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7 Aug 2019

Suppose you enter into a loan agreement to borrow $100,000 to help finance the purchase of a new home. The loan contract specifies a term of 30 years with monthly payments determined at a fixed rate of 6% APR (compounding monthly). a. What is the amount of your monthly repayments? b. Now suppose that exactly five years have passed (you made the 60th repayment yesterday). A rival lender offers to refinance your loan at a fixed rate of 5% APR (compounding monthly). Costs associated with this refinancing amount to $2,000. Should you refinance?

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Bunny Greenfelder
Bunny GreenfelderLv2
9 Aug 2019

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John took a mortgage loan 5 years ago for $120,000 at 7% interest for 15 years, to be paid in monthly payments. Now, a lender is offering him a new mortgage loan at 5% for 10 years. The new loan amount is $92,895, the outstanding loan balance of the existing loan. Suppose that a prepayment penalty of 3% must be paid if John refinances the existing loan. Moreover, the lender who is making the new loan requires an origination fee of $3,000. John plans to hold the property for 10 years. Note: John has to pay the refinancing fees (i.e., the origination fee and the prepayment penalty) out of his pocket.

(a) What is the total financing cost (not include the loan amount itself) if John decides to refinance the old loan?

(b) What is the monthly savings that John could realize by refinancing?

(c) Given the information provided here, should John refinance? Please support your answer by calculating the effective interest rate of the new loan.

(d) Now suppose that John’s current income is low. The new lender allows him to pay a monthly payment of $300 for the new loan (i.e., the actual monthly payment to the lender is only $300, while the loan interest rate is 5%). In this situation, negative amortization occurs. What will be the accrued interest or the amount of increased loan balance for the loan three years later from now?

(e) Assume that John has to borrow two loans in order to refinance. That is, he has to borrow a new mortgage ($70,000) at 5% for 10 years (i.e., the loan maturity and the amortization period are the same, 10 years) and another mortgage ($22,895) at 9% for 5 years (the loan maturity and the amortization period are the same, 5 years). In this case, with the same origination fee of $3,000 (i.e., a total of $3,000 for the two loans) and the prepayment penalty of 3%, should John go ahead with the refinancing plan? Why?

(I primarily need assistance with Sections D and E as I believe I have A-C correct)

Jane plans to borrow from a bank to finance her investment in a real estate project. She considers an ARM loan with three-year loan term, $100,000 loan amount. The loan has the following terms: 1) initial interest rate = 8.5%; 2) margin = 3%; 3) loan amortization period = 15 years; 4) frequency of adjustment = 1 year (monthly compounding); 5) interest rate cap = none; 6) payment cap = none; and 7) discount points = 3%; 8) no negative amortization is allowed. The index rates (i.e., based on 3 year treasure rate) for next two years (i.e., the 2nd and 3rd year) are expected to be 11% and 8%, respectively.

(a) If the loan will be repaid after 3 years, what would be the monthly payment and the ending loan balance for each of the three years?

(b) What is the effective mortgage yield for borrowing this mortgage?

(c) Now suppose that there is an annual interest rate cap of 2% specified in the loan contract. What is the effective mortgage yield for borrowing this mortgage, assuming that no negative amortization is allowed?

(d) Now suppose, instead of the annual interest rate cap of 2%, the bank prefers a 3% annual payment cap. Assume that negative amortization is allowed, what is the effective mortgage yield for borrowing this mortgage?

Mark Sexton and Todd Story, the owners of S&S Air, Inc., were impressed by the work Chris had done on financial planning. Using Chris’s analysis, and looking at the demand for light aircraft, they have decided that their existing fabrication equipment is sufficient, but it is time to acquire a bigger manufacturing facility. Mark and Todd have identified a suitable structure that is currently for sale, and they believe they can buy and refurbish it for about $35 million. Mark, Todd, and Chris are now ready to meet with Christie Vaughan, the loan officer for First United National Bank. The meeting is to discuss the mortgage options available to the company to finance the new facility.

Christie begins the meeting by discussing a 30-year mortgage. The loan would be repaid in equal monthly installments. Because of the previous relationship between S&S Air and the bank, there would be no closing costs for the loan. Christie states that the APR of the loan would be 6.1 percent. Todd asks if a shorter mortgage loan is available. Christie says that the bank does have a 20-year mortgage available at the same APR.

Mark decides to ask Christie about a “smart loan” he discussed with a mortgage broker when he was refinancing his home loan. A smart loan works as follows: Every two weeks a mortgage payment is made that is exactly one-half of the traditional monthly mortgage payment. Christie informs him that the bank does have smart loans. The APR of the smart loan would be the same as the APR of the traditional loan. Mark nods his head. He then states this is the best mortgage option available to the company since it saves interest payments.

Christie agrees with Mark, but then suggests that a bullet loan, or balloon payment, would result in the greatest interest savings. At Todd’s prompting, she goes on to explain a bullet loan. The monthly payments of a bullet loan would be calculated using a 30-year traditional mortgage. In this case, there would be a 5-year bullet. This would mean that the company would make the mortgage payments for the traditional 30-year mortgage for the first five years, but immediately after the company makes the 60th payment, the bullet payment would be due. The bullet payment is the remaining principal of the loan. Chris then asks how the bullet payment is calculated. Christie tells him that the remaining principal can be calculated using an amortization table, but it is also the present value of the remaining 25 years of mortgage payments for the 30-year mortgage.

Todd has also heard of an interest-only loan and asks if this loan is available and what the terms would be. Christie says that the bank offers an interest-only loan with a term of 10 years and an APR of 3.5 percent. She goes on to further explain the terms. The company would be responsible for making interest payments each month on the amount borrowed. No principal payments are required. At the end of the 10-year term, the company would repay the $35 million. However, the company can make principal payments at any time. The principal payments would work just like those on a traditional mortgage. Principal payments would reduce the principal of the loan and reduce the interest due on the next payment.

Mark and Todd are satisfied with Christie’s answers, but they are still unsure of which loan they should choose. They have asked Chris to answer the following questions to help them choose the correct mortgage.

QUESTIONS

4. Assume S&S Air takes out a bullet loan under the terms described. What are the payments on the loan?

5. What are the payments for the interest-only loan?

6. Which mortgage is the best for the company? Are there any potential risks in this action?

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