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  • RES 3200 Chapter 5 Adjustable and Floating Rate Mortgage Loans

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    This document discusses adjustable rate mortgages (ARMs) and floating rate loans. It explains that ARMs have interest rates that periodically adjust based on an index reflecting the lender's cost of borrowing. The most important features of ARMs are the initial interest rate, reset dates, index rate, margin, interest rate caps and floors, potential discounts, possibility of negative amortization, conversion options, and prepayment terms. It provides an example to illustrate how the monthly payment amount is calculated for an ARM and how the loan balance changes over time as rates adjust.

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    RES 3200 Chapter 5 Adjustable and Floating Rate Mortgage Loans(1) (1)

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    This document discusses adjustable rate mortgages (ARMs) and floating rate loans. It explains that ARMs have interest rates that periodically adjust based on an index reflecting the lender's cost of borrowing. The most important features of ARMs are the initial interest rate, reset dates, index rate, margin, interest rate caps and floors, potential discounts, possibility of negative amortization, conversion options, and prepayment terms. It provides an example to illustrate how the monthly payment amount is calculated for an ARM and how the loan balance changes over time as rates adjust.

    Copyright:

    © All Rights Reserved
    Download as PPT, PDF, TXT or read online from Scribd
    Flag for inappropriate content
    Download as ppt, pdf, or txt
    150 views12 pages

    RES 3200 Chapter 5 Adjustable and Floating Rate Mortgage Loans

    Uploaded by

    baorunchen
    This document discusses adjustable rate mortgages (ARMs) and floating rate loans. It explains that ARMs have interest rates that periodically adjust based on an index reflecting the lender's cost of borrowing. The most important features of ARMs are the initial interest rate, reset dates, index rate, margin, interest rate caps and floors, potential discounts, possibility of negative amortization, conversion options, and prepayment terms. It provides an example to illustrate how the monthly payment amount is calculated for an ARM and how the loan balance changes over time as rates adjust.

    Copyright:

    © All Rights Reserved
    Download as PPT, PDF, TXT or read online from Scribd
    Flag for inappropriate content
    Download as ppt, pdf, or txt
    of 12

    Chapter 5: Adjustable and Floating

    Rate Mortgage Loans (ARMs)

    • ARMs and Floating Rate Loans: An


    Overview

    • ARM Payment Mechanics

    1
    ARMs and Floating Rate Loans:
    An Overview

    • A mortgage loan with the interest rate


    on the note periodically adjusts based
    on an index which reflects the cost to
    the lender of borrowing on the credit
    markets.

    2
    ARMs and Floating Rate Loans:
    An Overview

     The most important basic features of


    ARMs are: [3]

    • Initial interest rate - The beginning interest rate.

    • The reset date - The point in time when the mortgage


    payments will be adjusted. The rate is reset at the end
    of this period, and the monthly loan payment is
    recalculated.

    3
    ARMs and Floating Rate Loans:
    An Overview

     The most important basic features of


    ARMs are: [3]

    • The index rate - Most lenders tie ARM interest rates


    changes to changes in an index rate. Lenders base ARM
    rates on a variety of indices, the most common being:
     Rates on one, three, or five-year Treasury securities.
     The average cost-of-funds index (COFI).
     The London Interbank Offered Rate (LIBOR).

    4
    ARMs and Floating Rate Loans:
    An Overview

     The most important basic features of


    ARMs are: [3]

    • The margin - The percentage points (premium) that


    lenders add to the index rate to determine the interest
    rate.

    • Interest rate caps – Maximum increases allowed in


    payments, interest rates, maturity extensions, and
    negative amortization (or loan balances) on reset
    dates.

    5
    ARMs and Floating Rate Loans:
    An Overview

     The most important basic features of


    ARMs are: [3]

    • Interest rate floors – Maximum reductions in payments


    or interest rates on reset dates.

    • Initial discounts - Interest rate concessions, often used


    as promotional aids, offered the first year or more of a
    loan. They reduce the interest rate below the prevailing
    rate (the index plus the margin).

    6
    ARMs and Floating Rate Loans:
    An Overview

     The most important basic features of


    ARMs are:
     [3]

    • Negative amortization - The mortgage balance is


    increasing. This occurs whenever the monthly mortgage
    payments are not large enough to pay all the interest
    due on the mortgage. This may be caused when the
    payment cap contained in the ARM is low enough such
    that the principal plus interest payment is greater than
    the payment cap.

    7
    ARMs and Floating Rate Loans:
    An Overview

     The most important basic features of


    ARMs are:
     [3]

    • Conversion - The agreement with the lender may have a


    clause that allows the buyer to convert the ARM to a
    fixed-rate mortgage at designated times.

    • Prepayment - Some agreements may require the buyer


    to pay special fees or penalties if the ARM is paid off
    early. Prepayment terms are sometimes negotiable.
    •

    8
    ARM Payment Mechanics
     1st Month Payment:

    • PV = $60,000.

    • i = 8%.

    • n = 30.

    • FV = 0.

    • Payment = ?

    9
    ARM Payment Mechanics
     1st Month Payment:
    • Step 1
     PV = $60,000.

     i = 8% / 12 =.66666%.

     n = 30 x 12 = 360.

     FV = 0.

     Payment = ?

    10
    ARM Payment Mechanics
     1st Month Mortgage Balance:
    • Step 2
     PMT = -$440.26.

     i = 8% / 12 =.66666%.

     n = 29 x 12 = 348.

     FV = 0.

     PV = ?

    11
    ARM Payment Mechanics
    30 Year Loan

    Month Beginning Monthly Interest Amortization Ending Loan


    Loan Balance Payment Rate Balance

    1. $60,000.00 $440.26 8% $40.26 $59.959.74

    2. $59,959.74 $616.92 12% $17.32 $59,942.42

    3. $59.942.42 $571.25 11% $21.78 $59,920.64

    4. $59,920.64 $617.07 12% $17.86 $59,902.78

    12

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