4 HOUR NONTRADITIONAL MORTGAGE TYPES

Transcription

1 NMLS Approved Provider ID West 48th St, Suite 333, New York, NY HOUR NONTRADITIONAL MORTGAGE TYPES Course Approval: 1156/1008/1699 Course Material Date: 10/26/2015 Course Approval Date: 7/1/2015

2 2 Rules of Conduct Course Overview

3 NONTRADITIONAL MORTGAGE TYPES

4 Alternative Mortgage Types I. I N T R O D U C T I O N I I. I I I. I V. I O M O R T G A G E N E G AT I V E A M O R T I Z AT I O N M O R T G A G E A D J U S TA B L E R AT E M O R T G A G E ( A R M ) A N D O P T I O N A D J U S TA B L E R AT E M O R T G A G E V. B U Y D O W N M O R T G A G E V I. V I I. V I I I. I X. C R O S S - C O M PA R I S O N S B A L L O O N M O R T G A G E S E C O N D L I E N L O A N, S E C O N D M O R T G A G E C O N S T R U C T I O N L O A N R E V E R S E M O R T G A G E 4

5 I. Introduction 5

6 6 Introduction This Course Fixed Rate Mortgages (FRMs) Adjustable Rate Mortgages (ARMs) Interest Only (IO) Mortgages Negative Amortization (NegAm) Mortgages

7 7 Introduction Definition of Nontraditional Mortgage Product SAFE Act definition: any product other than a 30 year fixed rate mortgage FRM = 30-year fixed rate mortgage Fully amortizing General differences: Interest rate Monthly or periodic payments The terms of repayment

8 8 Introduction Origin of Alt Loans 1980s High interest rates Alternative mortgages helped homebuyers afford houses New loans included: Adjustable rate mortgages (ARMs) Interest Only (IO) Mortgages ( IOs ) Negative Amortization mortgages

9 9 Introduction Risks Interest rate may increase May increase payment greater than the borrower can pay Declining Market Declining home value (or even remains stable) as principal balance grows Refinance risk Not meeting DTI, LTV, or credit eligibility Not for everyone Must be able to afford the risk

10 10 Introduction Higher Risk, Higher Return Ideal for the right homebuyers Can really hurt the wrong homebuyer Return is lower overall interest payments Risk cannot be ignored

11 11 Introduction Current Era Low Interest Rates 5-6% in the end of 2002 Below 7% until 2005 Best rates in forty years Home Values Soared Financial Institutions made greater supply of alternative mortgage loans Although the intended purpose for nontraditional loans was to lower payments in a high interest rate environment

12 12 Introduction Results Loans made to wrong borrowers Couldn t afford the risk Were not aware of the risk Interest rates went up (ARM, IO, etc..) and housing prices slowed Homeowners couldn t make payment with adjusted interest rates Borrowers could not sell or refinance Defaults Began, foreclosures ensued Downward spiral

13 13 Dodd Frank & Ability To Repay Introduction After 2008 crisis, many studies commenced to determine cause. Underwriting standards did not properly account for capacity Income and assets not verified Borrowers qualified on teaser rates, and unable to pay loan when reduced teaser expired. Capacity based solely on equity.

14 14 Dodd Frank & Ability To Repay Introduction Verifying Ability to Repay becomes a top legislative goal. TILA creates Higher Priced Mortgage Loans (HPML) rules. Lenders face increased liability and risk if they don t show ability to repay Increased Reserves Can be fined 5 times the amount earned in transaction ATR can be used as a defense in foreclosure

15 15 Ability to Repay Rule Overview Implements Sections 1411 and 1422 of the Dodd-Frank Act Requires lenders to determine the ability of a borrower to repay the mortgage over the long term. At a minimum,a lender must consider eight underwriting standards Truth In Lending Act (TILA) REG Z Source: (e)(2)(v)(B) Copyright MortgageEducation.com. All Rights Reserved.

16 16 Ability to Repay Rule Eight Underwriting Standards 1. Current income or assets 2. Current employment status 3. Credit history 4. The monthly payment for the mortgage Truth In Lending Act (TILA) REG Z 5. The monthly payments on any other loans associated with the property Source: (e)(2)(v)(B) Copyright MortgageEducation.com. All Rights Reserved.

17 17 Ability to Repay Rule Eight Underwriting Standards (cont.) 6. The monthly payment for other mortgage related obligations (such as property taxes) 7. Other debt obligations; including Alimony and Child Support and Truth In Lending Act (TILA) REG Z 8. The monthly debt-to-income ratio or residual income the borrower would be taking on with the mortgage. (Debt-to-income ratio is a consumer s total monthly debt divided by their total monthly gross income). Source: (e)(2)(v)(B) 17 Copyright MortgageEducation.com. All Rights Reserved.

18 18 Ability to Repay Rule Qualified Mortgage (QM) General Definition A mortgage which has complied with certain characteristics and for which a lender has proven compliance with the Ability-to-Repay rule Issuing a QM proves compliance with Abilityto-Repay Rule Truth In Lending Act (TILA) REG Z Compliance with the Ability-to-Repay Rule provides a Safe Harbor or rebuttable presumption of compliance Source: Copyright MortgageEducation.com. All Rights Reserved.

19 19 Ability to Repay Rule QM Statutory Requirements Specifically requires lender to: Verify and document the income and financial resources relied upon to qualify the obligors on the loan; and Truth In Lending Act (TILA) REG Z Underwrite the loan based on a fully amortizing payment schedule and the maximum interest rate during the first five years, taking into account all applicable taxes, insurance, and assessments Source: Copyright MortgageEducation.com. All Rights Reserved.

20 20 Ability to Repay Rule QM Characteristics May be prime loans or higher-priced loans No interest only loans. No loans where the principle can increase such as negative amortization loans. No loan terms over 30 years. No balloon payment loans except by smaller creditors in rural or underserved areas. Truth In Lending Act (TILA) REG Z 20 Copyright MortgageEducation.com. All Rights Reserved.

21 21 Ability to Repay Rule QM Characteristics (continued) No balloon payment loans except by smaller creditors in rural or underserved areas. No excess upfront points and fees. Fees paid by the consumer may not exceed three percent (3%) of the total loan amount, although certain bona fide discount points are excluded for prime loans. Truth In Lending Act (TILA) REG Z Limits debt-to-income ratios to 43% or less. Or temporarily higher. 21 Copyright MortgageEducation.com. All Rights Reserved.

22 22 Ability to Repay Rule QM Benefits Provides a Safe Harbor for lower-priced Prime loans made to borrowers who pose fewer risks. Provides a Rebuttable Presumption of Compliance for higher-priced loans made to borrowers with weak credit history. Truth In Lending Act (TILA) REG Z Source: (e)(1)(i) and (e)(1)(ii)(A) 22 Copyright MortgageEducation.com. All Rights Reserved.

23 23 Introduction Our Example These mortgages also have unique features and typically don t have a fixed payment, fixed interest rate, and may not all have the full 30 year maturity term In this course, we will contrast loans with an FRM for a more thorough understanding

24 24 Introduction Assumptions Our assumptions: Loan Amount = $100,000 Note Rate = 4.875% First payment is on Feb 1 st, 2010 Mortgage Payment is $529 a month

25 25 Introduction Our FRM Base Case Interest amortizes to zero 30 Year Fixed Mortgage Total Interest Owed end of period $ 0 Total interest approaches loan amount Total Interest Payment $ 90,515 Beginning Payment Period Ending Payment Period Monthly Interest Payment Monthly Principal Payment Monthly Mortgage Payment 1-Feb-10 1-Jan-40 From $406 to $2 From $123 to $527 $529 Fixed Monthly Payment = Interest + Principal Note: Numbers rounded for ease of presentation

26 $ Monthly Payment 26 Introduction FRM Base Case While Interest and Principal vary, mortgage payment remains constant Components of Monthly Mortgage Payments 30 Yr Fixed Interest Payment 30 Yr Fixed Principal Payment Years Since Closing

27 II. IO Mortgage 27

28 28 A. IO Mortgage Features Definition Allow borrower to only pay interest only Initial term, or IO Period Typically 5-7 years Can range from 3 to 10 May have teaser rates IO Mortgage After IO Period, payment includes interest and principal, a fully amortized payment Mostly an adjustable rate

29 29 A. IO Mortgage Features Payment Shock After IO Period, payment can become significantly higher Same principal $300,000 = $300,000 Less than 30-years to pay down $300,000 in 25 years FRM could look much better IO Mortgage

30 30 B. IO Mortgage Pros and Cons Target Borrowers (continued) Lumpy Compensation Once a year bonus or stock options Executives or Salespeople Affluent borrowers with fluctuating income Small Business Owners Seasonal income, cash management IO Mortgage Savvy Investors Strong knowledge of other investments High tax bracket Take more advantage of interest deduction

31 31 B. IO Mortgage Pros and Cons Target Borrowers (continued) Fast Track Employees E.g. law student going into a corporation E.g. clear career promotion path Better than buying a small house and trading up later Transaction costs for new home could be expensive IO Mortgage Homeowner s Investment Predicting property value will increase Can sell or refinance before interest rises Buyer must be able to afford risk

32 32 B. IO Mortgage Pros and Cons Managing Payment Shock Options Prepay Pay down principal during interest only period Generally allowable (watch out for prepayment penalties) The IO loan is an OPTION to not pay principal down Costs money = higher interest rate Borrower should intend to use the option of the Interest Only payment. Otherwise, why get it? IO Mortgage

33 33 B. IO Mortgage Pros and Cons Manage Payment Shock (continued) Pay at the end of IO period Often if investing in other vehicles Liquidate other investments to pay down principal IO Mortgage Refinance into FRM Home value supported Refinance into a lower rate FRM because of lower LTV Standard risks always apply Meet lender credit underwriting guidelines for eligibility considering LTV, DTI, cash required for closing or reserve requirement, and sufficient market value of home

34 34 C. IO Mortgage Potential Pitfalls Risk Summary Borrowers must focus on paying principal Everyone can lose a job or suffer financial setbacks Discipline is key E.g must pay down once a year at bonus time if that was the plan IO Mortgage Make sure IO applicants can handle the downside Praying for declining interest rates or increasing home values is a dangerous path to pursue

35 C. IO Example Compare to our FRM example of $529 Payment shock is $171 5 Year IO Note Rate: 4.875% Term: 30 years Mortgage Amount: $100,000 Amortization: IO for first 5 years, then fixed mortgage payment for 25 years Monthly Mortgage Payment Monthly Interest Payment Monthly Principal Payment Remaining Principal Year 1 $ 406 $ 406 $ - $ 100,000 Year ,000 Year ,000 Year ,000 Year ,000 Year ,829 Year 30* *Data displayed is the payment on the first month of the year, except that in Year 30, data displayed is the last month of the year Interest is paid as calculated for five years. Principal stays the same Total Interest Payment $ 97,574 Total Principal Payment $ 100,000 Note: Numbers rounded for ease of presentation 35

36 $ 36 C. IO Example Comparison After initial period, the higher IO mortgage brings the Principal to zero in the same time period as the FRM Remaining Mortgage Balance 120, ,000 IO Remaining Principal 30 Yr Fixed Remaining Principal 80,000 60,000 40,000 IO Mortgage 20, Years After Closing

37 III. Negative Amortization Mortgage 37

38 38 Negative Amortization Mortgage Amortization Definition The process of lowering the principal amount of a loan Loan payment decreases principal Negative Amortization Definition Negative Amortization Mortgage Principal actually increases! Loan payment is less than Interest Due The interest compounds Principal Increase = (Interest Due Interest Payment)

39 39 A. Negative Amortization Mortgage Features Negative Amortization Mortgage (NegAm) Similar to an IO Mortgage Monthly mortgage payment is even lower than an IO Not always designed that way in the loan structure ARM with cap if interest rates go up can experience negative amortization Negative Amortization Mortgage

40 40 A. Negative Amortization Mortgage Features Comparison (FRM v. IO v. NegAm) Assume interest rate is the same: $1000 on $300,000 principal FRM 1. 1 st month: $1450 P&I payment, 2. $1000 interest and $450 in principal 3. 2 nd month principal = $299,550 IO 1. 1 st month: Payment of $1000 interest 2. 2 nd month principal = $300,000 Negative Amortization Mortgage NegAm 1. 1 st month: Assume payment set to $ nd month principal = $300,500

41 41 A. Negative Amortization Mortgage Features Interest Due v. Interest Payment Due Two separate concepts Interest Due = Interest rate x principal Interest Payment Due = payment range set by loan terms For FRM or IO, both are the same For NegAm, Interest Due likely greater than Interest Payment Due Negative Amortization Mortgage NegAm borrower may have $1010 Interest Due 2 nd month Payment is set to $500 Unpaid $510 now added to principal

42 42 B. NegAm Mortgage Pros and Cons Benefits Low initial mortgage payment Initially lower than an FRM or IO Good option for appropriate borrowers similar to an IO People with once a year bonuses Cash management for small businesses Savvy Investors Negative Amortization Mortgage Can alleviate Payment Shock for ARM borrowers when NegAm is structured with a fixed rate mortgage

43 43 B. NegAm Mortgage Pros and Cons Cons High Payment Shock Mortgage payment greater with interest rate increases and recasting LTV could be over 100%! Borrower couldn t sell Borrower couldn t refinance Negative Amortization Mortgage Very dangerous if the borrower is not able to handle the risk Like an IO loan, no payment towards principal but with much greater risks

44 44 B. NegAm Mortgage Pros and Cons Assumptions Note rate 4.875% Initial 5 years payment only 2.875% Remaining 2% is added to balance Negative Amortization Mortgage After Initial period, 25 year fixed rate amortization using 4.875%

45 C. NegAm Example Initial Interest is much lower than $529 for FRM Payment shock is $378 5 Year Negative Amortization Mortgage Note Rate: 4.875% Term: 30 years Mortgage Amount: $100,000 Amortization: Interest Payment at 2.875% for first 5 years, then fixed mortgage payment for 25 years Monthly Mortgage Payment Monthly Interest Payment Monthly Principal Payment Remaining Principal Year 1 $ 240 $ 240 $ - $ 100,167 Year ,188 Year ,251 Year ,355 Year ,502 Year ,319 Year 30* (0) *Data displayed is the payment on the first month of the year, except that in Year 30 data displayed is the last month of the year Total Interest Payment $ 95,996 Total Principal Payment $ 110,508 Interest payment increases Principal increases Note: Numbers rounded for ease of presentation 45

46 $ 46 C. NegAm Example Comparison Like an IO, there is no initial reduction of principal The principal actually increases! Remaining Mortgage Balance 120, ,000 IO Remaining Principal 30 Yr Fixed Remaining Principal NegAm Remaining Principal 80,000 60,000 Negative Amortization Mortgage 40,000 20, Years After Closing

47 $ Monthly Payment 47 C. NegAm Example Comparison The mortgage payment is even lower than the IO in the initial period After the initial period the mortgage payment is higher $700 Monthly Mortgage Payments of FRM and NegAM $600 $ Yr Fixed Total Mortgage Payment Negative Amortization Mortgage $400 $300 $200 $100 NegAm Total Mortgage Payment IO Total Mortgage Payment $ Years Since Closing

48 IV. Adjustable Rate Mortgage (ARM) 48

49 49 Adjustable Rate Mortgage (ARM) Definition Adjustable Rate Mortgage (ARM) is a mortgage that changes its rate over a given period of time Changes with an index The note rate equals the index rate plus a margin Usually 1-2% margin Adjustable Rate Mortgage (ARM) First appeared in the 1960 s Regulatory approval in the volatile and high interest rate early 1980 s

50 50 Adjustable Rate Mortgage (ARM) Higher Return Adjustable rates are often lower than an FRM IF interest rates remain the same over the next 30 years Lender offers Lower APRs than with an FRM Around 1% in a low rates environment Up to 5% for non-conforming mortgages Discount points / teaser rates Adjustable Rate Mortgage (ARM)

51 51 Adjustable Rate Mortgage (ARM) Higher Risk Lenders discount loans in order to offload risk to the borrower Interest rates may fluctuate They may rise significantly Monthly payments could increase significantly Higher Risk, Higher Return Adjustable Rate Mortgage (ARM)

52 52 A. ARM Mortgage Features Index Definition The adjustable interest rate in an ARM is tied to an underlying index Examples Cost of Funds Index (COFI), the 12-Month Treasury Average (MTA) or the Prime Rate When the index rate goes up, the ARM rate goes up When the index rate goes down, the ARM rate goes down Adjustable Rate Mortgage (ARM)

53 53 A. ARM Mortgage Features Margin Definition The rate the borrower pays is Index plus Margin, sometimes called the Full Indexed Rate The Margin represents the lender s profit. The lender: Borrows at the Index Rate Lends at the Index Rate + Margin The Margin usually stays constant during the life of the loan Adjustable Rate Mortgage (ARM)

54 54 A. ARM Mortgage Features Margin, Lender s Example Often lenders borrow at one Index Rate, but lend at another Index Rate + Margin E.g. For example, if The Prime Rate is 5%, the COFI index might be at 2% If the lender s profit is 3.5%, the lender might borrow at COFI and charge either 3.5% + COFI or 0.5% + Prime Adjustable Rate Mortgage (ARM)

55 55 A. ARM Mortgage Features Teaser Rates / Payment Shock Most ARMs have a lower fixed interest rate for the first few years These rates are called Teaser Rates E.g. - a loan may be a 2/28 or 3/27 Initial 2 or 3 years of unchanging note rate Then 28 or 27 years of adjustable rate Lenders or homesellers may buydown initial rates The ARM benefit is mostly during the first few years Adjustable Rate Mortgage (ARM) Payment Shock can increase substantially

56 56 A. ARM Mortgage Features Payment and Rate Caps Periodic Rate Cap Maximum rate change allowable in a given period of adjustment Typically 1-2% per year Not all ARMs have periodic rate caps Life or Overall Rate Cap Rate ceiling that cannot be exceeded during the loan live Typically an absolute percentage value Adjustable Rate Mortgage (ARM)

57 57 A. ARM Mortgage Features Adjustment Period The period between potential interest rate adjustments Terms Can describe an ARM as 2/1/3 2 = initial adjustment cap 1 = periodic cap 3 = lifetime adjustment cap Adjustable Rate Mortgage (ARM) For example, an ARM with a 6% starting interest rate Could go to 8% then 9%, but not over 9%

58 58 A. ARM Mortgage Features Carryovers Sometimes the Periodic Rate Cap will keep the Interest Payment Due less than the Interest Due The difference in interest is carried over to the next period Adjustable Rate Mortgage (ARM) The mortgagor may have no idea this is happening, so it is important to explain

59 59 A. ARM Mortgage Features Adjustable Rate Mortgage (ARM) Hidden NegAm Features Payment Caps may cause NegAm If the payment cap restricts required payment adjustments to align with fully-indexed rate, negative amortization may occur Principal increases due to the difference in the payment at the fully-indexed rate and outstanding principal balance required by lender and designated payment amount due to payment cap Interest compounds Risk of default increases

60 60 A. ARM Mortgage Features Qualifying Rate Cannot qualify for an ARM based on the initial teaser rate Lender will add points to the rate Typically 2% Still, teaser rates with ARMs may ease qualifying a borrower Especially with subprime borrowers Of course, this doesn t mean the borrower should take out the ARM Adjustable Rate Mortgage (ARM)

61 61 B. ARM Mortgage Refinance Refinancing to an ARM Refinancing can often make sense Doing the math is important Transaction costs E.g % rate cut, probably not worth it Adjustable Rate Mortgage (ARM)

62 62 B. ARM Mortgage Refinance Refinancing to an FRM Can often result in an increase in the rate Reasons client may want an FRM Decides to stay in the home for several years Has a steady income now Reduce volatility Lock in a good interest rate Adjustable Rate Mortgage (ARM)

63 63 C. Benefits of ARMs Qualification Likely easier to get qualified Rate is likely lower than an FRMs Some lenders are less stringent on ARM lending Less than perfect credit more acceptable Adjustable Rate Mortgage (ARM) Larger loan may be possible Low rates mean lower payments so borrower may secure a larger loan amount More favorable than a larger payment on a smaller loan amount with higher interest rates and higher DTI Lower DTI may help to meet lender eligibility requirements for easier approval

64 64 C. Benefits of ARMs Lower APRs First few years high savings Generally good for short-term ownership If clients are able handle the risk, it can create real savings Adjustable Rate Mortgage (ARM) Important to have Fixed rate for the first few years Low Periodic Rate/Payment Cap

65 65 D. ARM Considerations ARM Considerations It is attractive to get a lower APR Borrowers often do not understand the trade-offs It is just human nature to focus on the lower rate opportunity Adjustable Rate Mortgage (ARM) Consumer Handbook on Adjustable- Rate Mortgages (CHARM) Booklet a requirement

66 66 D. ARM Considerations Interest Rate Increases The rate could become higher than an FRM Over 30 years, rates will likely increase Inflation Volatility Adjustable Rate Mortgage (ARM) Maximum rate cap is good protection

67 67 D. ARM Considerations Low Interest Rate Example The 1970s High interest rates Rates likely to go down The mid 2000s Low interest rates Rates likely to go up ARMs much more risky Adjustable Rate Mortgage (ARM)

68 68 D. ARM Considerations ARM Risk Factors Prepayment penalties Rates could increase drastically Income could decrease drastically What if a borrower can t afford the maximum rate from the beginning? Adjustable Rate Mortgage (ARM) An ARM borrower needs Discipline or High-Risk protection

69 69 D. ARM Considerations Lessening ARM Risk Factors High down payment Low periodic cap No prepayment penalty Strong asset base Buy a cheaper house Adjustable Rate Mortgage (ARM) Don t get an ARM!

70 70 D. ARM Considerations Risk Assessment Questions Can the borrower truly afford the house? Can the borrower pay the rate cap? Is there a prepayment penalty clause, a NegAm clause or Carryover clause with this loan? Adjustable Rate Mortgage (ARM) Investors must know and highly consider risks

71 71 D. ARM Considerations Historical Example In the 70s, Prime rates ~ 19% Adjustable rates ~8% Hard to qualify people outside of ARMs Lots of NegAm clauses with ARM loans Adjustable Rate Mortgage (ARM) Unfavorable situation

72 72 E. ARM High / Low Interest Rate Examples ARM Examples Assumptions Index is treasury, which is 0.5% at closing; margin is 2% Annual Rate Cap = 1% Lifetime Rate Cap = 7.75% SCENARIO 1: Treasury rate goes to 0.5% lifetime of mortgage Adjustable Rate Mortgage (ARM) SCENARIO 2: Treasury rate goes to 7.0% for lifetime of mortgage

73 $ Monthly Payment 73 E. ARM High / Low Interest Rate Examples High / Low Interest Rate Comparison Mortgage payments can deviate significantly once the initial period ends ARM Interest Payments for High and Low Interest Scenarios $ $ $ ARM Total Mortgage Payment (low interest scenario) $ $ $ ARM Total Mortgage Payment (high interest scenario) Adjustable Rate Mortgage (ARM) $ $ Years Since Closing

74 74 E. ARM Low Interest Rate Examples ARM Low Interest Rate Example 3 Year ARM (Constant 0.5% Index rate for 30 years, 1% Annual Cap) Total Interest Owed $ - Total Interest Payment $ 46,672 Compare to FRM amount close of $90,515 Fixed at initial rate for 3 years Adjustable Rate Mortgage (ARM) Index 0.5% Index +2% Margin 0.5% Index +2% Margin 0.5% Index +2% Margin Interest Rate Used Beginning Monthly Payment Period Ending Monthly Payment Period Fixed at 3.75% 1-Feb-10 1-Jan-13 Fixed at 2.75% (due to 1 year cap) 1-Feb-13 1-Jan-14 Fixed at 2.5% 1-Feb-14 1-Jan-40 Interest rate only moves down 1% because of annual cap Monthly Mortgage Payment $463 Fixed $413 Fixed $401 Fixed Note: Numbers rounded for ease of presentation

75 75 E. ARM High Rate Example Interest rate would be 9% without caps Annual cap of 1% Lifetime cap of 7.75% Adjustable Rate Mortgage (ARM) ARM High Interest Rate Example 3 Year ARM (Constant 7% Index Rate, 1% Annual close Cap, of 7.75% Life Cap) $90,515 Total Interest Payment $ 134,606 Beginning Ending Monthly Interest Rate Payment Payment Mortgage Used Period Period Payment Index 7% Index +2% Margin 7% Index +2% Margin 7% Index +2% Margin 7% Index +2% Margin 7% Index +2% Margin Compare to FRM amount Fixed at 3.75% 1-Feb-10 1-Jan-13 Capped at 4.75% 1-Feb-13 1-Jan-14 Capped at 5.75% 1-Feb-14 1-Jan-15 Capped at 6.75% 1-Feb-15 1-Jan-16 Capped at 7.75% 1-Feb-16 1-Jan-40 $463 Fixed $517 Fixed $572 Fixed $628 Fixed $685 Fixed Note: Numbers rounded for ease of presentation

76 76 F. Option Adjustable Rate Mortgage Overview Definition Combines ARM, IO, and NegAm The borrower chooses a payment Can be fixed rate and with short Initial Period Interest only Fully amortized over 30 or year terms Minimum payment per loan term Adjustable Rate Mortgage (ARM) Gives many Options, but More risk More cost

77 77 F. Option Adjustable Rate Mortgage Overview Dangers Magnified dangers of IO and ARM Interest Rates increases Housing Prices decline Designed to have NegAm Higher risk for lender when borrower is unable to make adjusted payment Adjustable Rate Mortgage (ARM) Larger Payment Shock with Recast Requires payment to fully amortize the outstanding balance over the remaining loan term.

78 78 F. Option Adjustable Rate Mortgage Overview Loan Recast Recasting occurs when NegAm caps are reached 110%, 115%, 125% LTV Specific years of the term reached May be five years after closing Adjustable Rate Mortgage (ARM) Establishes new payment terms and minimum payment calculation Outstanding balance Current interest rate Remaining term

79 79 F. Option Adjustable Rate Mortgage Overview Results Borrowers would take loan to buy a house they cannot afford Wanted to take advantage of lower interest rates Predatory Lending Lenders also took on higher risk Adjustable Rate Mortgage (ARM) High default rate with borrowers inability to handle payment shock

80 Appendix 80

81 81 Summary Alternative Mortgages Not your standard fixed payment due each month for 30 years Shorter maturity dates Payments change through time Structure (IO, Buydowns) Indices (ARMs)

82 82 Summary High Risk, Higher Potential Return Higher Return: Many of these alternative loans are less costly than FRMs and offer lower payments for a specific period of time which offer borrower limited savings Higher Risk: Borrowers are taking on the risk to get that higher return! Increasing Interest rate risk Refinance eligibility risk Risk of Sustaining Property Market Value (home price value)

83 83 Summary Understand Intended Use Can be great for the right client Can be horrible for the wrong client Know the requirements and target borrowers Understand well the pros and cons Explain important concepts like Payment Shock and Carryover

84 Cross-Comparison 84

85 Terms Year Fixed 5 Year IO 5 Year NegAm 3/27 ARM Low 3/27 ARM High Mortgage Amount $100,000 $100,000 $100,000 $100,000 $100,000 Term 30 years 30 years 30 years 30 years 30 years Initial Period NA 5 years 5 years 3 years 3 years Interest Rate at Close 4.875% 2.875% 2.000% 3.75% 3.75% Note Rate 4.875% 4.875% 4.875% NA NA Index after close NA NA NA 0.5% 7.0% Margin NA NA NA 2.0% 2.0% Annual Rate Cap NA NA NA 1.0% 1.0% Lifetime Rate Cap NA NA NA 7.75% 7.75%

86 Interest Rate Comparison 86 Interest Rate 30 Year Fixed 5 Year IO 5 Year NegAm 3/27 ARM Low 3/27 ARM High Year % 2.875% 2.000% 3.750% 3.750% Year % 2.875% 2.000% 3.750% 3.750% Year % 2.875% 2.000% 3.750% 3.750% Year % 2.875% 2.000% 2.750% 4.750% Year % 2.875% 2.000% 2.500% 5.750% Year % 4.875% 4.875% 2.500% 6.750% Year 30* 4.875% 4.875% 4.875% 2.500% 7.750% *Data displayed is the payment on the first month of the year, except that in Year 30, data displayed is the last month of the year

87 Monthly Mortgage Payment Comparison 87 Monthly Mortgage Payment 30 Year Fixed 5 Year IO 5 Year NegAm 3/27 ARM Low 3/27 ARM High Year 1 $529 $406 $240 $463 $463 Year Year Year Year Year Year 30* *Data displayed is the payment on the first month of the year, except that in Year 30, data displayed is the last month of the year Note: Numbers rounded for ease of presentation

88 Remaining Principal Comparison 88 Remaining Principal 30 Year Fixed 5 Year IO 5 Year NegAm 3/27 ARM Low 3/27 ARM High Year 1 $99,877 $100,000 $100,167 $99,849 $99,849 Year 2 98, , ,188 98,005 98,005 Year 3 96, , ,251 96,090 96,090 Year 4 95, , ,355 94,074 94,127 Year 5 93, , ,502 91,673 92,379 Year 6 91,508 99, ,313 89,126 90,805 Year 30* *Data displayed is the payment on the first month of the year, except that in Year 30, data displayed is the last month of the year Note: Numbers rounded for ease of presentation

89 Summary Comparison 89 Summary 3/27 ARM Low 3/27 ARM High 30 Year Fixed 5 Year IO 5 Year NegAm Total Interest Payment $90,515 $97,574 $95,996 $46,672 $134,606 Total Principal Payment 100, , , , ,000 Payment Shock ($) (51) 54 Payment Shock Adjustment Year 0% 42% 146% (11%) 12% Payment Shock Lifetime 0% 42% 166% (13%) 48% Note: Numbers rounded for ease of presentation