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FIN 3334- Lender risk mitigation notes (lesson 4)

Iv prepaymentrisk a borrowerscanprepaystrategically 1

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Unformatted text preview: 0 5/1 ARM loan with an initial rate of 6.12% and margin of 276bp indexed to LIBOR which is 4.8% at the time of origination? 1st Payment: 56th Payment: 61st Payment: f) Caps: Contractual Limits on Adjustments (i) Based on Either: % Increase in Payment or Interest Rate (ii) Periodic Caps: Maximum Change Each Adjustment Period (eg, 200 bp of Rate) (iii) Lifetime Caps: Max Change Over Life of Loan (eg, 600 bp of Rate) (iv) Less Caps = More Interest‐Rate Risk Transferred to Borrower (v) Negative Amortization: Capped Interest Payment Possibly Transferred to Balance Example 4. You have been offered a 30‐year 1/1 ARM loan with a current composite rate of 7.2%, but a teaser rate of 3.6% and 200bp cap on annual adjustments from the teaser. What are the scheduled payments if you assume interest rates don’t change? Create Timeline of Path towards indexation: Payment 1st ‐12th: Payments 13th ‐24th: Payments 25th – 360th: 2. Calculating APR and EBC with ARMs a) Unclear which Rate for Lenders to Use Since Actual Future Index Rate Unknown b) Assume Interest Rates Do NOT Change from Origination Example 5. What is the APR of the Loan in Example 4 disclosed by the Lender at closing they char...
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