ARE144_chap_06_bf13ed_v2_KEY - 1 Managerial Economics (ARE)...

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1 Managerial Economics (ARE) 143 University of California, Davis Instructor: John H. Constantine KEY—Handout: Chapter 6, Residential Financial Analysis (1) Why do points increase the effective interest rate for a mortgage loan more if the loan is held for a shorter time period than a longer time period? Points are a one-time charge paid when the loan is obtained. The same dollar amount is paid whether the loan is held to maturity or prepaid. The longer the loan is held, the more these costs are, in effect, spread out over more payments. Conversely, if the loan is held for a shorter period of time, the borrower does not get the full benefit of having paid these up-front costs. (2) What factors must be considered when deciding whether to refinance a loan after interest rates have declined? The payment savings resulting from the lower interest rate must be weighed against the costs associated with refinancing such as points on the new loan or prepayment penalties on the loan being refinanced. (3) Why might the market value of a loan differ from its outstanding balance? The balance of a loan depends on the original contract rate, whereas the market value of the loan depends on the current market interest rate. (4) Why might a borrower be willing to pay a higher price for a home with an assumable loan? An assumable loan allows the borrower to save interest costs if the interest rate is lower than the current market interest rate. The investor may be willing to pay a higher price for the home if the additional price paid is less than the present value of the expected interest savings from the assumable loan. (5) What is a buydown loan? What parties are usually involved in this kind of loan? A buydown loan is a loan that has lower payments than a loan that would be made at the current interest rate. The payments are usually lowered for the first one or two years of the loan term. The payments are “bought down” by giving the lender funds in advance that equal the present value of the amount by which the payments have been reduced. (6) Why might a wraparound lender provide a wraparound loan at a lower rate than a new first mortgage? Although the wraparound loan is technically a “second mortgage,” the wraparound lender is only required to make payments on the existing mortgage if the borrower makes payments on the wraparound loan. Furthermore, the wraparound lender is typically taking over an existing mortgage that has a below market interest rate. Thus, the wraparound lender is benefiting from the spread between the rate being earned on the wraparound loan and that being paid on the existing loan. This allows the wraparound lender to earn a higher return on the incremental funds being advanced even if the rate on the wraparound loan is less than the rate on a new first mortgage.
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2 (7) Assuming the borrower is in no danger of default, under what conditions might a lender be willing to accept a lesser amount from a borrower than the outstanding balance of a loan and still consider the loan paid in full?
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This note was uploaded on 03/14/2012 for the course ARE 144 taught by Professor Johnson,e during the Spring '08 term at UC Davis.

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ARE144_chap_06_bf13ed_v2_KEY - 1 Managerial Economics (ARE)...

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