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Lecture3 Updated
Lecture3 Updated
Week 3
Mingxuan FAN
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Last lecture
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Interactive questions
▶ Go to: PollEv.com/re2706
▶ OR use the QR code
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Interactive questions
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Interactive questions
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Common questions on Lecture 2
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Common questions on Lecture 2
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Common questions on Lecture 2
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Common questions on Lecture 2
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Learning objectives
1 More on ARM
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Reference
Brueggeman and Fisher (2022) Real Estate Finance and Investments, 17th
ed., Chap 5.
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Learning objectives
1 More on ARM
More on ARM 12 / 44
ARM terms
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Loan Closing Costs
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Loan Closing Costs: Example
A borrower bought a property for $60,000 and would like to finance it for
30 years at 12% annual interest rate. The lender indicates that an
origination fee of 3% of the loan amount will be charged. What is the
actual interest cost of the loan?
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Loan Closing Costs: Example
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Loan Closing Costs: Example
More on ARM 17 / 44
ARM calculation example
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ARM calculation example
Index assumption
▶ year 1: 4%
▶ year 2: 4%
▶ year 3: 7%
▶ year 4: 5%
Calculate the effective borrowing cost assuming that you will pay off the
loan at the end of the 4th year?
More on ARM 19 / 44
ARM calculation example
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ARM calculation example
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ARM calculation example
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ARM calculation example
More on ARM 23 / 44
ARM calculation example
More on ARM 24 / 44
ARM calculation example
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ARM calculation example
▶ CF0: 150000*0.98
▶ C01:-760.03; F01:12
▶ C02:-895.82; F02:12
▶ C03:-1087.52; F03:12
▶ C04:-991.69; F04:11
▶ C05: -(991.69+142313); F05:1
▶ IRR (monthly) =0.57%
▶ IRR (annual)=0.57%*12=6.86%
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RECAP: Problems with ARM
▶ Risk of default is greater as compared to FRM
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RECAP: Problems with ARM
▶ More complex and difficult to understand for borrowers
▶ Agarwal and Mazumder (2013) find that consumers with higher math
scores are less likely to make a financial mistake
Source:https://sayingimages.com/funny-math-memes/
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Who is more likely to make financial mistakes?
Source:https://dash.harvard.edu/bitstream/handle/1/4554335/laibson_
ageofreason.pdf?sequence=2
More on ARM 29 / 44
Learning objectives
1 More on ARM
ARM only:
▶ “Fixed” rate mortgages: interest rate is pre-determined and fixed for
a duration of 1-5 years before it becomes floating
▶ Floating rate mortgages: pegged to an index rate (SORA)
▶ HDB concessionary loan is the closest to an FRM
▶ pegged at 0.1% above the prevailing CPF Ordinary Account interest
rate, which has been 2.5% since July 1999.
Source:https://www.hdb.gov.sg/about-us/news-and-publications/
publications/hdbspeaks/housing-loan-at-a-concessionary-interest-rate
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Lock-in
▶ Typically, 1 - 5 years
▶ If you decide to prepay the loan within the pre-specified lock-in
period, you will have to pay “lock-in penalty”
▶ Penalty is typically 1.5% of outstanding loan amount
▶ You will get lower rate as “special discount” if a loan has lock-in
Two-in-one:
▶ The current spread between FRM and ARM rates is the predominant
determinant of the share of ARMs in all nine countries studied in the
paper
▶ Current cost minimization appears to be the most prominent
determinant of mortgage product choice at household level