rate loans have Due rarely had a great deal of popularity, the secondary market has created variable rate loans that are convertible at certain points in time. time. What this amounts to is that the variable is a What variable for say a five year period, and then the borrower has the option of converting the variable to fixed rate loan. variable Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 33 Clauses When you make or get a loan, in When California, we normally have a Trust Deed, accompanied by a note. The note spells out the terms of the agreement, the Trust Deed is the Recorded evidence of the agreement. Many of the terms of the note are contained on the face of most trust deeds. most Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 34 Clauses 2 Clauses There are several clauses associated with the There note when making a loan. These clauses help protect the investor, maker of the loan, and sometimes the borrower. sometimes It is important to realize that our economy It has been built predicated on these clauses being enforceable. When they are ignored there is a strong possibility that we will upset the availability of funds for loans. the Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 35 The Acceleration Clause The Acceleration Clause simply says that the The note has to be paid off right now because a certain thing has happened. certain Normally the acceleration clause is employed Normally when the borrower fails to pay the taxes, keep the property up, keep the property safe, fails to keep insurance on the improvements, or the borrower willfully destroys the property. property. Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 36 The Alienation Clause Often called the “Due on Sale Clause”, this Often clause allows the lender to call the loan due and payable if the borrower transfers title to a third party. All due on sale clauses are enforceable in the United States, except for transfers between spouses and family trusts. transfers Often the purpose of calling the loan due, Often when payments are being made in a timely fashion, is to simply renegotiate the loan rate and charge assumption fees. (Points) and Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 37 Sub-Ordination Clause A clause where the holder of a trust deed clause agrees to become Junior to a new trust deed that is being placed on the property. that An example of this would be a land seller An who has carried a 1st Trust Deed and Note who with the agreement that they would subwith ordinate all or part of this first trust deed to a ordinate construction loan, and then to a permanent loan. loan. Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 38 Pre-Payment Penalty Clause A pre-payment penalty clause is put into pre-payment the note of a Trust Deed or Mortgage to off-set the lost interest if a note is paid off. off. The lender agrees to make a loan for 30 The years and the borrower re-finances in 2 years. The lender then has to re-lend their funds. their Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 39 Pre-Payment Penalty Clause - 2 Pre-Payment In California the Pre-Payment Penalty In Sunsets, (goes away) after five years. Sunsets, With most lenders if you are going to With refinance and you refinance through them, they will waive any pre-payment penalty. they Adjustable Rate Mortgages rarely have prepayment penalties. payment Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 40 Rates of Interest Real Interest Rate an interest rate that does not include a premium for anticipated an inflation. inflation. Annual Percentage Rate The annual percentage is the Effective rate plus any points on the The loan or fees. It is an attempt to measure one loan against another for shopping purposes Effective Rate Effective The annual rate equivalent to a nominal rate that is compounded The more frequently than annually. If the Nominal rate is 10% annually, the effective rate would be(1+(0.10/12))12 be(1+(0.10/12)) Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 41 Rates of Interest Nominal Rate The stated interest rate in a note or contract. Internal Rate of Return (IRR) A rate of return that discounts all expected future cash flows to a rate present value that is equal present to the original investment. Adjusted Internal Rate of Return An Internal Rate of Return Model in which the negative and An positive cash flows have different reinvestment rates. positive Financial Management Rate of Return (FMRR) similar to the adjusted IRR. Cash flows are adjusted, negative similar cash flows to a safe rate, and positive cash flows as if invested at a reinvestment rate. reinvestment Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 42 Loan To Value (LTV’s) For example a $1,000,000 building that For you can obtain a $700,000 loan on would be an illustration of a 70% Loan to Value. be A $500,000 property with a $400,000 $500,000 loan would be an example of an 80% Loan to Value. Loan Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 43 Loan To Value (LTV’s) -2 -2 Loan This is the same as dividing the loan by the This value of the property, or; value Loan Amount/Property Value = LTV $700,000/$1,000,000 = 70% Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 44 Loan To Value -3 -3 Loan With larger income properties, more With expensive properties, where the loan to value would be low, it is not uncommon to have the seller carry back a 2nd Trust Deed to increase seller the Loan To Value ratio. This has the same effect as expanding the This market by making more buyers able to purchase the property. Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 45 Test Your Knowledge 1. Loans are classified according to; a. the ability of the borrower to pay. b. the paying habits of the borrower. c. the type of property securing the the loan. loan. d. The income of the borrower. Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 46 1. If we approach a lender for a loan on a 30 If unit apartment building and they turn the loan down it is probably because? loan a. We have the wrong lender. b. The borrower doesn’t measure up The to the lenders criteria. to c. The building doesn’t measure up to the The lenders expectations. lenders d. The borrower doesn’t appear to have The the experience to manage the property. the Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 47 1. The most desirable loan to most The lenders is? lenders a. b. c. d. Spring 2004 Spring Office buildings. Strip malls. Commercial buildings. Owner occupied single family homes. homes. Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 48 1. Loans are classified according to risk. When Loans loans are classified according to risk the are referred to as? referred a. Suicide loans. b. A, B, and C paper. The lower the A, letter in the alphabet the better the less the risk with loan. less c. A, B, and C paper. The higher the letter A, in the alphabet, the less the risk with the loan. loan. d. 1, 2, and 3 risk paper. Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 49 5. When you are working on a high risk When project you will have to go to a lender that deals in high risk loans. This means you will? will? a. Pay more points and a higher interest Pay rate. rate. b. Have to have an exceptional credit line. c. Have a lower Loan to Value Ratio. d. All of the above. Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 50 1. There are several types of loans based on There the payments of the principal and interest on the loan. Two of these loans are? on a. Interest only and fully amortized. b. Partially amortized on no payment Partially loans. loans. c. Intermittent payment loans and Intermittent annual payment loans. annual d. Partial payment loans and preferred Partial loans. loans. Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 51 1. Financial calculators are handy tools to Financial have when we are working with loans on a constant basis. If we do not own a financial calculator we can? financial a. Memorize the loan constant for that Memorize day. day. b. Memorize the formulas for the six Memorize functions of one dollar. functions c. Use simple interest rates. d. Use financial tables. Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 52 1. Adjustable Rate Loans have several very Adjustable desirable features. One important features is? desirable a. The borrower can qualify for a The greater loan amount. greater b. The borrower can have very marginal The credit. credit. c. The borrower will have a larger The payment. payment. d. The seller can get a higher price for their The property. property. Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 53 1. A sub-ordination clause in a loan means? a. The lender has made a loan The commonly called “B” or “C” paper. commonly b. The borrower has poor credit. c. If the borrower sells the property the If loan has to be paid off. loan d. The lender will let the owner put The another loan above their loan. another Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 54 1. An acceleration clause in a loan means that? a. The borrower can get the loan a lot The faster. faster. b. The loan may require an immediate The payoff if the borrower doesn’t perform as agreed. c. The borrower can make payments c. The more often than once a month. more d. The lender will advance additional funds The to the borrower as the property increases in value. in Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 55 1. Pre-Payment penalties in California Pre-Payment are? are? a. Forbidden by statute. b. Allowed for the first five years of the Allowed loan. loan. c. Enforceable for the term of the loan. d. Not allowed to be more than 4 Not months interest. months Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 56 1.There are several names for interest There rates on loans. The stated rate on a loan is called? is a. The Annual Percentage Rate. b. The Real Interest Rate. c. The Nominal Rate. d. The Effective Rate. Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 57 13. Interest only loans are normally called? a. Straight Notes. a. b. Bullet loans. c. Amortized Loans. d. Partially Amortized Loans. Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 58 14. A loan that is amortized for 30 years, but 14. all due and payable in 10 years is called?? all a. Straight Notes. a. b. Bullet loans. c. Amortized Loans. d. Partially Amortized Loans. Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 59 Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 60 Spring 2004 Spring Advanced Finance Chapter 1 - A long look at loans - Robert Rooks 61 ...
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