Mortgage Financing Concepts
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Questions and Answers

What happens when a mortgage note with a contract rate of 12 percent is sold to yield a 10 percent return?

  • It was sold at par.
  • It was sold at a discount. (correct)
  • It was sold at a premium.
  • There is insufficient information to determine the sale condition.

How do discount points affect effective interest rates?

  • They decrease the effective interest rate.
  • They have no effect on effective interest rates.
  • They may vary the effective interest rates depending on tax deductibility. (correct)
  • They increase effective interest rates.

What is a consequence of paying discount points if a loan is paid off early?

  • It has no impact on effective interest.
  • Its effect depends on timing in the amortization period.
  • It increases the effective interest rate. (correct)
  • It decreases the effective interest rate.

A mortgage note sold at a higher yield than the contract rate indicates it was sold:

<p>At a discount. (B)</p> Signup and view all the answers

What is true about the effect of discount points on a mortgage?

<p>They can either increase or decrease the effective interest rate. (B)</p> Signup and view all the answers

Which option describes the sale of a mortgage note at a yield lower than the contract interest rate?

<p>Sold at a discount. (B)</p> Signup and view all the answers

What may affect the effective interest rate when discount points are involved?

<p>Tax deductibility of the discount points. (A)</p> Signup and view all the answers

If a borrower pays discount points and then repays the loan early, the outcome will likely be:

<p>An elevated effective interest rate. (B)</p> Signup and view all the answers

What is the annual debt service constant on a monthly mortgage payment?

<p>Exactly twelve times the amount of the monthly constant. (B)</p> Signup and view all the answers

What defines the contract interest rate?

<p>It is the nominal rate. (A), It is the effective rate when there are no front-end fees. (C), It is the rate of interest stated in the promissory note. (D)</p> Signup and view all the answers

Which factors influence the size of the annual debt service?

<p>All of the above. (D)</p> Signup and view all the answers

If the nominal interest rate is 7% and domestic inflation is 4%, what is the real interest rate?

<p>3% (A)</p> Signup and view all the answers

What is the effective annual rate when a bank pays a stated annual interest rate of 12% with monthly compounding?

<p>12.68% (A)</p> Signup and view all the answers

What is true about the relationship between nominal and real interest rates?

<p>Nominal interest rate can be higher due to inflation rates. (D)</p> Signup and view all the answers

What happens to the real interest rate if inflation decreases?

<p>It increases. (D)</p> Signup and view all the answers

Flashcards

Mortgage note sold at a discount

The sale price of a mortgage note is lower than the remaining principal balance due to a lower yield rate for the buyer.

Mortgage note sold at a premium

The sale price of a mortgage note is higher than the remaining principal balance due to a higher yield rate for the buyer.

Effective Interest Rate

The effective interest rate is the actual rate of return on a loan, accounting for all fees and charges like discount points.

Discount Points and Effective Interest Rate

Discount points increase the effective interest rate for the borrower.

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Early Loan Payoff and Effective Interest Rate

Early loan payoff, with no prepayment penalty, reduces the effective interest rate for the borrower.

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Early Payoff and Investor Yield

The investor's yield increases when the mortgage note is paid off early with no penalty.

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Contract Interest Rate

The contract interest rate is the rate stated in the mortgage note.

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Yield to Maturity (YTM)

The yield to maturity (YTM) is the total return an investor expects to earn on a bond or note if held until maturity.

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Mortgage Note Valuation

The sale price of a mortgage note can be determined by discounting the future cash flows (payments) back to the present using the required yield for the buyer.

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Discount Points

The borrower pays points upfront to lower the interest rate on a loan.

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Annual Debt Service Constant

The annual debt service constant on a monthly payment, fully amortizing mortgage note is slightly more than twelve times the amount of the monthly constant.

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Real Rate of Interest

The real rate of interest on a fixed-rate loan is reduced when inflation increases during the period of the loan. Inflation erodes the purchasing power of the interest payments, resulting in a lower real return for the lender.

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Annual Debt Service

The size of the annual debt service depends on three key factors: the amount borrowed, the interest rate, and the repayment period.

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Real Interest Rate

The real interest rate is calculated by subtracting the inflation rate from the nominal interest rate. It reflects the true return on an investment after accounting for the erosion of purchasing power due to inflation.

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Effective Annual Rate

The effective annual rate is the actual annual interest rate earned after accounting for compounding. It is higher than the nominal interest rate due to the effect of compounding interest.

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Monthly Constant

The monthly constant represents the portion of each monthly payment that goes towards both principal and interest. It is a key factor in determining the annual debt service.

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Annual Debt Service (ADS)

The annual debt service (ADS) is the total amount of principal and interest payments made on a loan in one year. It's a measure of the overall financial burden of the loan.

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Nominal Interest Rate

The nominal interest rate is the stated interest rate on a loan. It is the rate advertised and used to calculate interest payments, but it doesn't account for inflation or compounding.

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Amortization Period

The amortization period is the length of time over which a loan is repaid. It is a key factor in determining the annual debt service, as longer amortization periods generally lead to lower monthly payments but higher total interest costs.

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Study Notes

Mortgage Note Sales

  • A mortgage note sold after two years at a yield of 10%, with a contract rate of 12%, was sold at a discount.

Effective Interest Rates

  • Effective interest rates increase when discount points are charged.

Prepayment Impact

  • Early loan repayment (no prepayment penalty) increases the effective interest rate.

Early Note Payment

  • If a note is paid off before maturity, the investor's yield decreases.

Debt Service Constants

  • The annual debt service constant is slightly less than twelve times the monthly constant for a fully amortizing mortgage.

Contract Interest Rate

  • The contract rate is the nominal rate stipulated in the promissory note.

Real Interest Rate

  • The real interest rate decreases when inflation increases during the loan period.

Annual Debt Service Factors

  • Annual debt service depends on loan amount, interest rate, and amortization period.

Nominal vs. Real Interest Rate

  • If the nominal rate is 7% and inflation is 4%, the real rate is 3%.

Effective Annual Interest Rate

  • A stated annual interest rate of 12% with monthly compounding results in an effective annual rate of approximately 12.68%.

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Description

Explore the key concepts of mortgage financing, including yield, effective interest rates, prepayment impact, and debt service constants. This quiz covers important factors that influence mortgage notes, allowing you to test your knowledge in this crucial area of real estate finance.

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