Chapter 4: Fixed Interest Rate Mortgage Loans Flashcards

Vocabulary flashcards covering the determinants of interest rates, risk types, loan amortization patterns, and closing costs associated with fixed interest rate mortgage loans.

Real Rate of Interest

The minimum rate of interest that must be earned by savers to induce them to divert the use of resources (funds) from present consumption to future consumption.

Nominal Interest Rate

The contract interest rate agreed on by borrowers and lenders.

Default Risk

The risk that borrowers will default on obligations to repay interest and principal.

Interest Rate Risk

The uncertainty about what interest rate to charge when a loan is made.

Prepayment Risk

The risk that the loan will be prepaid when interest rates fall below the loan contract rate.

Liquidity Risk

The risk associated with how easily securities can be sold and resold; securities in well-established markets require lower premiums than those difficult to sell.

Legislative Risk

Risk that refers to changes in the regulatory environment in which markets operate.

Mortgage Interest Rate Formula

$i = r + p + f$, where $i$ is interest, $r$ is real rate of interest, $p$ is premium, and $f$ is anticipated inflation.

Loan Amount

The amount borrowed and what the borrower is legally required to repay.

Loan Maturity Date

The date by which the loan must be fully repaid.

Periodic Payments

Regular cash flows from the borrower to the lender according to the amortization schedule.

Accrual Rate

The frequency at which a loan requires interest to be accrued, calculated as $\frac{i}{m}$.

Pay Rate

The ratio of the loan payments to the loan amount.

Fully Amortizing Loan

A loan where the pay rate exceeds the accrual rate and the loan balance is fully repaid at maturity.

Partially Amortizing Loan

A loan where the pay rate results in a payment exceeding accrued interest but not by enough to fully repay the balance at maturity.

Interest-Only (Zero-Amortizing) Loan

A loan where the pay rate equals the accrual rate, and the loan balance at maturity equals the amount borrowed.

Negative Amortizing Loan

A loan where the pay rate is less than the accrual rate, resulting in a loan balance at maturity that is greater than the amount borrowed.

Loan Origination Fees

Fees intended to cover lender expenses for processing and underwriting loan applications, preparing documentation, and obtaining credit reports.

Loan Discount Fees (Points)

Fees used to adjust the yield on a mortgage loan, where one point equals $1\%$ of the loan balance.

Buying Down the Interest Rate

The practice of charging borrowers loan discount points instead of raising the contract interest rate.

Effective Borrowing Cost

The actual cost of a loan when including all points and fees, reflecting the true interest rate from the borrower's perspective.

Constant Amortizing Mortgage (CAM)

A mortgage pattern where a constant amount of each monthly payment is applied to the principal balance.

Callable Loan

A loan that the lender will or may demand to be repaid prior to the maturity date.

Loan Structuring

A process of adjusting loan terms to calibrate loan payments, loan balances, and amortization rates to achieve desired results.

Reverse Mortgages

A loan where the amount is taken down as irregular periodic payments until the balance and accrued interest reach an agreed-upon amount.