FI 413 Exam 2
Terms in this set (124)
What are the monthly payments on a 30-year, 6%, $280,000 fixed rate mortgage?
What is the remaining principal after 10 years on a 30-year, 6%, $280,000 fixed rate mortgage?
Do partial prepayments on a fixed-rate fully amortizing mortgage (1) reduce future required monthly payments to maintain the original term, or (2) effectively reduce the term of the loan?
Partial payments effectively reduce the term of the loans.
Calculate the monthly payment and the balloon payment for a $280,000 loan with 7-year maturity and a 30-year amortization period if the interest rate is 6% compounded monthly.
Suppose you are advising a borrower that is offered the choice of a 30-year amortization, 7-year maturity balloon at 4%, and a fully amortizing 30-year loan at 4.25%. What types of borrowers should choose the balloon?
Selling house soon, take the low interest rate
Compute the monthly payments for months 12 and 120 on a 5%, 30-year, $150,000 interest-only mortgage with a 5-year interest only period.
Compare a fully amortizing 30-year mortgage with an interest-only (for 10 years) 30-year mortgage. All else equal, which of the two loans is riskier for the lender?
interest-only, because the value of house could go down without any principal paid back
Comparing a $200,000 5% 15-year mortgage to a 6% 30-year fixed rate mortgage, ______will have lower monthly payments.
Controlling for LTV, FICO, and debt-to-income ratios, should the rate on a $500,000 mortgage be any different than the rate on a $350,000 mortgage in Michigan? Explain.
No, because 500,000 is not jumbo in a higher cost area, but maybe elsewhere.
The down payment is $200,000 on a house with an agreed-upon price (and appraisal) of $700,000. Jumbo mortgage rates are 4.7% and conforming rates are 4.4%. If the conforming loan limit is $424,100 in the area, then the breakeven rate on a second mortgage piggyback arrangement is _____.
From the WSJ article, what explains the trend in jumbo mortgage originations? What key risks do banks face in holding such loans on the balance sheet?
People are low-risk. Banks face interest rate risk because our loans are for so long.
As a potential homebuyer, if you are offered a fixed-rate mortgage at 4% and a 1-year ARM at 4%, and you expect market interest rates to fall in the future, you should choose the _______. Explain.
Bank X offers a 1-year ARM with a first-year rate of 5.0% and a 2% per year cap. The current index rate is 2% and the margin is 3%. If the index rate jumps to 4.8% after one year, what rate will be charged in the second year of the mortgage? If the index is 3.4% at the end of year two, what rate will be charged in year three?
7 year 2, 6.4% year 3
The initial rate on a 3/1 ARM is 3.5%, the margin is 2.75%, and the index is the 1-year T-bill, now 0.70%. Assuming a 2% per year cap and a 5% lifetime cap, what will be the interest rates charged in the fourth and fifth years if the index is 1% at the end of year 3 and 3.5% at the end of year four? What is the maximum rate that can ever be charged on this mortgage?
At the end of year 4, 5.75%. Maximum that could be on lifetime is 8.5% (initial+lifetime)
As a lender, can making a loan with (possible) negative amortization ever be justified? Explain why or why not.
A lender could make this only if property values are rising faster than the loan.
A lender offers 15-year mortgages at 4.5% with no points, and 4.125% with 1.5 points. What is the crude breakeven point in years for the borrower? True breakeven is _______ than that.
4 years, better
Paying 1 discount point to save 1/8% on the rate is a _______ idea for a 30-year mortgage than for a 15-year mortgage.
Better, you get interest savings for more years. Points are banks property, so you shouldn't use them if you're moving either.
discount points, loan origination fees, mortgage insurance premiums, mortgage broker fees, transaction fees.
APR doesn't include
application fees, survey, title, taxes, appraisal and credit report fees.
In a competitive market for 30-year fixed rate mortgages, all else equal, which will have the lower Annual Percentage Rate (APR), a loan with 1 discount point or a no-points loan? In other words, which loan will appear cheaper?
The loan with 1 discount point will have a lower APR, because APR assumes the borrower will live-out the full 30-year mortgage.
In the APR calculation for ARMs, how is the PMTt calculated after the rate starts to adjust, like in years four and beyond on a 3/1 ARM? Explain.
Once adjustments start, the monthly payments are based on the remaining principal at the time, using an assumed interest rate of the current index plus margin now, subject to the cap if binding. We ASSUME IRs CONSTANT.
In what situations is the APR a reasonably good estimate of the true annualized cost of a mortgage loan? In what situations is it a poor estimate, and does the APR underestimate or overestimate the true cost?
APR is a good estimate when you think you're going to keep your house for a long-time.... It's a poor estimator when you have a lot of up-front fees.
Dodd-Frank Ability to Repay
Mortgage lenders must make a "reasonable and good faith" determination that the borrower has a "reasonable ability to repay (ATR) the loan".
Dodd-Frank "safe-harbor" provision
Qualified mortgage (QM)
To be a QM, what is the maximum origination fee for a $200,000 loan, if the loan has a 2% prepayment penalty in the first two years?
To be a QM, the maximum origination fee for a $200,000 loan given the loan has a 2% prepayment is 2000. (3%-2%=1%*200,000)
What is the total debt-to-income (back-end) ratio limit for a Wells Fargo QM, if the loan is not sold to Fannie or Freddie nor is FHA guaranteed?
43%, if Fannie and Freddie are willing to buy it, it can be higher.
With very limited exceptions for small rural lenders, which types of mortgage loans cannot be QMs?
Balloon loans, interest-only, over-30 years, payment-option
Which ARM products (1-year ARM, 3/1, 3/3, 5/1, 5/5, 7/1, 10/1) are unlikely to be QMs for most borrowers in practice? Explain.
1 year ARM, or 3/1 ARM because underwriting is based on the maximum rate in the first five years. Pushes up D/I ratio.
If a Wells Fargo mortgage has an interest rate 3% above the national average mortgage interest rate, is it a safe-harbor QM? Assume all other conditions are satisfied.
No, 1.5% max to not get sued, above that there is rebuttable presumption, or the possibility to be sued
What are three motivations for prepaying and refinancing a fixed-rate first mortgage? An ARM?
1. lower interest rate. 2.reduce risk-premium with lower FICO 4.cash out (ex. to pay for college or credit cards)
Under the Dodd-Frank act of 2010, which types of mortgages are allowed to have prepayment penalties? What is the maximum prepayment penalty, if allowed at all?
commercial mortgages, qualified mortgages to a limit. 2% outstanding balance year 2. 1% year 3.
How do limitations on prepayment penalties affect the mortgage interest rates that banks are willing to offer?
limitations on preypayment penalties raise interest rates.
With a second mortgage or other second liens on the property, what must happen before a first mortgage can be refinanced?
Typical refinancing costs
Loan origination fees, application, survey and appraisal fees
Lender title insurance, often discounted if within a few years of original purchase
Discount points perhaps
Five years ago, you borrowed $100,000 at 7% to buy your house. The mortgage has $665 monthly payments, and $93,900 in remaining principal. If you refinance with a new 30-year 7% mortgage, the payments will be $625, so you will save $40 per month or $480 per year on your payments. After-tax closing costs are $1000. If you expect to keep living in the house for around 5 years, then should you refinance?
you're not saving anything, you're just stretching out payments
A homeowner in the 25% tax bracket is considering refinancing a mortgage with 20 years remaining and $200,000 in principal. The current rate she pays is 5% and the new 20-year loan is at 4.25%. Non-deductible closing costs total $1200, and the new loan has 0.75 discount points and a 1% tax-deductible origination fee. What are total after-tax closing costs? During the first year, how much will the homeowner save in after-tax interest? From your answers to these two questions, the crude breakeven point is thus X= ____ years for refinancing to make sense. The true breakeven point is somewhat ____ than X years, after accounting for the time value of money and the paying down of principal over time.
Costs=1125, Savings=3825, x=3.4 years, true breakeven would be somewhat longer
Why should most borrowers not refinance if the math indicates just a small net gain from refinancing?
Closing costs often erase gains
Why was the cash-out refinancing share of all refinancing lower in 2012 versus 2006?
Lenders became more conservative during the crisis and they were less likely to take high LTVs, and home values were down
A homeowner has an existing mortgage (with another lender) at 4% with a $150,000 remaining balance and 20 years remaining, and a new appraisal indicates the property is worth $250,000. The 80% LTV 30-year mortgage rate for a home purchase would normally be 5% for someone with this homeowner's FICO score. Why might a bank charge more or less than 5% on a $200,000 cash-out refinance into a 30-year loan?
The fact that they need cash means they're kind of desperate.
Suppose an appraisal indicates a house is worth $200,000 and there is an outstanding first mortgage with $100,000 principal remaining. If a HELOC lender uses an 80% rule, the credit limit offered is
How often do HELOC interest rates typically adjust, and are they subject to caps?
They typically adjust monthly, and they're tied to market. There is a lifetime cap.
What is the typical HELOC minimum payment during the draw period? At the end of the HELOC draw period, what are the typical repayment terms?
accrued interest for the month payments are generally require over the life of the draw period.
Apart from fraud, missed minimum payments, or failure to insure the property, when can banks freeze borrowing or reduce credit limits on HELOCs?
Significant decline in home value or material change in financial circumstances
Discuss the considerations in foreclosing on a seriously delinquent HELOC, versus foreclosing on a seriously delinquent first mortgage.
While a HELOC retains recourse, it has a junior claim, so if the borrower is underwater on the first mortgage they get nothing.
From the WSJ article, why are HELOC default risks suddenly a concern, given the strong recent performance in the real estate market?
They're ones resetting from interest only, to pay back, and they were taken on near peak of the bubble. (10 year time)
When can a homeowner with a reverse mortgage be forced into foreclosure?
Never. unless you fail to pay insurance or taxes
Are reverse mortgages recourse or non-recourse?
Usually, the upfront premium for a FHA HECM loan is 0.5% of the value of the home. What is the ongoing annual mortgage insurance premium?
When the total amount owed to the bank reaches the "maximum claim amount", normally equal to the original value of the house, what can the lender do?
The lender can exit the program, FHA pays the lender amount owed and takes over
Consider a reverse mortgage that offers two possible borrowing structures, a line of credit, and a house tenure annuity. In which case is there a financial disincentive for the borrower to move to an assisted living facility or nursing home?
If you have little equity on the house, people won't move because when selling they won't have any cash for rent.
What is the adverse selection problem with reverse mortgages?
People who will live a long-time will choose it.
From the WSJ article, is there any reason for a senior citizen to take out a reverse mortgage line of credit, pay a significant upfront loan origination fee and mortgage insurance premium, even when they don't really need the money now? Explain
Unused line of credit grows, would want to do this if they are playing the stock market and can use it as a safety value.
Who are the parties in a four-party system, which cards are used, and who does the lending in this system?
Consumer, depository institution (issuer), retail merchant, and the retailer's depository institution. This is used by all PIN debit cards and Visa, Mastercard
Who are the parties in a three-party system, which cards are used, and who does the lending in this system?
Consumer, Merchant, network. AMEX and Discover use this traditionally. In the system, network does the lending.
Does the "honor all cards rule" mean that a merchant that accepts Visa debit cards must also accept Visa credit cards?
No, card networks allow merchants to accept debit cards only or credit cards only
Does the "honor all cards rule" mean that a merchant that accepts Chase Visa standard credit cards must also accept Bank of America Visa standard credit cards? What about Chase Visa premium credit cards?
Yes, both would be required acceptance
Under the Dodd-Frank Act, merchants can offer discounts for paying with a _____ card rather than a ______ card.
Under the Dodd-Frank Act, merchants can prohibit credit card use for ______ transactions.
small transactions (up to $10)
Who is generally liable for fraud losses in card-not-present transactions? Who is generally liable in card-present transactions when the customer has a "chip" card and the merchant has (and requires using) a chip card reader?
Merchant, if "chip" card transaction and customer is forced to use a chip card reader, issuer is liable
A credit card account was opened 3 months ago at a variable interest rate, the prime rate plus 8%. The balance on the account is now $2000. If the issuer discovers that the cardholder's FICO score has declined, what can they do to increase the interest rate? Explain.
They cannot increase the rate in the first year. Can only raise on additions to balance.
Which of the following is illegal for a credit card? Assume the cardholder has always paid at least the minimum payment on-time.
The minimum payment is $45 and the late fee is $35
The minimum payment is $15 and the late fee is $25
The minimum payment is $30 and the late fee is $25
If you've been making your payments, can't be more than $27.
Can an issuer decide to let a cardholder to go (somewhat) over their credit limit, and then charge them a fee for doing so? Explain.
Cardholders must specifically opt-in to allow the lender to approve transactions over the credit limit.
Can a credit card account be profitable even if the cardholder pays their balance in full each month? So, how is underwriting for a credit card account different than underwriting for a closed-end unsecured loan (e.g. vacation loan)? Explain.
Interest rates are extremely high for credit cards, and companies also gain on the transaction fees. Underwriting is highly automated, but issuers also attempt to assess accounts activity/borrowing.
According to the coursepack, about how much does "fresh" delinquent credit card debt sell for in a strong economy?
According to Experian, which categories of lenders experiences the highest and lowest 60-day delinquency rates?
finance is highest, credit unions is lowest
According to Experian, is the auto loan interest rate more sensitive to the FICO score for used cars or for new cars?
Used cars because the don't often have warranties on collateral.
Indirect Vehicle Lending options
-Flat dollar fee to dealer, bank sets the "retail" interest rate schedule charged to the customer
-Percentage of the loan principal to dealer, possibly on a sliding scale, bank sets the "retail" interest rate schedule charged to the customer
-Dealer sets the interest rate charged to the customer, at a level higher than the "wholesale" rate required by the bank (sometimes called the buy rate). Bank and dealer share the extra yield.
Suppose the indirect lender requires that the retail LTV is no more than 90% for a high-risk borrower, the true retail value of a (used) car is $16,000, and the true value of the trade-in is $500. How much does the borrower need in cash in an arms-length transaction, and how much does the borrower need in cash if both the car price and trade-in value are inflated by $1,000? Ignore any sales taxes.
Which type of student loan, public or private, is not eliminated in a Chapter 7 bankruptcy unless there is an "undue hardship" finding by a judge?
Neither private or public student loans are discharged
Suppose a construction loan for an office building has the maximum LTV under the regulatory guidelines. The forecasted value of the completed project is $10M. If the project is now 60% complete, how much in total should be advanced to the borrower at this point, assuming typical holdback?
.8(10 million)--- 80 million 60% done 80*.60(1-.1)=4.32 million
Why are land development and construction loans typically structured as interest-only balloons, rather than amortizing loans?
There is no incoming cash flow to repay the principal
Which real estate sector has very unfavorable risk factors? Very favorable?
Apartment and health care are lower risk, while motels and hotels are riskiest.
total revenues less real estate expenses (including such items as repairs and maintenance, utilities, property taxes and insurance, advertising and management fees, and typical 'maintenance' capital expenditures, also called replacement reserves).
A stabilized DSCR of _______ or higher is normally acceptable for a lender.
1.2 or higher is usually required
If the amortization period on the loan is 30 years rather than 25 years, what happens to the DSCR?
DSCR increase (smaller payments)
Given the financial statements from an apartment property owner, if the owner manages the property but does not pay herself a salary, how should a lender adjust NOI?
Under a yield maintenance prepayment penalty, how does the size of the penalty vary with market interest rates?
If interest rates on treasury notes are now below the interest rate on the mortgage, a penalty is imposed to compensate for the reduced yield going forward.
If a borrower wants to "defease" a loan, what does it have to do?
Give the lender a portfolio of treasury securities that provides the same cash flows as the now canceled loan
From the Federal Reserve Board Survey of Terms of Business Lending, Table 3 (large banks), what is the percentage of C&I loans made using a line of credit (commitment) versus term, and the percentage of loans where there is a syndicate or participation?
91.5%, 55.7% syndication
From the Federal Reserve Board Survey of Terms of Business Lending, Table 4 (small banks), what is the typical maturity of a C&I loan, and what percentage of loans have collateral?
655 days, 91.5% secured by collatral
From the Federal Reserve Board Survey of Terms of Business Lending, how does the average interest rate charged by small domestic banks on C&I loans differ from the rate charged by large domestic banks? Could a business then get a cheaper loan just by switching banks? (Tables 3 and 4)
Lower effective loan rate at large. Small banks usually go to small banks.
How does syndication of a loan affect the incentives of the lead bank, regarding its underwriting standards and its future monitoring of the borrower?
They care less about repayment
From the below WSJ article, what is a leveraged loan? What explains the growth of non-bank lending in this space?
Leveraged loans, are loans to companies below investment-grade credit. Typically high-risk senior loans. They're being issued by non-banks because banks face more regulations.
Why do lenders often calculate the EBITDA of a business, as well as net income after taxes?
Lenders receive interest before taxes, so taxes are unimportant sometimes. EBITA won't be good though, if it is a high cash-flow business.
If Chris has a $150,000 checking account and a $300,000 savings account at Bank X, what dollar amount of Chris' deposits is uninsured?
If Chris also has a joint checking account with Pat at Bank X of $400,000, with equal withdrawal rights, what dollar amount of Chris' share of the deposit is uninsured?
In addition to the accounts described above, if Chris has a traditional IRA worth $300,000 at Bank X, what dollar amount of Chris' IRA deposit is uninsured?
In addition to the accounts described above, if Chris has revocable trust account worth $225,000 at Bank X naming Pat as beneficiary, what dollar amount of Chris' trust account deposit is uninsured?
Which size category of commercial banks (small, medium, large) has the lowest percentage of insured deposits out of total deposits?
Large banks, only 46.71% are uninsured
In just a few words, how do transaction accounts differ from non-transaction accounts?
Transfer accounts provide the ability to transfer third parties on an unlimited basis, and transfers between depositers.
NOW accounts must include what contract provision?
Banks must reserve the right to require seven days notice of intent to withdraw funds.
What is the debit card interchange fee schedule under Dodd-Frank, and which banks does it apply to?
21 cents + (.05% the value of the transaction). This does not apply to issuers with less than 10 billion assets.
In just a few words, how does the maximum customer liability for a lost or stolen debit card compare with that for a lost or stolen credit card?
Worse. Could end up paying the full amount
If a consumer "bounces" a check, or a preauthorized ACH or debit payment exceeds the account balance, what are the implications? Assume the consumer does not have overdraft protection.
w/o protection it will be denied. For cATM/POS, check, or pre-authorized, the bank will refuse to honor the claim presented on it, and will charge a NSF fee.
What types of overdraft protection plans must be 'opt-in', by law? Consider paper checks, preauthorized ACH or debit card transactions, point-of-sale transactions, and ATM withdrawals.
ATM, one-time debit transactions
How can daily "batch" processing of checks and other debits be conducted in an abusive manner, for accounts with overdraft protection programs? How is such a method probably good (on balance) for depositors without overdraft protection?
Increases the number of items triggering an overdraft. This helps customers w/o protection because the largest payments are often the most important.
For cash, U.S. government checks, and intra-bank checks deposited at the teller, and ACH deposits, when must that money be available to the depositor?
First business day following the baking day of deposits
For the first $200 of inter-bank check deposits at the teller, when must that $200 be available to the depositor? What about the rest of the money?
1 business day, or 200-5000, 2 days. +5 days for special situations and above 5000
In a few words, what are the basic differences between savings accounts and NOW accounts?
Now allows unlimited transactions, and are similar in that they provide interest
For a MMDA or other savings account, what is the total number of permitted "convenient" withdrawals per month? Is using an ATM "convenient"?
6 convenient transfers a month for savings. ATM is not convenient.
In a few words, what are the basic characteristics of time deposits? How do they differ from savings accounts?
higher interest rate,, maturity is minimum a week, and require notice of withdrawl.
Based on the typical CD contract, what happens at maturity (unless the customer directs otherwise)?
For a 2-year CD, can a bank allow for penalty-free withdrawals on the last day of every quarter? What is a typical early withdrawal penalty for a 2-year CD?
Yes, typical early witdrawl is 6 months interest or 3 or one month interest on shorter-term.
One year ago, Sharon invested $5000 into a 3-year CD with a 3% annual interest rate, compounded annually. If all interest is reinvested, what is the principal plus interest at maturity? Now, annual interest rates on new 2-year CDs are 3.8%. You lose 6 months of interest on the original principal if you withdraw your money early. How much will Sharon have after 2 years from withdrawing the old CD early and buying a new 2-year CD with the proceeds?
If a 5-year callable CD has an interest rate of 3.3% and a 5-year regular CD has an interest rate of 3.1%, the depositor should buy the regular CD, rather than the callable CD or just keeping your cash in a savings account paying 2%, only if they expect market interest rates to ______ in the future.
If a depositor of a brokered CD wants their money back prior to maturity, what do they need to do?
It is possible to sell brockered CDs on the secondary market.
Which deposit has the greater risk of non-renewal at maturity, a CD brokered with a full-service stockbroker, or a regular retail CD of the same size?
Brockered, becuase retail care more about client loyalty.
Regarding early withdrawal, how do CDARS compare with brokered deposits?
Banks don't want to pay higher deposit rates than necessary. What can banks do to offer better deals to customers that tend to be more responsive to the deposit rates offered?
Banks prefer customers with low servicing costs. What can banks do to offer better deals to customers that probably will have a low cost to service the account, per dollar of deposits?
Do large "bricks and mortar" banks need to offer higher deposit rates than small banks for the same dollar amount of the deposit?
Lower because they have greate access to borrowing in federal funds, commercial paper, and bond markets, so they don't need to compete for deposits as much.
If a bank does not have enough capital and subsequently fails, who can lose, in addition to the bank's common and preferred stockholders?
From the WSJ and Bloomberg articles, how does a contingent convertible bond (Coco) differ from a regular convertible bond that you learned about in FI312?
regular convertible bond is bullish. Contingent convertible provides a benefit to the bank when the stock goes down the tubes.
If a bank issues a 10-year subordinated unsecured bond, how does that count towards capital 7½ years later?
Tier 2 capital
A business line of credit has an original two-year maturity and is not unconditionally cancellable. If the account has a $200,000 limit and a $50,000 balance, and is current, what is the risk-weighted asset for the entire account?
Suppose the credit limit for a 10-year HELOC can be reduced at the bank's discretion. If the account has a $100,000 limit and a $40,000 balance, and the account is current, what is the risk-weighted asset for the entire account?
In addition to the rules for the capital conservation buffer, to what degree are banks limited in the amount of dividends they can pay or the amount of stock they can repurchase?
They cannot make a capital distribution that would make them undercapitalized.
What are the two restrictions on banks that fall below the "well capitalized" rating? What is the logic for each?
may accept brockered deposits only with an FDIC waiver, and only allowed to offer up the national rate plus 75 basis points.
What are some ways that a well-capitalized bank can become an undercapitalized bank?
Acquisitions, rapid expansion, buying risky assets, or just losing money.
When a bank becomes undercapitalized, what are the key things that it cannot do, and what must it do?
Cannot acquire any interest in any company, add branches, and cannot increase avg total assets. Must submit a capital restoration plan.
Why do banks often resist issuing new common stock, when doing so will move them back up to adequately or well-capitalized status?
dilution, and no one wants it because debt holders have higher seniority.
When a bank becomes significantly undercapitalized, what are the key things that it cannot do, and what can the regulator make it do?
pay any bonus to a senior exec, or increase compensation to senior execs. Regulator can force the sale of shares, restrict asset growth, or require new election of directors
When a bank becomes critically undercapitalized, what is it prevented from doing?
Cannot make any payment of principal or interest on the institution's subordinated debt.
In recent years, how have most bank failures been resolved?
THIS SET IS OFTEN IN FOLDERS WITH...
FI 413 Exam 4
FI 413 Exam 1
FI 413 Exam 3