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Unit 8 Seminar: Mortgages Professor Otis D. Jackson ojackson@kaplan.edu

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Monthly mortgage payment from a table Monthly mortgage payment from a formula Total interest on a mortgage Principal, Interest, Taxes, and Insurance payments Amortization Qualifying ratios 2

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Market value: the expected selling price of a property. Collateral: the property that is held as security on a mortgage. Mortgage: a loan in which real property is used to secure the debt. Conventional mortgage: a mortgage that is not insured by a government program. First mortgage: the primary mortgage on a property. Equity: the difference between the expected selling price and the balance owed on the property. An equity line of credit, or second mortgage, allows a homeowner to borrow against the equity in the home. It is in addition to the first mortgage. 3

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The repayment of a loan in equal installments that are applied to principal and interest over a period of time is called the amortization of a loan. To calculate the monthly mortgage payment, use a per-$1,000 monthly payment table. Table 8-1 in your lecture notes. 1. Calculate the amount financed = Purchase price – down payment. 2. Find the number of $1,000’s of the amount financed = amount financed ÷ $1,000. Call this value “#Thousands”. 3. Using the number of years financed and the annual interest rate find the associated value on the payment table. 4. Monthly mortgage payment = #Thousands * Table value 4

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Ms. Miller is purchasing a home for $87,000. Her loan application has been approved for a 30-year fixed-rate loan at 7% annual interest. Ms. Miller pays 20% of the purchase price as a down payment, calculate the monthly payment. Down Payment = $87,000(0.20) = $17,400 Amount Financed = $87,000 - $17,400 = $69,600 #Thousands= $69,600 ÷ $1,000 = $69.6 Use the table to find the factor for financing a loan for 30 years with a 7% annual interest rate. Table factor = 6.65 Monthly payment = $69.6 * 6.65 = $462.84 The monthly payment of $462.84 includes both, principal and interest. 5

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Joan Williams has been approved for a 30-year fixed-rate loan at 6.5%. The home that she is purchasing costs $140,000; she is going to put 20% down. Calculate her monthly payment including principal and interest using the table. 6

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Calculate the down payment: $140,000 * 0.20 = $28,000 Amount financed = $140,000 - $28,000 = $112,000 Divide $112,ooo by $1,000 to get #Thousands = 112 Using the lecture note table, find the factor for financing a loan for 30 years at 6.5%. Table factor = 6.32 Monthly payment = Table factor * #Thousands Monthly payment = 6.32 * $112 = $707.84 The monthly payment of $707.84 includes the principal and the interest. 7

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M = P * [R ÷ (1 -(1 + R) -N )] R =monthly rate as a decimal equivalent N = number of months P = loan principal Reworking our first example: Ms. Miller took an $87,000 loan for 30 years at 7%. We calculated the principal amount financed = $69,600 R = 7% ÷ 12 = 0.07 ÷ 12 = 0.005833 N = 30 * 12 = 360 M = 69,600[0.005833 / (1 - (1 + 0.005833) -360 )] M = $463.05 But earlier we calculated $462.84? This is because of the decimal places carried out in the formula vs. the table shorthand. This would work itself out in the final payment to the bank. 8

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Find the total number of payments: multiply the number of payments by the amount of the payment. Subtract the amount financed from the total of the payments. (No. of payments * amount of payment) - amount financed = total interest Back to our example: Our $87,000 loan for 30 years at 7% interest with a 20% down payment netted a monthly payment of $462.84. Total interest = [(12 payments/year * 30 years) * $462.84] - $69,600 Total interest =(360 * $462.84) - $69,600 Total interest = $166,622.40 - $69,600 The total interest paid is $97,022.40 9

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Joan Williams’ monthly mortgage payment is $707.84. Find the total interest on her 30-year mortgage. The amount financed is $112,000. Find the total interest on the mortgage. 10

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We are given: Amount of payment for principal and interest = $707.84 Time is 30 years Amount Financed = $112,000 Total interest = (number of payments * amount of payment) – amount financed. TI = ((30 * 12) * $707.84) - $112,000 TI = $166,622.40 - $112,000 The total interest on this loan is $142,822.40 11

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The adjusted monthly payment that includes the principal, interest, taxes and insurance is abbreviated “PITI.” Our previous work teaches us how to calculate the principal and interest. Taxes and insurance are often billed yearly so their monthly costs need to be calculated by ÷ 12. The monthly mortgage payment that the borrower will make each month will typically include all four elements. 12

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Our home buyer has a monthly payment of principal and interest of $462.84. If her annual insurance premium is $560 and the property taxes are $985, find the adjusted monthly payment that includes PITI. Monthly principal + interest payment = $462.84 Annual taxes = $985, Monthly taxes = $985/12 = $82.08 Annual insurance = $560, Monthly insurance = $560/12 = $46.67 PITI = Principal + Interest + Taxes + Insurance PITI = $462.84 + $82.08 + $46.76 = $591.59 The adjusted monthly payment = $591.59 13

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Trying to determine whether to accept a 25-year 6.5% mortgage or a 20-year 6% mortgage, Quan Wau needs to finance $125,700 and has budgeted $1,000 for his monthly payment. His insurance agent says the new place will cost $475 per year to insure. Taxes in this area are $1,200 annually. Which mortgage should Quan choose given his budget constraints? 14

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Let’s list what we know: Quan’s monthly PITI budget = $1,000 Taxes = $1,200 annually Insurance = $475 annually Financed amount = $125,700 (purchase price – down payment) Number of $1,000 financed = $125,700÷$1,000 = $125.70 Table 8-1 in the lecture notes gives us monthly payments of a $1,000 mortgage for a given rate and years financed P + I payment = Number of $1,000 financed * table value And we have two options to work out: Option 1: 25 year mortgage @ 6.5% Option 2: 20 year mortgage @ 6.0% What is the monthly mortgage payment for each option? 15

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Number of $1,000 financed = $125,700÷$1,000 = $125.70 P+I payment = Number of $1,000 financed * table value Taxes = $1,200 annually ÷ 12 = Monthly taxes of $100 Insurance = $475 annually ÷ 12 = Monthly insurance of $39.58 Option 1: 25 year mortgage @ 6.5% Table 8-1 value for 25 years at 6.5% = 6.75 P+I payment = $125.70 * 6.75 = $848.48 PITI payment = $848.48 + $100 + $39.58 = $988.06 Option 2: 20 year mortgage @ 6% Table 8-1 value for 20 years at 6.0% = 7.16 P+I payment = $125.70 * 7.16 = $900.01 PITI payment = $900.01 + $100 + $39.58 = $1,039.59 > $1,000 16

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We also know: Total mortgage = Number of payments * monthly payment Total interest paid = Total mortgage – amount financed Option 1: 25 year mortgage @ 6.5% P+I payment = $125.70 * 6.75 = $848.48 Total mortgage = (12*25)*$848.48 = $254,544 Total Interest paid = $254,544 - $125,700 = $128,844 Option 2: 20 year mortgage @ 6% P+I payment = $125.70 * 7.16 = $900.01 Total mortgage = (12*20)*$900.01= $216,002.40 Total Interest paid = $216,002.40 - $125,700 = $90,302.40 17

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Option 1 PITI = $988.06 Option 2 PITI = $1,039.59 With Quan’s monthly budget of $1,000 for housing expenses, Option 1 is the better option. Option 1 Interest paid = $128,844 Option 2 Interest paid = $90,302.40 However, if Quan can find the additional $39.59 each month, he can save $128,844 - $90,302.40 = $38,541.60 over the life of the loan. The length of the loan can have a tremendous effect on your total interest and be a bigger driver of costs than the rate. 18

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An amortization schedule is given to homeowners shows the amount of principal and interest for each payment of the loan. Extra amounts paid with the monthly payment are credited against the principal, allowing for the mortgage to be paid sooner. Example of a $28,500 loan over 15 years: 19 MonthMonthly Payment Interest Paid Principal Paid End of Month Principal 1$213.14$202.55$10.59$28,489.41 2$213.14$201.85$11.29$28.478.12 …………… 180$211.21$11.18$200.03$0

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Step 1: For the first month ▪ Find the interest portion of the first monthly payment = original principal * monthly interest rate. ▪ Find the principal portion of the monthly payment = monthly payment – interest portion of the first monthly payment. ▪ Find the end of month principal = original principal – principal portion of the first monthly payment. 20

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Step 2 (for each remaining month) ▪ Find the interest portion of the monthly payment = previous end-of-month principal * monthly interest rate. ▪ Find the principal portion of the monthly payment = monthly payment – interest portion of the monthly payment. ▪ Find the end-of-month principal = previous end-of month principal – principal portion of the monthly payment. 21

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Remember from the first home buyer example, the amount financed was $69,600 and the monthly payment was $462.84. Step 1: Interest = original principal * monthly rate Interest = $69,600 * (0.07/12) (convert annual rate to a monthly rate) Interest = $406.00 Principal portion of the monthly payment = $462.84 - $406 = $56.84 End-of-month principal = $69,600 - $56.84 = $69,543.16 22

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Step 2: Interest portion = End of period 1 principal * monthly rate $69,543.16 * (0.07 ÷ 12) = $405.67 Principal portion of monthly payment = $462.84 - $405.67 = $57.17 End of month principal = $69,543.16 - $57.17 = $69,485.99 Follow the same steps for subsequent months. To generate an amortization schedule that shows the interest and principal breakdown for each payment of the loan, software programs, such as Excel are normally used. 23

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Joan Williams has a monthly mortgage payment of $707.84, an original loan amount of $112,000 and a 6.5% interest rate. Calculate the first two months of an amortization schedule. 24

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Step 1 Interest = $112,000 * (0.065/12) = $606.67 Principal portion of the monthly payment = $707.84 - $606.67 = $101.17 End-of-month principal = $112,000 - $101.17 = $111,898.93 Step 2 Interest portion = $111,898.03 * (0.065 / 12) = $606.11 Principal portion of monthly payment = $707.84 - $606.11 = $101.73 End of month principal = $111,898.20 - $101.73 = $111,797.09 25 MonthInterest Paid Principal Paid End of Month Principal 1$606.67$101.17$111,898.93 2$606.11$101.73$111,797.09

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Lending institutions examine first, your credit report, and then mortgage ratios to determine loan applicants' capacity to repay a loan. By dividing the amount mortgaged by the appraisal value of the property, the loan-to-value ratio (LTV) is found. If this ratio, when expressed as a percent, is more than 80%, the borrower may be required to purchase private mortgage insurance (PMI). Loan-to-value ratio = Amount mortgaged (bank risk) Appraised value of property 26

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By dividing your fixed monthly expenses by your gross monthly income, the debt-to-income ratio (DTI) or back-end ratio is found. The debt-to- income ratio should be no more than 36%. Fixed monthly expenses are monthly housing expenses (PITI plus any other expenses directly associated with home ownership), monthly installment loan payments, monthly revolving credit line payments, alimony and child support, and other fixed monthly expenses. Income from employment, including overtime and commissions, self-employment income, alimony, child support, Social Security, retirement or VA benefits, interest and dividend income, income from trusts, partnerships and so on are all considered monthly income. Debt to income ratio = Total fixed monthly expenses (what you can afford) Gross monthly income 27

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By dividing the monthly housing expenses (PITI) by your gross monthly income, the housing ratio or front-end ratio is found. In most cases the housing ratio should not exceed 28%. A rule of thumb often used is that no more than one week of your salary each month goes to PITI. Housing ratio = Total mortgage payment (PITI) (housing burden) Gross monthly income 28

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Reminder of what to complete for Unit 8: Discussion = initial response to one question + 2 reply posts MML assignment Instructor graded assignment (download from doc sharing) Seminar quiz if you did not attend, came late, or left early 29

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