real estate finance exam 2 Questions With Multiple Choices And Verified Answers.

incremental borrowing cost - correct answer calculations: -what is the real cost of borrowing money at higher interest rate? and what is the required return to justify my lower down payment? basic principal when comparing choices: what are the cash flow differences? assumable loans - correct answer buyer can assume sellers existing mortgage -now why would the owner be willing to give you a below market rate? a seller with below market rate assumable loan in place may be able to sell the property for more than the seller would otherwise be able to -a buyer is paying a higher purchase price now in exchange for lower debt payments over the life of the loan -compute Interest rate and compare it to other equivalent risk investments effect of LTV ratio on loan cost - correct answer -the more you borrow the higher the interest rate will be -it is not economically rational to borrow as much money as possible because the interest rate will be to high accounting for holding period - correct answer -how much should i borrow? calculations: different fees - correct answer differences in maturity - correct answer refinance or no refinance, with and without PPP - correct answer refinance: pay off current loan with new loan - why refinance?= cash, contractually required, get a lower rate things to consider when refinancing: -how much to pay of the original loan today? -what is the new mortgage payment? -how much will you save every month? -it cost(blank) today to get those monthly savings what is the return on investment? effective cost of multiple loans - correct answer calculations: -compute payment for the loans -combine into cash flow stream -compute the effective cost of the amount borrowed given the cash flow stream -compare the cost to alternative financing options assume or not assume - correct answer -common in 70 and 80s for residential not common for commercial two options: 1. buy the property with market financing 2. assume the current owners loans and get a second mortgage at the market rates -assume if the cost of assuming and getting a 2nd mortgage is less than the cost of 1 loan pricing with an assumable loan - correct answer -calculate PMT on assumable loan -how much would the buyer be able to borrow at market rates and get that payment? -benefit to buyer /borrower of below market financing= cash equivalent(CE) value of seller financing(FP) builder buy down - correct answer temporarily buys down borrowers PMT for a certain period of time -what builder pays lender upfront for buy down is the same as if they just lowered the price and they do this so the transaction price does not reflect the incentives given two embedded options in mortgages - correct answer -prepayment call option -default prepayment(callability)risk - correct answer call option embedded in contract that gives borrowers the right to pre pay outstanding balance -only exercise when " in the money" -substantial decrease in rates= refinance -any increase in rates= hold tight LENDERS ALWAYS worse with a change in interest rates, most acute in FRM non strategic prepayment - correct answer need to move strategic prepayment - correct answer cash out:remove acquired equity -depends on opportunity cost and TVM -also possible to take out 2nd mortgage lower effective borrowing cost: -new loan to prepay existing loan -decrease in interest rates -bad for lenders because they have to reinvest at a lower rate value of repayable versus non-callable mortgage to lender - correct answer how do lenders mitigate prepayment risk - correct answer -defeasance -yield maintenance -fixed penalty -hard lock out lockout clause - correct answer does not allow prepayment -common in commercial mortgages -shorter than full loan period a fixed PPP - correct answer borrower must pay % more than OMB PPP(prepayment penalty) - correct answer takes away potential benefits that borrowers gain from rate refinancing -reduce value of call option, however doesn't eliminate the value of the option entirely variable PPP - correct answer very common for commercial RE loans -yield maintenance fee -defeasance -index penalty to rate of reinvestment yield maintenance fee - correct answer gurantees minimum yield -indexed to T bond -borrower pays penalties based on changes in T bond -PV of lost cash flows at maintained yield defeasance - correct answer common on conduit(MBS) loans, type of variable prepayment that uses collateral substitution -buy government securities that replicate mortgage CF's and give them to the lender to be released from the mortgage -super expensive for the buyer because bonds do not have high rates -why do this? defeasance gets around legal issues