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LESSON 9 INTRODUCTION TO MORTGAGE FINANCE Required Reading 1. UBC Real Estate Division. 2016. Real Estate Trading Services Licensing Course Manual. Vancouver: UBC Real Estate Division. Chapter 13: Introduction to Mortgage Finance Recommended Reading Available on the Course Resources webpage under Course Materials : 1. Lecture Tutorials: Introduction to the HP10BII+ 2. Websites of Interest General Objectives This lesson provides students with a basic introduction to mortgage finance and covers concepts such as: the role of financing in real estate transactions; the basis of the capital market; and the characteristics, classifications, and history of mortgage loans. As well, the lesson introduces students to mortgages, mortgage repayment plans, and interest rates. By the end of this lesson, students should be able to solve interest, future value, and present value problems on a financial calculator. Learning Objectives Upon completion of this lesson a student should be able to: 1. explain the importance of financing in the purchase of real estate; 2. discuss the market in which financial arrangements (including mortgages) are traded and who the participants are in these markets; 3. identify the specific characteristics of mortgage loans as investments and discuss the manner in which these characteristics influence the supply of mortgage funds; 4. differentiate between some of the different types of mortgages and repayment plans currently available; 5. differentiate between nominal and periodic rates of interest; and 6. solve financial problems on the calculator. Instructor's Comments For most people, real estate represents the single most significant investment they will ever make. Because of the significance of the scale of the investment and the complexity of the process, many will seek expert advice. The increasing complexity of real estate and mortgage markets requires real estate licensees to evaluate alternative financing arrangements in order to assist their clients; they must also satisfy the duty to protect the public imposed by the Real Estate Services Act. Accordingly, an introduction to mortgage finance will be presented in this lesson. Review and Discussion Questions Choose 5-10 questions from your Examination Study Guide that are from Chapter 13. Please note that the corresponding chapter number for each question is listed in the back of the Examination Study Guide in the Answer section. It is a good idea to do these review questions now so that you become familiar with the types of questions that you will see on your examination.
9.2 Real Estate Trading Services Licensing Course Workbook ASSIGNMENT 9 CHAPTER 13: INTRODUCTION TO MORTGAGE FINANCE Marks: 1 mark per question. 1. Which of the following statements regarding insured mortgages is TRUE? (1) The lender has only the personal covenant of the borrower and the value of the property as security for the loan. (2) If the borrower defaults, the lender has no means of recovering the capital invested. (3) Default insurance is paid for by the borrower. (4) The rate of interest tends to be higher than that for an uninsured mortgage. 2. Which of the following statements regarding interest rates in the capital market is TRUE? (1) Usually, the longer the term of the investment, the lower the interest must be paid to the investor. (2) The more risk an investment poses, the higher the rate of interest charged. (3) Due to the very low risk present with a government bond, there is no capital risk associated with it. (4) Second or third mortgages are more secure investments than first mortgages. 3. Accelerated biweekly mortgage payments are an effective way to pay off a mortgage loan because: (1) an equal amount of principal is repaid every interest compounding period, plus interest for that period. (2) the principal amount of the loan never increases or decreases. (3) they allow borrowers to pay up to double the regular mortgage payment on any payment due date. (4) the borrower makes the equivalent of one extra monthly payment per year, thus paying down the principal faster and paying less interest. 4. Which of the following statements about first and second mortgages is FALSE? (1) The first mortgage is not distinguished from subsequent mortgages in any way. (2) A second mortgage is commonly referred to as the first equitable mortgage on a property. (3) As property rights are pledged as collateral for a loan, possession and the right to receive clear title still remain with the borrower. (4) A first mortgage is the earliest dated claim registered against the property. 5. Which of the following statements regarding interest accruing loans is TRUE? (1) The lender is actually borrowing money back from the borrower. (2) Interest accruing loans are usually written for terms of more than two years. (3) No payments of interest or principal are made during the life of the loan. (4) The entire original investment by the lender is rarely at risk throughout the life of the loan. Assignment 9 continues on next page
Lesson 9 9.3 6. The prepayment privilege described in the federal Interest Act extends to: (1) the mortgagee. (2) companies. (3) individuals. (4) All of the above 7. Which of the following statements regarding the sources of mortgage funds is TRUE? (1) Most mortgage loans are initiated by private lenders. (2) Both federal and provincial governments provide mortgage loans. (3) The life insurance industry remains the most important source of mortgage funds in Canada. (4) Chartered banks are currently one of the smallest sources of institutional mortgage funds in Canada. 8. There are three innovative mortgage repayment schemes discussed in the course manual: Graduated Payment Mortgages (GPM); Variable Rate Mortgages (VRM); and Reverse Annuity Mortgages (RAM). Which of these would be the most appropriate to recommend in each of the following situations? A. Grania has just retired from 30 years of teaching in Richmond and wishes to supplement her pension income. She owns and occupies a reasonably expensive waterfront property in Vancouver. B. Mike and Sarah have just graduated from school and want to purchase a house and start a family. However, their current low income does not allow them to meet the payments required for a large enough loan to purchase their dream home. They expect their income to increase quickly in the near future. C. George and Angela have been saving for a long time and now want to invest their savings in a mortgage loan. However, they are very concerned about locking their investment in at current interest rates because rates may rise in the future. (1) A = GPM; B = VRM; C=RAM (2) A = VRM; B = GPM; C=RAM (3) A = RAM; B = VRM; C=GPM (4) A = RAM; B = GPM; C=VRM 9. Why are mortgage rates from banks in Canada generally quoted with semi-annual compounding? (1) In order to comply with the Federal Interest Act (2) So that compounding frequency matches payment frequency (3) In order to comply with the Real Estate Services Act (4) All of the above 10. Which of the following is TRUE of an individual borrower's prepayment rights, as stated in the Federal Interest Act? (1) The borrower has the right to tender all of the outstanding debt, with an additional three month's interest in lieu of notice, at any time after five years from the initial date of the mortgage. (2) The borrower has the right to tender all of the outstanding debt at any time during the term of the mortgage contract. (3) The borrower may be legally bound to a mortgage contract with a clause included stating absolutely no prepayment whatsoever until the end of the ten-year term. (4) All of the above Assignment 9 continues on next page
9.4 Real Estate Trading Services Licensing Course Workbook 11. Joe is currently in Vancouver, BC, and looking to purchase residential real estate for investment purposes. His goal is to purchase a property and hold it for 10 years while earning a return of 5% per annum, compounded annually over this time. If Joe wants to sell his property for $1,000,000 at the end of a 10-year holding period, what is the maximum price he can purchase the home for today in order to achieve his required return of 5% per annum, compounded annually? (1) $613,913.25 (2) $675,564.17 (3) $644,608.92 (4) $781,198.40 12. An interest only loan in the amount of $200,000 was issued January 1, 20xx. The interest rate charged on the loan is 5% per annum, compounded semi-annually (i.e., 2.5% per semi-annual period) with semi-annual payments. If the term of the loan is two years, what amount will be due and payable on January 1, two years from origination? (1) $5,000 (2) $10,000 (3) $205,000 (4) $210,000 13. Larson purchased a condominium and sold it at the end of its 7 th year for $400,000. He calculated that he received a return of 6% per annum, compounded annually over this time. What is Larson s original purchase price of the condominium? (1) $298,017.68 (2) $266,022.85 (3) $302,039.57 (4) $315,140.85 14. Carla has received an interest accruing loan of $150,000 to start her own flower shop. The term of the loan is 10 years, with an interest rate of 4.5% per annum, compounded monthly. At the end of 10 years, Carla will have to pay the full amount of the loan, in addition to all the interest at the end of 10 years. Calculate the amount that Carla will have to pay at the end of 10 years. (1) $257,098.94 (2) $235,048.92 (3) $155,720.88 (4) $156,890.97 15. Which of the following statements regarding periodic and nominal interest rates is TRUE? (1) A monthly periodic rate (i mo ) of 2% is equivalent to a nominal rate of j 12 =12%. (2) A daily periodic rate (i d ) of 0.025% is equivalent to a nominal rate of j 365 =9.125%. (3) A semi-annual periodic rate (i sa ) of 2.5% is equivalent to a nominal rate of j 2 =9%. (4) A quarterly periodic rate (i q ) of 3.25% is equivalent to a nominal rate of j 4 =10.5%. Assignment 9 continues on next page
Lesson 9 9.5 16. Kenyan has been collecting empty beer bottles and cashing them in for money at regular intervals. He receives 10 cents for each bottle and collects an average of 450 bottles per week. The market rate of interest is j 52 = 5%. How much will Kenyan have at the end of one year if he deposits his earnings into a savings account (earning j 52 = 5%) at the end of each week? (1) $2,398.31 (2) $3,314.25 (3) $2,840.95 (4) $2,182.82 17. Kenyan would like to put aside some money into his savings account so that he can purchase a minivan to haul the bottles he collects. If Kenyan could set aside $20 at the end of every week, and the savings account earns interest at j 52 = 10%, how much money will have accumulated in the savings account by the end of the 7 th year? (1) $7,280.00 (2) $9,866.66 (3) $10,482.37 (4) $10,528.95 18. Harpreet has received $500 as a birthday gift from a friend. She wants to use the money in exactly 2 years to pay $1,000 for a new laptop computer. Harpreet has deposited the money in an account bearing a periodic interest rate of 0.5% per month, compounded monthly. Will Harpreet have enough money to pay for the laptop computer in two years? (1) No, she will be $212.41 short. (2) No, she will be $36.18 short. (3) Yes, she will have enough money. (4) No, she will be $436.42 short. 19. An interest only loan in the amount of $660,000 was issued January 30 th, 20xx. The interest rate charged on the loan is 9% per annum, compounded quarterly, with quarterly payments. Calculate the amount of the quarterly interest only payments, if the loan term is 4 years. (1) $942,230.16 (2) $123,750.00 (3) $446,920.14 (4) $14,850.00 20. The Glovers have been granted an interest only loan in the amount of $155,000 to purchase a boat for their fishing charter business. The term of the loan is 3 years, and the contract rate of interest is 0.5% per month. What will be the amount of the second monthly payment? (1) $775 (2) $500 (3) $155,775 (4) $155,500 End of Assignment 9