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FIN 101 Lecture Notes - Lecture 13: Lenders Mortgage Insurance, The Purchase Price, Down Payment

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School
Ball State University
Department
Finance
Course
FIN 101
Professor
Olga S Mc Atee

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Document Summary

Mortgage- make sure your down payment is at least 20% of the purchase price. Renting is good until you can afford to buy something. When you decide to buy a house, the most important thing will be: Some lenders will give you a mortgage if you put down less than 20% of the down-payment down. They will charge more for it to you and you"ll have to get a pmi, private mortgage insurance, which is more cost to your mortgage. Even if the lender doesn"t charge more, you should put down at least 20% for the down payment. This makes sure you don"t buy more house than you can actually afford. More people foreclose their hoes because they don"t put 20% down on their home purchase. The assumption is that home prices will continue to increase so people should put small down payments on homes and they found themselves in a lot of trouble when they couldn"t afford the house.

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Related Questions

You are given with the following information of two proposals of financing programs for

your home loan. Suppose the new house costs you $540,000 (sales taxes and others are

included). One program is asking you to deposit a 20% down payment on the $540,000 and it

provides you with 3.24% interest rate for 15-year monthly payments of the remaining

balance, the other program is a 100% financing program which gives you a 2.2% for the first

5 year plus the PMI (property mortgage insurance) as $300 per month with a balloon

payment as $530,000.(That is, a lump-sum payment at the end of 5th year). The mortgage rate

increases to 5.85% afterward for a 30-year mortgage if the balloon payment is not paid and

refinancing is applied (That is, the extended program is for 30 years not for the 25 years

leftover). Let there be no prepayment penalty. That is, you may pay off the loan should you

have some extra cash later on. The brokerage fees and commissions are already taken into

account in all the numbers given. Answer the following questions.

a) What is the monthly payment for each program in the first 5 years? Which one is more

favorable to you if your monthly income is $7,000 before tax? (Notice that most lenders will

require the borrower to have ratio between mortgage payment and monthly income no

greater than 33%).

It's due tommorow and need help with these following problems.

Please solve the following problems. Show all relevant time lines and calculations and make sure to highlight the final answer to the question. Where MS Excel is required, please either cut and paste the spreadsheet where it belongs or staple the printout directly from MS Excel. For spreadsheets that are too long to print, just include a sample printout of the first and last pages. Note that some questions require a written answer, not just a number.

Vanilla Ice Co. bonds pay an annual coupon rate of 10% and have 5 years to maturity. If investors' required rate of return is now 8% on these bonds…

Will the bonds be selling at a premium or a discount with respect to their $1000 face value? Why?

b. What is the price of the bonds?

Austin Power Co. bonds have a 14% annual coupon rate. Interest is paid semi-annually. The bonds have a par value of $1,000 and will mature 10 years from now. If the (annual) required rate of return is 12%, what is the price of the Austin Power bonds? [Hint: you need to convert your coupon rate, your number of periods, n, and your req. rate of ret. to a semi-annual basis.]

Consider a $1,000 par value bond with a 9 percent annual coupon that is currently selling for $943. The bond pays interest annually. There are 15 years remaining until maturity.

What is the size of the annual coupon payments?

What is the current yield on the bond?

A preferred share of Phillips, Co. is currently selling for $65.00 on the New York Stock Exchange. If this instrument pays a dividend of $5 a year, what is its yield?

Assume that you plan to buy a share of IBM stock today and to hold it for 2 years. Your expectations are that you’ll receive a dividend of 19.00 at the end of Year 1 and a dividend of $19.25 at the end of Year 2. In addition, you expect to sell the stock for $150 at the end of Year 2. If your expected rate of return is 11 percent, how much should you be willing to pay for this stock today?

A share of common stock has just paid a dividend of $2.00. If the expected long-run growth rate for this stock is 15 percent, and if investors require a 19 percent rate of return, what is the price of the stock?

What would be the interest earned on a $6,000 deposit during the second year of its life if no money is withdrawn from the bank during that time, and the deposit pays an annual interest rate of 2.5 percent, with annual compounding?

Using excel, build a monthly amortization table for a 30-year mortgage on a $350,000 home, no money down. Use 7% as the yearly interest on the loan.

Using the amortization table you built for Question 8, answer the following questions.

How much money will you still owe on the loan after making one full year of payments?

How much money will you still owe on the loan after making 10 full years of payments?

If you want to refinance after 15 years of making payments, how much financing would you need to secure from your bank to do so?

How much money can you expect to pay in interests alone during the 30 year life of the mortgage?

You plan to purchase a $100,000 house using a 30-year mortgage obtained from local credit union. The mortgage rate offered to you is 8.25%. You will make a down payment of 20% of the purchase price.

Calculate your monthly payments on this mortgage.

Calculate the amount of interest and, separately, principal paid in the 25th payment.

Calculate the amount of interest and, separately, principal paid in the 225th payment.

Calculate the amount of interest paid over the life of this mortgage.

You plan to purchase a house for $115,000 using a 30-year mortgage from your local bank. You will make a down payment of 20% of the purchase price.

Your bank offers you the following two options for payment:

Option 1: Mortgage rate of 9% and zero discount points.

Option 2: Mortgage rate of 8.85% and two discount points.

Which option would you choose?

Your bank offers you the following two options for payment:

Option 1: Mortgage rate of 10.25% and 1 discount point.

Option 2: Mortgage rate of 10% and 2.5 discount points.

Which option would you choose? [Hint: consider only the incremental costs and benefits of Option 2 with respect to Option 1]

You just got a promotion and you are now taking home $75,000 a year before taxes. You are thinking about upgrading your home and moving to a nicer neighborhood. You’ve been living for the past six years in a 1,300 square foot, 3 bed/2 bath home, currently valued at $137,000. Thanks to the strong capital appreciation of the past few years, you estimate that after liquidating the mortgage and covering realtor fees, you’ll be able to walk away with $40,000, which you intend to use as down payment on your new home. Your debt payments ratio is only 7% and your credit rating is 700, so qualifying for a loan won’t be a problem. The best bank rate you’ve found is 5.9% fixed for a 30 year mortgage.

Ignoring mortgage insurance premiums, homeowner’s insurance premiums, and property tax obligations, how much of a home could you afford?

Would your mortgage be considered conforming or non-conforming?

Do you think you’ll be required to obtain private mortgage insurance? Why?

Alan recently joined Friendly Investment and Financing Options(FIFO) as a loan officer. FIFO is a national company thatspecializes in mortgage lending. One of Alan’s responsibilities isto increase the amount of mortgages FIFO initiates. In a meeting hehad with the CEO yesterday, Alan was told about a new mortgage thatFIFO intends to market. The new mortgage is called an optionadjustable rate mortgage, or an option ARM for short, and its mostattractive feature is that homeowners can choose to make relativelylow monthly payments at the beginning of the mortgage period.However, the payments increase significantly later in the life ofthe mortgage. In fact, depending on the amount the borrower choosesto pay early (hence, the term “option”), the amounts that must bepaid later could be substantial—as much as four to five times theinitial payments. In many cases, when a homeowner chooses to paythe minimum amount or an amount that he or she can afford, themortgage turns “upside down,” which means that the amount due onthe mortgage grows to an amount that is greater than the value ofthe house. The primary benefit of option ARMs to borrowers is thatsuch loans allow those who cannot afford the monthly paymentsassociated with conventional mortgages the opportunity to purchasehouses. A borrower with income that is lower than is needed toqualify for a conventional mortgage can borrow using option ARMs,choose an affordable (lower than conventional) payment in the earlyyears of the mrotgage, and then make the higher payments in lateryears, when their incomes presumably will be higher. Thus, optionARMs permit those who can’t afford conventional mortgages to buyhouses today that they otherwise couldn’t afford until years intothe future. Lenders such as FIFO like selling option ARMs becausethey can recognize as current revenues the monthly payments thatwould be required if the loans were conventional mortgages,regardless of the amounts that the borrowers opt to pay. In otherwords, companies can “book” revenues that will not be collected fora few years. Unlike most people, including many professionals, Alanunderstands the complexities of option ARMs. He knows that manyborrowers who choose such mortgages will lose their houses three tofive years after buying them because the payments increase sosignificantly after the low-payment option period expires thatthese borrowers cannot afford the new monthly payments. And,although they would like to refinance with conventional mortgages,often these homeowners do not have good enough credit. Thisscenario is quite disturbing to Alan. He would like to explain tohis customers in clear terms the possible pitfalls of option ARMs,but the CEO of FIFO has instructed Alan that he should provide onlythe information that is required by law and to follow companypolicy, which states that lending officers should provide basicprinted material, give simple advice, and answer questions thatmight provide negative information only when asked. Alan has a badfeeling about option ARMs. He knows that they are greatlending/borrowing tools when used as intended. He is afraid,however, that FIFO is more concerned about booking revenues thanabout the financial wellbeing of its customers (borrowers). Whatshould Alan do? How would you handle this situation if you wereAlan?