Due:

Oct 5, 2015
Thu, Oct 22

HW 1
FRL 383
Full points 50. For any spreadsheets you hand in you must hide repetitive rows so that,
for example, an amortization sheet fits onto 1, 2 at most, pages [5pt deduction
otherwise]. Show only the first few months and the last few, and, if applicable, any
intermediate rows where things change. You must annotate excel tables and show all
work, even if your answer is right, to get full points. Note that in an exam, youll only
be allowed a financial calculator so make sure you can do the problems that way,
too.
Staple all pages. Put your name on the front of the first page, AND back of the last
page you hand in. [1pt]
1. [14 pts] A fully amortizing CPM for $100,000 is made at 8% MEY for 20 years
a. [2] Calculate the monthly payment.
b. [2] Assume the loan is repaid at the end of 8 years. What is the
outstanding balance?
c. [4] Produce an amortization sheet, annotate it. See instructions above.
d. The borrower chooses to curtail the loan by $5,000 at the end of year 5.
i. [3] What will be the new loan maturity, assuming the payments
do not change?
ii. [3] Assume the loan maturity will not change. What are the new
payments?
2. [8 pts] John wants to buy a property for $105,000 and wants an 80% loan. The
lender indicates that a fully amortizing loan can be obtained for 30 years at 12%
MEY, with loan origination fees (all lender controlled fees) of $3,500.
a. [1] How much will the lender actually disburse?
b. [3] What is the effective interest cost to the borrower, assuming that the
mortgage is paid off after 30 years?
c. [2] If John pays off the loan after 5 years, what is the effective interest
charge? Why is it different from the APR in b?
d. [2] Assume the lender also imposes a prepayment penalty of 2% of the
outstanding balance if the loan is repaid within the first 8 years of closing.
What is the effective cost of the loan if John repays after 5 years?
3. [6 pts] A borrower is faced with choosing between two loans. Loan A is available
for $75,000 at 10% MEY for 30 years, with 6 points included in the closing costs.
Loan B would be made for the same amount, but for 11% MEY for 30 years, with
2 points included in the closing costs. Both loans would be fully amortizing.
a. [4] If the loan is to be repaid after 15 years, which is the better choice?
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b. [2] If the loan is repaid after 5 years, which is the better choice?
4. [12] A reverse annuity mortgage is made with a balance not to exceed $300,000
on a property now valued at $700,000. The loan calls for monthly payments to
be made to the borrower for 120 months at an interest rate of 11% MEY.
a. [3] What will the monthly payments be?
b. [3] What will the RAM balance be at the end of year 3?
c. [4] Assume that the borrower must have monthly draws of $2,000 for the
first 50 months of the loan. The remaining draws from months 51 to 120
must be determined so that the $300,000 maximum is not exceeded in
month 120. What will the draws by the borrower be during months 51 to
120?
d. [2] Suppose property experiences a 1% appreciation (MEY, starting
today), and the borrower has a balance of $300,000 at year 10 (by
receiving payments computed in a). No payments are made thereafter.
How many years from loan closing will the loan balance begin to exceed
the house value?
5. [5] Refer to question 4, part d. The fact that healthy borrowers with longer
expected lives, or individuals that do not expect to move, are more attracted to
RMs than the opposite type of individuals is called adverse selection (the
lender will tend to get the worst kind of borrower, from her point of view).
Go to www.ssrn.com, under Search, look for terms Reverse Mortgage with
author Davidoff. Download the paper on selection and moral hazard. The
authors have found that in the last 15 years, lenders have experienced positive
selection (the opposite of adverse selection), in that RM borrowers have tended
to leave their homes faster than the population average. What is their proposed
explanation for this puzzling result, and can you think of an alternative one?
6. [5] Download the paper Measuring Housing Affordability, by Davidson and
Levin which was posted along with this HW document on BB. Discuss why the
authors disagree with the NAR about the affordability of homeownership as of
the date of the article.