RE-160 Chapter Notes - Chapter 1: Negative Amortization, Discount Points, Interest Rate Risk
Lenders preference in increasingly shifting from price level adjusted mortgages to mortgages with interest rates that are indexed to other market interest rates. Lenders thus avoid the hassle of estimating real interest rates and risk premiums for the term period of the loan. Lenders earn expected yields based on expected future values for r, p and f over a future period of time. Note that such indices are continuously updated in the market eg base rates, Arm adjustments are therefore more timely for lenders than plam. Arm indexes interest rate risk: interest rates on 6 month treasury bill, interest rate on 1-year treasury securities, interest rate on 3-year treasury securities, interest rate on 5-year treasury securities, weighted average national cost of funds (deposits) Problems with arms faced by lender and borrowers: complex and difficult to understand borrowers, uncertainty when making arms lenders, lack of market experience borrower, increase of risk of default lender. Affects borrower ability to make mortgage payments.