UGBA 180 Lecture Notes - Lecture 2: Libor, Negative Amortization, Reaction Rate Constant
25 Jun 2018
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Lecture 2: Fixed Rate Mortgages
Why are Mortgages Important?
What is a Mortgage?
●Def: a loan where funds are borrowed to acquire real estate that serves a security for the
loan
○Lender provides loan amount today
○Borrower pay off loan and interest in installments over several years
○If unable to pay (the borrower defaults) and the lender can seize the property
■Options in case of default
●Restructure the loan
●Short sale
●Foreclosure
Mortgage Components
●Key components
○Loan amount
○Loan maturity date
○Interest rate
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○Periodic payments (monthly usually)
●Note that i is generally a nominal annual interest rate, compounded monthly so a 12%
annual i compounded monthly is you pay 1% interest monthly
The “vanilla” mortgage
●For most we will focus on mortgages that are
○Fixed rate: borrower and lender agree on a single nominal interest rate at
origination and the rate is fixed throughout the life of the loan
○Constant payment: borrower pays the same amount back to the lender every
month
○Fully amortizing: loan is fully repaid at maturity
Amortization
●Define: the process of paying off a loan over multiple periods
●Suppose you have a fixed rate constant payment mortgage with monthly payments of
$PMT
●Each month your payment of $PMT contributes to
○Reducing the outstanding loan balance
○Paying accrued interest
●Relative contribution to both depends on the size of PMT and location in the repayment
schedule
Baseline EX
●$60k loan
●30 yr maturity
●12% nominal annual i
●CPM
●Size of PMT determines the amortization schedule
●Fully Amortizing
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○n = 30*12
○i = 12% / 12
○PMT = ?
○PV = -$60k
○FV = 0
○PMT = $ 617.17
●See how the amortization increases as the year pass and the interest decreases
●Partially amortizing
○PMT corresponds to:
■$60k loan
■30 year maturity
■12% nominal annual interest rate
find more resources at oneclass.com
find more resources at oneclass.com
Document Summary
Def: a loan where funds are borrowed to acquire real estate that serves a security for the loan. Borrower pay off loan and interest in installments over several years. If unable to pay (the borrower defaults) and the lender can seize the property. Note that i is generally a nominal annual interest rate, compounded monthly so a 12% annual i compounded monthly is you pay 1% interest monthly. For most we will focus on mortgages that are. Fixed rate: borrower and lender agree on a single nominal interest rate at origination and the rate is fixed throughout the life of the loan. Constant payment: borrower pays the same amount back to the lender every month. Fully amortizing: loan is fully repaid at maturity. Define: the process of paying off a loan over multiple periods. Suppose you have a fixed rate constant payment mortgage with monthly payments of. Each month your payment of contributes to.
