CHAPTER FOUR

FIXED RATE
MORTGAGE LOANS
 Chapter Objectives
• Characteristics of constant payment
(CPM), constant amortization (CAM),
and graduated payment mortgages
(GPM)
• Effective cost of borrowing v.s. lenders
effective yield
• Calculate discount points or loan
origination fees
Determinants of Mortgage
Interest Rates
• Real rate of interest- the required rate
at which economic units save rather
than consume
• Rate of inflation
• Nominal rate or constant rate i= r+f
• Nominal rate= real rate plus a
premium for inflation
Determinants of Mortgage
Interest Rates

• Default risk- creditworthiness of borrowers

• Interest rate risk- rate change due to market
conditions and economic conditions
• Prepayment risk- falling interest rates
• Liquidity risk
• i=r+ f+ P…
Development of Mortgage
Payment Patterns
• Constant amortization mortgage
(CAM)
• Constant payment
• Interest computed on the monthly loan
balance
• Constant amortization amount
• Total payment= constant amortization
amount plus monthly interest
Development of Mortgage
Payment Patterns
• Constant payment mortgage (CPM)
• Constant monthly payment on original
loan
• Fixed rate of interest for a given term
• Amount of amortization varies each
month
• Completely repaid over the term of the
loan
Development of Mortgage
Payment Patterns

• Graduated payment mortgage (GPM)

• Mortgage payments are lower in the
initial years of the loan
• GPM payments are gradually increased
at predetermined rates
 Loan Constants

• Used prior to financial calculators

• Loan constant=
annual debt service
original loan balance
 Loan Closing Costs and
Effective Borrowing Costs

• Statutory costs

• Third party charges

• Additional finance charges i.e. loan

discount fees, points
 Effective Interest Cost
Examples

• Contractual loan amount $60,000

• Less organization fee(3%) $ 1,800
• Net cash disbursed by lender $58,200
• Interest rate= 12%
• Term 30 years
 Effective Interest Cost
Examples Continued

• Calculator solution
– n=360
– PMT= -617.17
– PV= 58,200
– FV= 0
– i=1.034324 (12.41% annualized)
Other Fixed Rate Mortgages

• Characteristics and Requirements:

• Regulation Z- truth in lending (APR)
• RESPA- Real Estate Settlement
Procedures Act
• Prepayment penalties and other fees
• Reverse annuity mortgages (RAMs)
 Reverse Annuity
Mortgage Example

• Residential property value $500,000

• Loan amount (to be disbursed
• in monthly installments) $250,000
• Term 10 years 120 months
• Interest Rate 10%
 Reverse Annuity
Mortgage Example Continued
• Calculator solution:
– FV=-250,000
– i=10%/ 12
– PMT= ?
– n=120
– Solve for payment $1220.44