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FIN 3334- Mortgage interest rate notes (lesson 2)

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Unformatted text preview: you anticipate will produce $55,000 in Net Operating Income (NOI) p er year and you will receive $825,000 in proceeds net of brokerage costs when you sell the property in 5 years? A lender has offered you a $500,000 5‐ year interest only with annual payments at 6.5% to purchase. D escribe under what conditions you would e accept the offered loan. i B. Many Competing Uses of ‘Surplus’ Income to Invest 1. Most Be Compensated for: 2. Slope of Supply Curve: a) Perfectly: b) Demand does: c) # of Loans Given Right Price: C. What is Consumption worth to Me Today? 1. Can Always Consume More # of Loans a) Very Little Uncertainty Involved b) Diminishing Value: w More Consumption Each, s o Tend to Smooth over Life Cycle i Real Estate Finance Dr. Eriksen 2. Most Be Compensated to: a) Uncertainty Involved with Consumption Tomorrow b) Best Proxy: (i) Non‐Callable: (ii) Government Won’t Ever: D. What if a Borrower Doesn’t Pay Me Back? 1. Put Option of Borrowers: a) Necessary Condition for Strategic Default: Borrower Owes More Than Property Worth b) Why Doesn’t Everyone Immediately Default With Negative Equity? (i) Consumption: (ii) Aware of: (iii) Transaction Costs: (iv) Ability to Delay: 2. Pricing Mortgages to Incorporate Default Risk a) Ideal World: Lenders Able to Determine Good v. Bad Borrowers (i) Good Borrowers: (ii) Bad Borrowers: (iii) Solutions Always Exist with Perfect Information Example 3. You are a lender and want to earn a real rate of return of 8% on $100,000 of unsecured loans that mature next year and you are able to distinguish between two different types of borrowers. The first (ie, the good) type will pay you back 100% of the time. The second type (ie, the bad) will only pay you back 80% of the time and the other 20% of the time nothing. Given you can distinguish between types of borrower...
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