RE-160 Chapter Notes - Chapter 1: Interest Rate, Interest Rate Risk, Fixed-Rate Mortgage
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this is an ethical question regarding options ARMs posed by myinsturctor:
Alan recently joined Friendly Investment and Financing Options(FIFO) as a loan officer. FIFO is a national company thatspecializes in mortgage lending. One of Alanâs 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 âoptionâ), the amounts that must bepaid later could be substantialâas 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 âupside down,â 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 that suchloans allow those who cannot afford the monthly payments associatedwith conventional mortgages the opportunity to purchase houses. Aborrower with income that is lower than is needed to qualify for aconventional mortgage can borrow using option ARMs, choose anaffordable (lower than conventional) payment in the early years ofthe mrotgage, and then make the higher payments in later years,when their incomes presumably will be higher. Thus, option ARMspermit those who canât afford conventional mortgages to buy housestoday that they otherwise couldnât afford until years into thefuture.
Lenders such as FIFO like selling option ARMs because they canrecognize as current revenues the monthly payments that would berequired if the loans were conventional mortgages, regardless ofthe amounts that the borrowers opt to pay. In other words,companies can âbookâ revenues that will not be collected for a fewyears.
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 bad feeling about option ARMs. He knows that they aregreat lending/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).
Small business management class.
Please answer the two questions from the article belowplease.
Q1)Which one of the techniques to increase cash inflows is bestillustrated in the article? Explain how you know. ?
Q2)Which one of the techniques to decrease cash outflows is bestillustrated in the article? Explain how you know. ?
The financial crisis on Wall Street is quickly spiraling down tosmall businesses, making it extremely difficult for them to securefrom large banks the credit they need to start and maintain theiroperations.
Some businesses that currently have good relationships withbanks are getting more scrutiny and higher interest rates -- suchas 15% or more. Riskier borrowers are being denied creditaltogether.
Aside from falling back on friends or family -- or charging upyet another credit card -- here's a look at five alternatives forgetting extra cash to run a business in this economy.
-- Peer-to-Peer Lending Sites
Several Web sites now facilitate loans between individuals whodon't know each other. Typically, the prospective borrowers createprofiles that include how much they need to borrow, what the moneywill be used for and some credit history.
Other individuals can browse the loan requests and make offersthat include payment terms and interest rates. Prospective lendersalso get a risk assessment of the borrower generated by the Website based on the borrower's credit history.
Some "peer-to-peer" lending sites include LendingClub.com,Prosper.com, RaiseCapital.com and Zopa.com.
On Prosper.com, for instance, 25% of borrowers are individualsrunning or looking to start businesses, says Chief Executive ChrisLarsen. The site facilitates loans between individuals from $1,000to $25,000, and interest rates on those loans right now range from6% for those with the strongest credit ratings to about 30%.
Prosper, which has 800,000 registered users, is seeing moreentrepreneurs with good credit scores signing up. "We're certainlyseeing a steady increase of the quality of borrower coming to oursite," Mr. Larsen says. About 55% of the loans being funded are forborrowers with credit scores above 720, he adds, while only about5% are for those categorized as "subprime" borrowers.
-- Community Banks, Credit Unions
While big banks are being battered by all the financial turmoilon Wall Street, many local banks and credit unions are far morestable.
In fact, community banks continue to expand, although some havesuffered losses on securities issued by troubled mortgage giantsFannie Mae and Freddie Mac, says Camden Fine, chief executive ofthe Independent Community Bankers of America, an industryassociation in Washington.
Still, he says, even the community banks are more hesitant tolend to companies that lack rock-solid balance sheets.
-- Factoring, Asset-Based Loans
Though certainly not a cheap route to capital, some banks andnon- bank financing companies offer financing that is backed by abusiness's assets or accounts receivable.
So-called factoring, where a lender might, say, outright give aborrower 80 cents on the dollar for the company's accountsreceivable, can be a good option for businesses like manufacturersthat are owed a lot of money by customers and that have no betterlending option right now, says Raphael Amit, an entrepreneurshipprofessor at the University of Pennsylvania's Wharton School.
Interest rates on such financing can sometimes run 15% orhigher, so it's best to only resort to this approach when there'sno lower-cost option.
So-called asset-based loans -- loans in which assets such asinventory, equipment or real estate are used as collateral -- canbe good options for companies with lots of assets. But again, ratestend to run much higher than on traditional bank loans. The loanamounts are often capped at a percentage of the assessed value ofthe assets, such as 65%.
Also, even loans backed by assets can be difficult to get forcompanies with less-than-stellar credit ratings. Mark Sunshine,president of First Capital, a West Palm Beach, Fla., financecompany, says he's seeing more demand for loans based on accountsreceivable or assets, but isn't necessarily doing much morebusiness. "There's a reason local banks won't lend them money," hesays of riskier small companies. He says he's sticking to companieswith lots of assets to use as collateral.
-- Negotiating With Customers or Suppliers
Another smart strategy for helping cash flow -- perhaps even ifyou do have access to loans -- is striking better payment termswith customers and suppliers, Prof. Amit says. Especially whenbusiness relationships are strong and long-lasting, many companiesare willing to help each other out in tough economies.
A business that usually gives customers 30 to 60 days to pay thebills, for instance, might require customers to pay upon receipt ofgoods. A supplier, on the other hand, might be willing to extendlengthier payment terms to a business customer if it feels thecustomer is trustworthy and vital to its own business. Somesuppliers also will lend money to their longstanding, most valuedcustomers.
-- Changing Behaviors
Hard times call for small businesses to be nimble andentrepreneurial. Many businesses are using the tough economy toscrutinize their business practices and find creative ways tocreate better cash flow.
Some turn to leasing instead of buying equipment they need.
Others are identifying areas of the business that will tend tobe more lucrative in today's economy and shifting their resourcesin those directions.