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You are welcome to work on this assignment in a group of up to three people, and submit a
group answer. You should submit your final answer via NYU Classes by Wednesday, March
1. Please clearly indicate the name of each of your group members on your assignment, and
use the same group members throughout the semester.
It is your responsibility to make sure your group submits the assignment on time. Late
assignments will not be accepted.
In answering the written questions, be concise and choose your words carefully. In general,
you should be able to answer the questions in a paragraph or two, and in most cases a few
sentences or bullet points will be enough to get the key points across.
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Shorter questions:
1. Read the Wall Street Journal article posted on NYU Classes for Week 1, titled Mortgage-
Rate Rise Hits Coastal Property Markets Hardest. Answer the following short questions
based on the article and the material from class:
A. What is the key reason why the effect of the post-election rise in mortgage rates is having
different effects on mortgage payments in different areas? (e.g., San Francisco vs Cochran
County TX).
B. Based on the simple Hubbard and Mayer cap rate model we discussed in class, would you
expect this rise in mortgage rates to have different effects on home price appreciation in
these different parts of the country? If so, in which direction? (Ignore any differences due to
taxes when answering this part of the question).
C. Can you think of any real world factors or complications that would alter your answer
from part B? What effect would they have and why? [be brief, just a paragraph or two at
most]
2. After graduating from NYU Stern, you join the CRE originations business at a large
commercial bank. In your first deal, your bank originates a $35m fixed rate commercial
mortgage with a 4.75% annual interest rate, 10 year term, 30 year amortization period, and
monthly payments. What is the size of the balloon payment due on this mortgage?
Please calculate the answer using the two approaches we showed in class:
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- where the balloon payment is calculated as the future value of the cash flows
between months 0 and 120.
- where the balloon payment is calculated as the present value of the payments over
the remaining amortization period from months 121 to 360.
[Although not required, we recommend you also check that you can calculate these
answers both in Excel and on your financial calculator, to make sure you can do it both
ways.]
3. Your good friend Jennifer is very optimistic about the housing market and believes that
house prices can never go down. (Jennifer didnt pay much attention to what happened
between 2006 and 2012). As a consequence, she wants to buy the most expensive home
she can possibly afford, with the idea of selling this home at a profit in a few years. She has
$4,000 per month that she can spend on the mortgage payment (and her parents offered to
help out with the down payment).
Jennifers lender has offered her three types of mortgages: a standard 30 year FRM, a 5/1
ARM with standard amortization, and a 5/1 ARM with a 5-year interest-only period. Jennifer
asks you for help.
[Note: For simplicity, ignore taxes and tax deductions for this question].
B. Go to bankrate.com to find the current interest rates on FRMs and 5/1 ARMs (assume
both the 5/1 ARMs have this same interest rate). Based on this information, what is the size
of the mortgage she would receive under the option you recommended in part A?
C. What would be the size of her mortgage if she took out the worst of the three options
given her objective (again based on the interest rates you pulled from bankrate.com).
4. Your uncle has had a standard 30-year FRM with a 5% interest rate for 2 years (24
months); the original principal was $200,000. One day he calls you up, very excitedly: My
bank offered to refinance my mortgage to a new 30-year ARM with a 2.5% interest rate.
This is awesome since the interest rate is cut in half, my monthly payment will also be cut
in half!
A. Is the second part of his statement correct? By how much does his payment go down? In
addition to showing a calculation, please try to briefly explain intuitively what is going on.
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B. How would your answer to part (a) change if your uncle had had his old mortgage for 20
years (240 months) instead?
C. How would your answer to part (a) change if the new mortgage has an initial interest only
period?
5. Property mogul Ronald Prumt considers buying a multi-family property at a cap rate of
5%. Consider the simple user cost model seen in class and assume that the after-tax
mortgage rate at which Prumt can finance the purchase is 6%/year and the maintenance
expenditure is 2%/year. What is the minimum expected future price appreciation such that
this would be a winning deal for Prumt?
[Note: For parts (i) and (ii) below, you may need to do a little independent reading (although
please dont spend too much time on this and keep your answers to these parts brief). If
you are looking for some good additional references on the topic, please click here, here
and here.]
As you may have read in the news, the new Trump administration has made some noises
about capping or eliminating the mortgage interest deduction (e.g., see here).
A. What is the mortgage interest deduction? Which types of mortgage borrowers benefit
most from it, and why?
B. The mortgage interest deduction is often criticized by economists and others. What are
some of the key problems or issues which are highlighted by these critics? Can you think of
any counterarguments?
C. Thinking about the user cost model we studied in class, what effect would cutting or
eliminating the mortgage interest deduction have on the cap rate for residential real estate.
Would this effect be larger when interest rates are low or when rates are high? Explain.
D. Using the Wheaton DiPasquale model from class, what effect would reducing the
mortgage interest deduction have on the housing market overall (prices, construction, rents
etc.). Draw the diagram, and also provide a brief intuitive explanation for what you find.
E. How would your answer to part D be different if construction was very unresponsive
to home prices? Again, back up your answer graphically using the four sector Di
Pasquale and Wheaton model. Whats an example of a city or geographic area where
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this might be a reasonable assumption? Whats an example of a city / area where it
would be a bad assumption? Which type of city is likely to have more volatile home
prices?
You take out a 15 year fixed rate mortgage for $410,000, and buy down the interest rate by
purchasing two points. After the points, the interest rate you agree to is 4.125% per annum.
You subsequently retain this mortgage for 3 years, before prepaying it. You incur a $6,000
prepayment penalty when you prepay the loan, because of a clause in the mortgage note
contract.
A. What is the monthly payment on this mortgage? How much of the initial payment is
interest, and how much is principal?
B. Over the three years, what is the total of all the interest payments you make on this loan?
What is the total value of the principal payments?
C. What is the effective interest rate (or yield) on this mortgage, given that you decided to
prepay the loan after three years?
D. Given that you paid off the loan after three years, would you have been better off (in
terms of the effective interest rate) if you hadnt paid points but taken a 4.5% interest rate?
How would this answer change if you had held the loan until maturity instead?
E. What types of borrowers would generally not want to buy points on a fixed rate
mortgage?
[Although not required, we recommend you check that you can calculate these answers
both in Excel and using your financial calculator.]
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Problem 3: Adjustable Rate Mortgages
Carefully examine the mortgage contract attached to the end of this problem set. This is for
a mortgage originated on October 1 2005, for which the first payment was due on
November 1 2005. (Be particularly careful in reading the information in sections 1-4,
describing the interest rate, reset dates, caps and floors etc. it is a bit tricky).
Using the information in the contract, answer the following questions by constructing an
Excel spreadsheet showing all the payments on this mortgage over time.
Note #1: In case not clear, please interpret the language in the mortgage contract as
follows:
- The interest rate is fixed for the first 3 years (i.e. covering the first 36 payments --
occurring on Nov 1 2005, Dec 1 2005 ... Oct 1 2008).
- The interest rate then adjusts based on the Libor rate on October 1 2008*. This new
interest rate should be applied when calculating the Nov 1 2008 payment as well as the
following five payments (Dec 2008 through April 2009).
- The interest rate then changes again, effective for the May 2009 payment as well as the
following five payments. It then continues to change every six months (each May and
November).
* October 1 is the first business day of the month immediately preceding the month of the
first change date.
Note #2: You will need some information on the six month Libor rate in order to answer the
questions. Please use the spreadsheet containing Libor data that is posted on NYU Classes.
(In practice you can also obtain this data from the Wall Street Journal, Bloomberg, FRED
etc.)
A. Using the common nomenclature of ARMs, how would you refer to this mortgage (i.e., it
is a x/y ARM, what are x and y in this case)?
B. What are the initial payments on this mortgage? (This is the amount highlighted in yellow
in section 3.B of the contract which is not filled in, but instead replaced with $????.??).
C. What is the balance outstanding on this loan at the time the interest rate first adjusts?
Assume the borrower performs on this mortgage, making scheduled interest and principal
payments for five years, before prepaying the remaining balance on October 1 2010.
D. Construct a table that summarizes the interest rate the borrower pays at each point in
time over this five year period, taking into account all the features of the contract.
E. Build a cash flow model in Excel showing for each month showing the mortgage balance,
and the principal payment and interest payments. Using your model, calculate the effective
interest rate on the mortgage, taking into account the fact the borrower prepays the
remaining balance after five years.
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F. Was this borrower lucky or unlucky regarding the date on which their mortgage
interest rate first reset? What was going on during this period?
G. For how long did the market interest rate at the first reset date affect the contract rate
on the mortgage? Would things have been substantially different if the mortgage rate was
linked to a different index, other than Libor?
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Note contract for long problem 3
Loan Number:
I will make all payments under this Note in the form of cash, check or money order. I
understand that Lender may transfer this Note. Lender or anyone who takes this Note
by transfer and who is entitled to receive payments under this Note is called the Note
Holder.
2. INTEREST
Interest will be charged on unpaid principal until the full amount of Principal has been
paid. I will pay interest at a yearly rate of 7.190%. This interest rate I will pay may
change in accordance with Section 4 of this Note.
The interest rate required by this Section 2 and Section 4 of this Note is the rate I will
pay both before and after any default described in Section 7(B) of this Note.
3. PAYMENTS
(A) Time and Place of Payments
I will pay principal and interest by making a payment every month. I will make my
monthly payments on the 1st day of each month beginning on November 1, 2005. I will
make these payments every month until I have paid all of the principal and interest and
any other charges described below that I may owe under this Note. Each monthly
payment will be applied as of its scheduled due date and will be applied to interest
before Principal. If, on October 1, 2035, I still owe amounts under this Note, I will pay
those amounts in full on that date, which is called the Maturity Date.
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or at a different place if required by the Note Holder
I may make a full prepayment or partial prepayments without paying any prepayment
charge. The Note Holder will use all of my prepayments to reduce the amount of
Principal that I owe under this Note. If I make a partial prepayment, there will be no
changes in the due dates of my monthly payments unless the Note Holder agrees in
writing to those changes. My partial prepayment may reduce the amount of monthly
payments after the first Change Date following my partial prepayment. However, any
reduction due to my partial prepayment may be offset by an interest rate increase.
6. LOAN CHARGES
If a law, which applies to this loan and which sets maximum loan charges, is finally
interpreted so that the other loan charges collected or to be collected in connection with
this loan exceed the permitted limits, then: (a) and such loan charge shall be reduced by
the amount necessary to reduce the charge to the permitted limit: (b) any sums already
collected from me that exceeded permitted limits will be refunded to me. The Note
Holder may choose to make this refund by reducing the Principal I owe under this Note
or by making a direct payment to me. If a refund reduces Principal, the reduction will be
treated as a partial Prepayment.
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(B) Default
If I do not pay the full amount of each monthly payment on the date it is due, I will be in
default.
8. GIVING OF NOTICES
Unless applicable law requires a different method, any notice that must be given to me
under the Note will be give by delivering it or by mailing it by first class mail to me at
the Property Address above or at a different address if I give the Note Holder a notice of
my different address.
Unless the Note Holder requires a different method, any notice that must be given to the
Note Holder under this Note will be given by mailing it by first class mail to the Note
Holder at the address stated in Section 3(A) above or at a different address if I am given
a notice of that different address.
10. WAIVERS
I and any other person who has obligations under this Note waive the rights of
Presentment and Notice of Dishonor. Presentment means the right to require the Note
Holder to demand payment of amount due. Notice of Dishonor means the right to
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require the Note Holder to give notice to other persons that amounts due have not been
paid.
Transfer of the Property or a Beneficial Interest in Borrower: As used in this Section 18,
Interest in the Property means any legal or beneficial interest in the Property,
including, but not limited to, those beneficial interests transferred in a bond for deed,
contract for deed, installment sales contract or escrow agreement, the intent of which is
the transfer of title by Borrower at a future date to a purchaser.
If all or any part of the Property is sold or transferred (or if Borrower is not a natural
person and a beneficial interest in Borrower is sold or transferred) without Lenders
prior written consent, Lender may require immediate payment in full of all sums
secured by this Security Instrument.
To the extent permitted by Applicable Law, Lender may charge a reasonable fee as a
condition to Lenders consent to the loan assumption. Lender may also require the
transferee to sign an assumption agreement that is acceptable to Lender and that
obligates the transferee to keep all the promises and agreements made in the Note and
in this Security Instrument. Borrower will continue to be obligated under the Note and
Security Instrument unless Lender releases Borrower in writing.
If Lender exercises the option to require immediate payment in full, Lender shall give
Borrower notice of acceleration. This notice shall provide a period of not less than 30
days from the date the notice is given in accordance with section 15 within which
Borrower must pay all sums secured by this Security Instrument. If Borrower fails to
pay these sums prior to the expiration of this period, Lender may invoke any remedies
permitted by this Security Instrument without further notice or demand on Borrower.
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