MATH CLASS 7

GOBC • Real Estate & Mortgage Notes

www.GOBCrealestate.com
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Debt Financing (DF) Reasons for Investor:
1. can obtain the DF at a lower interest rate than the expected yield
on the project- means they can profit!
2. to invest the borrowed funds at a Higher rate of interest than
the borrowing rate
3. lack of adequate capital to make the desired investment
4. to release equity for other activities
5. to diversify investments and reduce overall risk by using only
part of the borrower’s total funds for any one investment
6. to purchase real estate as a hedge against inflation

› Supply & Demand

§ The supply affects the amount of activity in the real estate
market
› Savers (Lenders) & Borrowers
§ Funds that are saved are invested in segments of the economy
wanting to spend more than their current income.

MORTGAGES

› Primary Mortgage Market › Prime Mortgages (A Mortgages)

§ Loans to facilitate the sale of interests in land Ø Majority of mortgage lending in Canada
(banks, credit unions, mortgage brokers, etc.) Ø Deals with borrowers who can qualify for
§ Determines the cost & availability of mortgage mortgages based on their credit score and/or
funds gross income
Ø Less risky (low rate of default)
› Secondary Mortgage Market
§ Existing mortgages are bought and sold as › Subprime Mortgages (B Mortgages)
financial investments (Mortgage-Backed Ø High-risk candidates (poor credit, non-
Securities, Canada Mortgage Bonds) verifiable income, bankruptcy)
ND Ø Charge increased interest rates and higher
§ 2 investor/purchaser of a mortgage is buying administration and processing fees
the right to receive the stream of payments that Ø The market share of Canadian subprime
the borrower had agreed to make to the original mortgages is much lower than in the US
lender
§ Mortgage-Backed Securities and Canada
Mortgage Bonds has increased the strength of
the secondary market

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LENDERS
Borrower Qualification
› Institutional Lenders
5 Cs to Credit § Chartered banks – largest single source of
institutional mortgage funds in Canada
§ Credit unions
1. Character – employment, education
§ Trust and loan companies
2. Capital – down payment § Life insurance companies
3. Capacity – can he repay the loan?
4. Credit – credit history › Private Lenders:
5. Collateral – additional security § Private individuals investing extra funds
§ Vendors of property who carry a part of the purchase
price by granting a mortgage loan on the property,
either through a formal mortgage or an agreement-for-
sale
§ Investment groups (mortgage corporations)
Lender Risks
§ Trust companies whose estate and trust funds may be
invested in mortgages
Arrears (tardiness in making payments) and defaults (no § Pension funds
payments being made) are NOT COMMON on mortgage loans.

Risk involved in being a mortgagee (lender): CREDIT ANALYSIS

Ø Greater than the risk involved when investing in Credit Analysis evaluates the applicants’
Canadian government bonds for a similar time period Ability to meet the terms of a mortgage.
Ø Acceptable to many investors if the interest rate is high
enough
Ø Increased due to the greater degree of management CREDIT REPORT
time involved
Can be reduced: Credit Report is a Record identifying an
applicants’ HABITS regarding their
Ø through careful appraisal of the value of the property financial commitments
and the credit rating of the borrower
Ø reducing the loan-to-value ratio (LTV) • to gain access to an applicant’s credit
Ø reducing gross debt service(GDS) ratio- residential report, a company must follow the
Ø increasing the debt coverage ratio (DCR) - commercial legislation put forth by the provincial
and federal government
• bankruptcy will also be reported on
Credit Score applicant’s credit report

Strategies to IMPROVE credit score:

ü obtaining secured credit cards or loans

ü reducing credit utilization below 70% of each
revolving account’s credit limit
ü paying unpaid bills
ü correcting credit report errors

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MORTGAGE LOANS AS INVESTMENTS
“STICKY” Mortgages
Changes in interest rates tend to lag behind
Characteristics: changes in bond yields in both upward and
downward movements.
› Each mortgage is a unique investment. Result:
› Mortgages are difficult to trade (illiquid). • They have wide use of advance
› Mortgages have long repayment terms, which make it commitments for a rate of interest
difficult to reinvest for the lender/investor. before a loan is advanced
› Mortgages involve a great deal of administrative work. • the long-term nature of the loan
› Mortgage investment requires a large capital outlay. contract
› Mortgages are STICKY • a weak secondary mortgage market

Mortgage History

1900 to Late 1920s 1980s

Ø Interest Only (I.O.) Loans
Ø Refinancing Concerns and Mortgage
Supply Stability
Depression Years Ø introduction of interest rate protection
Ø long-term fully amortized mortgages
Ø Constant payment developed to
reduce principal risk
1990s and 2000s

Ø introduction of the 95% LTV & extending

Post-World War II Period
amortization up to 40 years
Ø use of mortgage default insurance
Ø trend for lenders to move their front-line
mortgage lending business to independent
Late 1960s to 1970s
brokers & absorb the brokerage fee
Ø Partially Amortized Mortgages

2011 to Present
Late 1960s to 1970s
Ø Partially Amortized Mortgages Ø historically low interest rates
Ø introduced the stress test

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TYPES OF MORTGAGES

Portable Mortgage

1. gives a borrower the flexibility to sell one

home and buy another before the current
mortgage matures.
2. may be able to transfer the terms, conditions,
and interest rate of the current mortgage to
the home the borrower would like to
purchase.
= Borrower can save money when the
existing mortgage has a lower interest
Teaser Rate Mortgage
rate than current market rates.
where a lender offers a low upfront mortgage
rate and then raises the mortgage rate to market
levels within six months to two years

Blend and Extend Mortgage

Allows you to:

• Change your mortgage rate (Blend) Graduated Mortgage
• Renew your mortgage term (Extend) • Payment will increase with years
• Borrow more money using your home • There is increasing indebtedness (risk)
equity occurring in the initial years of the loan.

Sinking Fund Assisted Mortgage (SFAM)

• Related to a graduated payment mortgage as both are methods

to reduce initial payments to improve affordability.
• SFAM advances the borrower an amount that is less than the
full face value of the loan, setting the difference aside in an
account that is used to draw down initial payments.

• is a fund set up so a company can set aside regular payments to

accumulate money for some specific purpose
• (examples: to pay off a debt over time, or to replace worn machinery or
equipment)
• typically invested in low-risk, income-generating assets with the goal of
accumulating money
• reduces the risk of default on the company’s debt obligations and may also Interest Accruing Mortgage
earn more interest on the investment than is owed on the debt
No payments of interest or principal are
RAM (Reverse Annuity) Mortgages made during the life of the loan.
The riskiest mortgage to the lender.
•
allows a means by which the equity rich
mortgagor may postpone selling his house
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Amortization
If you borrowed PV $500,000 over an Amortization of 20
Partially amortized years, that means if you make 20 years of payments, you
– loan IS NOT repaid by the end of the contract because pay the PV off completely and owe ZERO dollars.
the amort and the term are not the same length
- amortization period is longer than the loan term
Extending the amortization
_____5 Term ___________________ 20 Amort ¹ 5 Term ______________10 Amort
__________________________20 Amort
Fully amortized 1. The amount of OSB (outstanding principal)
– loan IS REPAID by the end of the contract because will be increased
the amort and term are the same length 2. Payments will be smaller (the repayment of
principal is spread over a greater number of
_____________________________ 20 Amort = 20 Term payments)

Term Identical Mortgages

_____________5 Term_____________20 Amort Term
_____2 Term_____________________20 Amort specifies the duration of the
contractual relationship
1. Payments on 2T and 5T will be the same!!!
2. OSB will be more on 2 Term
3. Does not change interest rate

Payments (PMT) Prepayment in a mortgage

the right of the borrower to pay off all

1. Constant PMT
(or some) of the outstanding balance
Ø each payment is identical to the preceding one
Ø developed in response to the principal risk during the term of the mortgage

2. Accelerated biweekly payments

Ø pays one-half of the monthly payment every two weeks. By increasing PMT:
Ø can pay off a mortgage loan much
3. Final PMT – Fully amortized loan faster
Ø Final PMT will be smaller
__________________________20 Amort & term

Rounding RULES
4. Balloon Payment - any payment of Principal
over and above the regular periodic payments, › When rounding UP the payment (like we do for most
whether it occurs during or at the end of the loan questions), the number of payments will probably decline
term › usually results in a lower final payment
› Only applies to Payment (PMT), nothing ELSE!
Ø can pay off a mortgage loan much faster › Every day rounding rules are used for all other dollar
____I_____I______5 T___________20 Amort amounts, unless specific rounding instructions are given

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Interest Rate
Interest charged on a mortgage:

Ø is a return on capital invested

Ø is a payment for a portion of the general overhead and operating
costs of the lender
Ø is an incentive to accept uncertainty or risk
NOT the cost of financing the lender's debt!

Daily interest can be charged on the amount of the missed payment

Mortgage Insurance

Insured Mortgage
Ø an insurance company guarantees that the
lender can recover all of the funds loaned
Ø high loan-to-value ratio over 80%
Ø Downpayment under 20%
Ø insurance premium can be added to the loan Uninsured Mortgage (Conventional)
amount Ø lender has only the personal covenant of the
Ø default insurance is paid for by the borrower borrower and the value of the property as
Ø No Personal Covenant security
Ø loans that are max 80% and under
Ø Downpayment of 20% or more

OPEN vs. CLOSED Market Value of the

Open mortgages generally have short terms, higher mortgage
rates. Allows prepayment at any time!
an estimate of the amount
Closed mortgages, cannot repay the outstanding that might be received if
balance (OSB) during the term. the existing mortgage was
sold in an arms-length
However, lenders typically allow prepayment of the transaction under current
remaining outstanding balance but charge: Book Value of a mortgage conditions

• a penalty of three months' interest equals the amount of principal

OR outstanding at a particular
• the interest rate differential (IRD) on the point in time
amount to be prepaid

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M7.1 In the ________ market, existing mortgages are bought and sold as financial investments, whereas in the ________
market, loans are initiated to facilitate the sale of interests in land.
1. Primary; secondary
2. Secondary; capital
3. Capital; primary
4. Secondary; primary

M7.2 The secondary mortgage market:

1. occurs when a borrower receives funds secured by a mortgage from a bank.

2. is the market in which existing mortgages are bought and sold as financial investments.
3. has been weakened by the introduction of mortgage-backed securities and Canada mortgage bonds.
4. is the market in which mortgage loans are initiated.

M7.3 Which of the following regarding the capital market is FALSE?

1. In this market, funds that are saved are invested in segments of the economy wanting to spend more than their current
income.
2. The existence of this market relies on the fact that some segments of the economy supply funds and other segments of the
economy demand funds.
3. The supply of mortgage funds affects the amount of activity in the real estate market since most transactions require debt
financing.
4. The secondary mortgage market determines the cost and availability of mortgage funds.

M7.4 Which one of the following statements is FALSE?

1. Subprime lenders account for risk by charging increased interest rates and incorporating higher administration and
processing fees compared to prime lenders.
2. One of the problems in the US subprime market arose because the subprime boom introduced lending practices that made
it easier to obtain loans.
3. The market share of Canadian subprime mortgages is much larger than in the US.
4. The Canadian subprime market is subject to less risk than its American counterpart because all high-ratio Canadian
mortgages must be secured with mortgage insurance.

M7.5 Which of the following is NOT one of the five C’s of credit?
1. Character
2. Capacity
3. Capital
4. Capability

M7.6 Which of the following is NOT a private lender?

1. Mortgage corporations
2. Vendors who carry a part of the purchase price by granting a mortgage loan on a property
3. Trust companies whose estate and trust funds are invested in mortgages
4. Credit unions

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M7.7 The risk involved in being a mortgagee (a lender of funds secured by a mortgage) is:
1. Lower than the risk involved when investing in Canadian government bonds for a similar time period.
2. Unacceptable to many investors if the interest rate is high enough.
3. Increased through careful appraisal of the value of the property and the credit rating of the borrower.
4. Increased due to the greater degree of management time involved.

M7.8 A credit report is:

1. A critical factor used to determine an applicant’s annual gross income.
2. A record identifying an applicant’s habits regarding their financial commitments.
3. The evaluation of an applicant’s ability to meet the terms of a mortgage.
4. Established by private lenders during the application process.

M7.9 The evaluation of an applicant’s ability to meet the terms of a mortgage and the amount of their income available for
future mortgage payment is known as:
1. a credit history
2. a credit review
3. a credit score
4. a credit analysis

M7.10 The purpose of a credit analysis of a mortgagor is:

1. to ensure that the borrower has both the ability and the intention of complying with the mortgage agreement.
2. to determine if the borrower is worth suing if he defaults on the mortgage.
3. to determine the proper interest rate to charge the borrower.
4. all of the above.

M7.11 Your client asked you for assistance with improving her credit score. Which of the following is a strategy that will
typically improve the credit score?
1. Reducing credit utilization below 70% of each revolving account’s credit limit.
2. Regularly exceeding the credit limit on multiple credit cards.
3. Increasing the number of credit applications and inquiries from an assortment of lenders.
4. Obtaining unsecured credit cards or loans.

M7.12 A friend of yours is cleaning out her office and is throwing away the hard copies of all her transaction-related documents.
When you ask her why, she explains that she has electronic copies of all of these documents and therefore, they are just taking
up space. Which of the following statements regarding data backup and legal considerations should your friend be aware of?
1. keeping only electronic copies of transaction-related documents is advisable and hard copies are not necessary in the real
estate industry
2. there is no need to keep hard copies because of the use of digital signatures
3. she should retain her hard copies in case there is a question as to the authenticity or origin of the electronic documents and
email communications
4. it is only necessary to retain hard copies of documents if they do not contain signatures or initials

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M7.13 Which of the following statements regarding mortgage broker origination software is/are true?
A. mortgage broker origination software allows mortgage application approvals to be granted very quickly.
B. mortgage broker origination software does not help eliminate many of the data errors which occur in re-keying
information.
C. mortgage broker origination software connects mortgage brokers to lender online system and can be set up with the
lenders guidelines to help mortgage brokers determine which lender is suitable for the application they are currently
dealing with.
D. mortgage broker origination software is designed to streamline the application process between mortgage brokers and
lenders.

1. only c
2. only b and d
3. only a, c and d
4. all of the above.

M7.14 Changes in mortgage interest rates tend to lag behind changes in bond yields in both upward and downward
movements. One reason for this “stickiness” is:
1. The short-term nature of a mortgage loan contract
2. Mortgages are highly liquid investments
3. They have wide use of advance commitments for a rate of interest before a loan is advanced
4. Mortgage rates do not change during fluctuations in the national economy

M7.15 Which of the following is characteristic of a mortgage as an investment?

1. Not “unique”, which makes it easy to trade
2. Requires a high degree of administrative work
3. Requires a low initial outlay of capital
4. Has a short repayment term, which makes it easy to reinvest the periodic payments at good rates

M7.16 Between 1900-1920, _______________ were the primary form of repayment for residential mortgage financing, whereas
after the Depression, ________________ were the primary form of repayment for residential mortgage financing.
1. interest only loans; long-term fully amortized mortgages
2. long-term fully amortized mortgages; interest only loans
3. interest only loans; graduated payment mortgages
4. partially amortized mortgages, straight line principal reduction loans

M7.17 Constant payment repayment schemes were developed in response to:

1. Rapid inflation.
2. The federal government’s desire to stimulate the demand for and supply of housing after World War II.
3. Interest rate risk.
4. Principal risk.

M7.18 Consider the scenario where a lender offers a low upfront mortgage rate and then raises the mortgage rate to market
levels within six months to two years. This would be best described as a:
1. Refinancing mortgage
2. Teaser rate mortgage
3. Blend and extend mortgage
4. Reverse mortgage

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M7.19 The "blend and extend" refinancing option:

1. involves renegotiating a first mortgage with the lender and making prepayment penalties.
2. requires one to obtain a second mortgage with a higher interest rate.
3. is illegal and not available in Canada.
4. typically allows a borrower to take advantage of a low interest rate on their current mortgage funds as well as additional
funds, while avoiding costly prepayment penalties.

M7.20 The risk on a graduated payment mortgage tems from:

A. the increasing indebtedness occurring in the initial years of the loan.
B. the increasing size of payments over time.
1. Statement A is correct.
2. Statement B is correct.
3. Both statements A and B are correct.
4. Neither statement is correct.

M7.21 With which one of the following loans is the lenders initial capital and periodic income at the greatest risk?
1. Straight line principal
2. Accelerated by-weekly loans
3. Interest only loans
4. Interest accruing loans

M7.22 Which of the following statements regarding alternative repayment and refinancing methods is/are TRUE?
A. From the mortgagor’s perspective, the reverse annuity mortgage allows a means by which the equity rich mortgagor may
postpone selling his house.
B. In a variable rate mortgage, the interest rate is change periodically for the required payment is never changed.
C. In graduate payment mortgages, payments are increased during the loan term.
D. One of the benefits that the “blend and extend” option of refinancing is that it helps borrowers avoid prepayment
penalties.
1. Only C is true
2. Only statement B and D are true
3. Only statement A, C, and D are true
4. All of the above

M7.23 Extending the amortization period of a loan to 30 years:

1. results in larger mortgage payments for borrowers.
2. means that borrowers will make payments every two weeks, instead of monthly, in order to reduce their interest cost.
3. results in less interest paid by the borrower.
4. means the repayment of principal is spread over a greater number of payments, making each payment smaller.

M7.24 All other things being equal, shortening the contractual term on a constant level payment mortgage always has the
effect of:
1. increasing the size of the periodic payments required to fully amortize the loan.
2. increasing the size of the outstanding balance payment due at the end of the term.
3. increasing the interest rate.
4. increasing the payment frequency.
____________5T_____________________20A
______2T___________________________20A
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M7.25 Which of the following statements regarding mortgage default insurance is FALSE?
1. A lender may apply a higher loan-to-value ratio to an insured loan than an uninsured loan.
2. The insurance company guarantees borrowers will be able to continue to make their mortgage payments without
interruption.
3. The insurance premium paid on an insured mortgage can be added to the loan amount.
4. Mortgage default insurance is insurance for the lender.

M7.26 Which of the following statements regarding mortgage loans is FALSE:

1. Default means that a borrower is not making any mortgage payments.
2. Partially amortized mortgages are almost universally used for long term mortgage financing in Canada.
3. An open mortgage usually has a contract rate that is lower than an equivalent closed mortgage.
4. An estimate of the amount that might be received if the existing mortgage was sold in an arms-length transaction under
current conditions is known as the market value of the mortgage.

ANSWERS:
M7.1 -4 M7.21- 4
M7.2- 2 M7.22- 3
M7.3 -4 M7.23- 4
M7.4- 3 M7.24- 2
M7.5- 4 M7.25- 2
M7.6- 4 M7.26- 3
M7.7- 4
M7.8- 2
M7.9- 4
M7.10- 1
END of MATH 7
M7.11- 1
M7.12-3
M7.13- 3
M7.14- 3
M7.15-2
M7.16- 1
M7.17- 4
M7.18- 2
M7.19- 4
M7.20 - 3

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