RE: Mortage and Mortage Market

Mortgage

Special form of debt contract created between a borrower and a lender, using real estate as the collateral for the loan

Mortgage Note

Legal doc where a borrower promises to repay a loan to a lender under specific terms (loan amt/principal, interest rate, and repayment schedule)

Mortgage notes include

Recourse vs non-recourse notes

Mortgage notes can be traded in

secondary market

4 principals of mortgages

principal amount, mortgage rate, maturity, and outstanding balance

Residential Mortgage

Longer term, less risky, personal credit score, allows prepayment, and DTI

Commercial Mortgage

Shorter term, riskier, business credit score, penalizes prepayment, and DSCR

What is mortgage underwriting

A screening process in which the lender verify the borrowers finances and assess the risk of lending them money

Residential Mortgage: Creditworthiness

FICO score

Residential Mortgage: Loan Size

Loan to Value Ration (LTV), usually <80%, max 97%

Residential Mortgage: Borrowers payment ability

Debt to income ratio test (<40%), protects against payment default

Residential Mortgage: Private Mortgage Insurance (PMI)

Required if down payment <20% of purchase price, maintain PMI until LTV is less than 80%

Commercial Mortgage: Creditworthiness

Business credit score (Dun and Bradstreet)

Commercial Mortgage: Loan Size

Loan to value ratio, usually 50%-70% for secured first mortgage

Commercial Mortgage: Borrowers payment ability

Debt service coverage ration (DSCR) test >1.25x

Commercial Mortgage: Target LTV formula

L1/V

L1=

LTV * V

Commercial Mortgage: Target DSCR formula

NOI/DS

DS=

NOI/DSCR

L2=

DS/r

Commercial Mortgage: Should you use target LTV or target DSCR

Use the LESSOR of the two ((L=min (L1,L2))

Mortgage Underwriting: Debt to Income Ratio (DTI)

Evaluates what percentage of the borrowers income must be used to pay off debt

DTI=

Debt Service Payment/ Annual Income

What is the ideal ratio for DTI in mortgage underwriting?

20% (ratio)

The higher the DTI,

the LESS cushion between debt and income, and MORE likely to default

Debt Service Coverage Ratio (DSCR)

Evaluates underlying property’s NOI as a multiple of annual debt service

DSCR=

NOI/Debt Service Payment

What is the target multiple for DSCR?

1.5x (Multiple)

The lower the DSCR, I

the less cushion between debt and NOI, MORE likely to default

IO mortgage

zero amortization loan, balloon loan, bond like payment schedule (fully deferred repayment of principal), debt service only contains interest payment

Effective Cost of Borrowing (ECB)

The IRR of a mortgage cash flow; borrowers effective cost of borrowing is the same as lender’s effective yield of lending

For IO loans with no loan points, ECB=

Mortgage Rate

ECB: Loan Points (Origination fees)

Cover lenders cost associated with conducting due diligence, credit checks, and environmental analysis

Loan points are normally paid by

borrower at closing of loan origination (year 0)

Loan points are a percentage of

Loan amount (Loan amount * 0.5%= Loan points)

Loan Points INCREASE the ECB for

borrowers