RF PPT Lesson 1.ppt

Financing Residential Real Estate Lesson 1: Finance and Investment © 2018 Rockwell Publishing Introduction This lesson will cover:  mortgage financing  investments and returns  types of investments  investment risks  market interest rates © 2018 Rockwell Publishing Borrowing for Home Purchase B...

Financing Residential Real Estate Lesson 1: Finance and Investment © 2018 Rockwell Publishing Introduction This lesson will cover:  mortgage financing  investments and returns  types of investments  investment risks  market interest rates © 2018 Rockwell Publishing Borrowing for Home Purchase Buyer’s ability to afford a home depends on:  housing prices  income level  tax considerations  mortgage financing available  many other factors © 2018 Rockwell Publishing Borrowing for Home Purchase Typical loan transaction:  Lender loans buyer portion of purchase price.  Buyer makes downpayment.  Buyer executes security instrument (mortgage or deed of trust), creating lien.  Lien released when loan paid off. © 2018 Rockwell Publishing Borrowing for Home Purchase Buyers repay loan with monthly payments over specified period.  Loan term: period of loan repayment.  Principal: amount borrowed.  Interest: cost of borrowing money. © 2018 Rockwell Publishing Borrowing for Home Purchase Lender sees loan as an investment.  Interest paid by buyer is lender’s profit from investment. © 2018 Rockwell Publishing Investments and Returns National economy is driven in part by investment capital: money used to fund business enterprises, ventures, projects. © 2018 Rockwell Publishing Investments and Returns Investor’s return takes various forms:  Return on investment: profit over and above the amount originally invested.  Return of investment: getting full amount originally invested back (also called recapture). © 2018 Rockwell Publishing Summary Investments and Returns Principal Loan term Interest Investment capital Return on investment Return of investment © 2018 Rockwell Publishing Types of Investments Two general categories of investments:  ownership investments  debt investments © 2018 Rockwell Publishing Types of Investments Ownership investments Ownership investment: asset (or property interest in an asset) purchased by investor:  generates income, and/or  appreciates in value over time. Return in the form of appreciation ordinarily not realized by investor until asset is sold. © 2018 Rockwell Publishing Ownership Investments Real estate Real estate is example of ownership investment. It may:  produce income (rent), and/or  appreciate in value. © 2018 Rockwell Publishing Ownership Investments Corporate stock Corporate stock another example of ownership investment.  Shares = ownership interest in corporation.  Stockholder’s return may take form of: dividends, and/or appreciation of stock value. © 2018 Rockwell Publishing Types of Investments Debt investments Debt investment: investor provides money to individual or company that will repay money along with interest. Examples: loans, bonds, savings accounts. © 2018 Rockwell Publishing Debt Investments Loans Loan that earns interest for lender is debt investment. Includes residential mortgage loans.  Bank makes debt investment by loaning money to home buyers.  Home buyers make ownership investment by investing money to purchase asset. © 2018 Rockwell Publishing Debt Investments Bonds Bond: certificate of indebtedness issued by governmental body or business entity.  Coupon rate: interest rate paid on bond.  Principal: face amount of bond. © 2018 Rockwell Publishing Debt Investments Savings accounts Funds deposited into savings accounts are used by bank to make loans to other borrowers.  Depositor loans money to bank and receives interest in return.  Bank makes another debt investment (loan to another customer). © 2018 Rockwell Publishing Debt Investments Certificates of deposit Certificates of deposit (CDs): similar to savings accounts.  Depositor agrees to keep funds on deposit for certain time period in return for interest payments.  Bank can charge penalty for early withdrawal of funds. © 2018 Rockwell Publishing Types of Investments Securities Securities: investment instruments that grant holder interest or right to payment, but no managerial control.  May be ownership or debt investments.  Liquid assets = quickly converted to cash.  Traded in established financial markets.  Examples: stocks, bonds. © 2018 Rockwell Publishing Securities Mutual funds Mutual fund: company that buys and sells stocks, bonds on behalf of investors.  Investors purchase shares in company.  Company uses capital to invest in securities.  Fund managers choose which securities to buy and sell. © 2018 Rockwell Publishing Securities Regulation of securities Issuance and trading of securities regulated by federal Securities and Exchange Commission (SEC).  Requires companies to disclose financial information to public.  Enforces insider trading rules. © 2018 Rockwell Publishing Securities Securities and the mortgage industry Securities trading affects mortgage lending in two ways:  Mortgage lending competes with other investments for funds.  Mortgages can be pooled together and “securitized” for sale to investors as mortgage-backed securities. © 2018 Rockwell Publishing Summary Types of Investments Ownership investments Debt investments Corporate stock Savings accounts Securities Liquid assets Mortgage-backed securities © 2018 Rockwell Publishing Key Investment Characteristics Investors look at three potential investment advantages:  safety  liquidity  yield © 2018 Rockwell Publishing Key Investment Characteristics Safety Investment is safe if there’s little risk that investor will actually lose money. Investor can count on return of investment, if not return on investment. © 2018 Rockwell Publishing Key Investment Characteristics Liquidity A liquid investment can be converted into cash (liquidated) quickly. Illiquid investments “lock up” investor funds, making them unavailable for other purposes. © 2018 Rockwell Publishing Key Investment Characteristics Yield Investment’s yield is its rate of return.  Low yield = safe and liquid investments.  High yield = high risk/illiquid investments. Yield isn’t necessarily fixed when investment is made. © 2018 Rockwell Publishing Key Investment Characteristics Diversification Investor diversifies portfolio by putting money into variety of different investments. Portfolio: a mix of investments and cash reserves. © 2018 Rockwell Publishing Investment Risk Lending risks From lender’s point of view, risks involved in mortgage lending include:  risk of default  risk of loss  interest rate risk  prepayment risk © 2018 Rockwell Publishing Lending Risks Risk of default Degree of risk for loan depends on likelihood of borrower default.  Underwriting process screens loan applicants for risk. Lender may charge borrower more to compensate for extra risk. © 2018 Rockwell Publishing Lending Risks Risk of loss Lenders take steps to limit risk of financial loss in event of default/foreclosure or damage to collateral property. Steps include:  appraising property  requiring borrower to maintain hazard insurance  requiring mortgage insurance for some loans © 2018 Rockwell Publishing Lending Risks Interest rate risk If market rates rise after loan is made at a certain interest rate, lender can’t reinvest money at higher rate.  Risk increases with length of loan term.  Lenders deal with risk by: using adjustable-rate mortgages selling loans on secondary market © 2018 Rockwell Publishing Lending Risks Prepayment risk Prepayment: borrower repays all or part of principal before it’s due.  Decline in interest rates = borrowers refinance and prepay existing loans.  Prepayment = lender’s yield is less. Some lenders compensate for reduced yield by charging prepayment penalty (restrictions apply). © 2018 Rockwell Publishing Investment Risk Misjudging risk Investors who underestimate risk of particular investment may get lower yield than expected or even lose money. Poor investment decisions may result from:  inaccurate information  deception  bad judgment © 2018 Rockwell Publishing Market Interest Rates Market interest rates: typical rates lenders are currently charging borrowers for loans. Can be influenced by:  size of loan  whether rate is fixed or adjustable  loan term  borrower’s credit score © 2018 Rockwell Publishing Market Interest Rates Mortgage rates have considerable impact on real estate activity.  High rates cause slowdowns in real estate activity.  Low rates spur market. Mortgage rates also respond to changes in supply and demand. © 2018 Rockwell Publishing Summary Investment Risk Safety Liquidity Yield Diversification Risk of default Risk of loss Prepayment Market interest rates © 2018 Rockwell Publishing