CASE 2: UNDER-

WRITING
Sarah Hu

SEPTEMBER 30, 2021

 TABLE OF
CONTENTS

Pricing and Valuation of Resi-

01 dential Property

02 Comparative Market Anal-

ysis

Residential Loan Underwrit-

03 ng: Amortization Table

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 Amount of Money Required
04 by Borrowers (Base Case)

05 Qualification of Buyers

Three Deal Structuring Alter-

06 natives

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 TABLE OF
CONTENTS

Creative Financing using a

07 5/1 Hybrid Arm

08 Buying Down the Loan

Decision: Best Way to Struc-

09 ture the Deal

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PREPARING DATA FOR ANALYSIS
Please see excel workbook.

COMPARATIVE MARKET ANALY-

SIS

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 Comparing 707 Cayuga Heights Road to the other active listings in the Ca-
yuga Heights neighborhood, the seller priced the home approximately at
the market. The current list price of the home ($325,000) falls right in be-
tween the mean and the median of the homes in the Cayuga Heights mar-
ket, which are about $395,000 and $312,000, respectively. The list price, as
expected, also aligns with the average of many of the other parameters such
as building square footage, number of bedrooms, number of baths, number
of garages and price per square foot. On average, homes in this market have
around 3.5 bedrooms while this house has 4. Homes also have an average
of about 1.75-2 baths while 707 Cayuga has 2 baths. In terms of building
square footage, 707 Cayuga is slightly smaller than the mean/median of the
other homes by around 100-200 square feet, but still very close to the mean.
The price per square foot falls right at the mean as well and the year built is
slightly above the median in the Cayuga Heights market. Given the charac-
teristics and profile of the home, 707 Cayuga Heights Road is priced right at
the market.

W I L L T H E P R O P E R T Y S E L L AT A D I S C O U N T O R A P R E M I U M ?

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As the original price to Zillow price estimate ratio increases, the discount or
premium ratio of the list price decreases. This means that the more over-
priced a property relative to its fundamental value (as proxied by the Zillow
Price Estimate), the heavier the property will be discounted on the list price.
For instance, if you overprice your property according to Zillow’s estimate,
you cannot expect for it to sell at your overpriced value because this trend
shows that this inflated list price will be discounted anyways when the home
sells.

Please see Excel workbook for regression output.

H O W D O E S T H I S I M PAC T T H E N U M B E R O F D O M ?

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 As the original list price to Zillow price estimate ratio increases, the number
of days the property is on the market also increases. This means that the
more overpriced a property relative to its fundamental value (as proxied by
the Zillow Price Estimate), the longer the property will remain on the market.
If you are looking to sell your home quickly, this trend would suggest that
you should list your home closer to the price of Zillow’s estimate. Otherwise,
if you price your property above its fundamental value, you can expect your
home to stay on the market for a longer period of time.

Please see Excel workbook for output.

E S T I M AT I O N O F P R I C E A D J U S T M E N T S

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 FHLMC APPR AISAL

C O R R E L AT I O N S W I T H P R I C I N G AT T R I B U T E S

All of our statistically significant independent variables have the right signs.
The statistically significant variables that have a positive correlation coefficient
with our dependent variable (sold price or list price) are: total assessed value,
bedrooms, baths, garage, fireplace, building size (sqft), stories, quality (good),
and condition (good). I expected there to be a positive co-movement between
these variables. For total assessed value, we can expect that homes that are
assessed to be worth more will also sell for more/list for a higher price. For

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 bedrooms and baths, the more living space a buyer gets, we can expect a higher
price for the home. For garage and fireplace, these are useful amenities of a home
and intuitively, we can expect to see an increase in the value of the home. For build-
ing size, intuitively, we can expect that a larger home will be listed/sold for a higher
price than a smaller home since they are buying more space. For the number of sto-
ries, intuitively, we can expect that a home with more stories will provide more space
and thus be listed/sold for a higher price. For quality (good) and condition (good),
these are the best ratings the house can receive for building structure and residential
structure. Thus, if they do have these ratings, we can also expect the house to sell/
list for higher.
The statistically significant variables that have a negative correlation coefficient are:
dum_ranch, condition (normal), and quality (economy). I expected there to be a nega-
tive co-movement between these variables. For condition (normal) and quality (econ-
omy), this means that the home’s building structure and residential structure ratings
are not as high as it could have been. Thus, if homes have these ratings, the sold/
list price of the home would be affected in a negative way. For ranch style homes,
because there are no basements, typically have higher heating bills, and were mainly
only popular with the post-war middle class of the 1940s to 1970s, we can expect a
home’s sold/list price to be negatively impacted if the type of home is a ranch style.

The statistically significant housing characteristics that the seller appears to consider
as having a positive impact on price but buyers don’t consider it worth paying extra
for include: offices, sun room and dum_summer. These variables were significant
when list price was the dependent variable but not when the sold price was the de-
pendent variable.

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R E L AT I O N S H I P B E T W E E N T H E L I S T I N G P R I C E A N D T O TA L A S S -
SE SSED VA LU E

As the total assessed value increases, so does the original list price. The fit
between these two variables is very good, considering the r^2 value was
0.922, indicating that there is a strong, positive correlation. The results also
coincide with what we can expect to see intuitively: the higher the assessed
value of a home, the higher the homeowners are going to list it for.

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 R E L AT I O N S H I P B E T W E E N T H E S O L D P R I C E A N D T O TA L A S S -
SE SSED VA LU E

The fit between the sold price and total assessed value is also very good.
However, the fit between the list price and the total assessed value may
be a bit better since there was a higher r^2 value for the trendline. For this
trendline, the r^2 value was only 0.88 while in the preceding problem, the
r^2 value was 0.922. Consistent with our intuition, as the total assessed value
increases, so does the sold price. This makes sense as people can expect to
sell their homes for higher prices if their home is assessed to have a higher
price.

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U S I N G M U LT I P L E R E G R E S S I O N T O E S T I M AT E T H E L I S T I N G
PRICE AND SOLD PRICE

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 PRICING SUMMARY

The list price is priced right at the estimated price from Zillow and slightly
above the appraised value. Using a single variable and multiple variable re-
gression for estimating the sold price, the home is priced slightly below the
estimated values of $334,375 and $347,570, respectively. Since the list price
is slightly below these estimated values, the seller is likely to receive at least
$325,000 for the subject property.

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RESIDENTIAL LOAN UNDER-
WRITNG: AMORTIZATION TABLE
Please see Excel workbook for full amortization table and calculations.
Henry and Leslie can expect a monthly payment of $1,164 if they take out a
loan with a 90% LTV ratio and want a 30-year fixed mortgage. For the first 58
months, they can also expect to pay $120.16 in PMI fees, making the monthly
payment for this period $1,284.

Interest is declining because over time, you pay off more of your loan bal-
ance. Because interest is calculated by multiplying the remaining balance
with the interest rate, the product is going to decrease over time since the
remaining balance will decrease. Principal is increasing over time due to the
combination of two reasons: 1) because principal can be calculated by sub-
tracting interest from the total debt service and 2) since interest is declining
over time, principal is increasing over time.

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 A mortgage, although a type of corporate bond, differs from the traditional
corporate bond in that each month’s payment includes both interest and
principal, thereby reducing the loan balance. For corporate bonds, only in-
terest is paid each month. At the end of the term’s maturity, the principal
is paid back in full whereas the principal is slowly paid back over time for a
mortgage.
The outstanding mortgage balance is declining over time because part of
the debt service in which you pay each month goes towards the mortgage’s
principal. Since the total debt service is equivalent to interest and principal,
and that the amount allocated to interest decreases over time, the ending
balance over time is a slightly convex graph. As the amount going towards
interest goes down, the amount going towards principal goes up and as a
result, the faster your outstanding mortgage balance will decrease over time.

AMOUNT OF MONEY REQUIRED

BY BORROWERS (BASE CASE)
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The total amount Henry and Leslie must come up with is $50,440 in order to
cover closing costs and their down payment if their offer price equals the list
price of $325,000.

QUALIFICATION OF BUYERS
The total long-term debt payments per month for Henry and Leslie is $3,007.
The monthly housing expense is $1,830. According to my bank’s housing
expense-to-total gross income ratio and long-term debt-to-total gross in-
come ratio, Henry and Leslie do not qualify for the mortgage. Their housing
expense ratio and long-term debt ratio are 22.6% and 37.2%, respectively.
While the housing expense ratio is valid, their long-term debt ratio is too
high and so they do not qualify for the mortgage.

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 THREE DEAL STRUCTURING AL-
TERNATIVES
Please see Excel workbook for calculations.

Henry and Leslie do not qualify for the first alternative where the sold price
of the house was reduced by 2%. However, they do qualify for the other two
alternatives. For the second alternative where they pay down their VISA debt
by $3,000, their housing expense ratio was 22.6% and the long-term debt
ratio was 35.7%. For the third alternative where they increased their down-
payment to 20%, the housing expense ratio was 19.6% and the long-term
debt ratio was 34.1%. For both of these alternatives, the calculated ratios
were less than 28% and 36% for housing expense and long-term debt, re-
spectively.

CREATIVE FINANCING USING A

5/1 HYBRID ARM
Please see Excel workbook for calculations.

If Henry and Leslie take out a 5/1 Hybrid ARM loan, the total mortgage pay-
ment per month for the first 5 years would be $1,260. The total long-term
debt payments would be $2,903, resulting in a long-term debt-to-gross in-
come ratio of 35.9%. The total housing expense per month is $1,806, result-
ing in a housing expense-to-gross income ratio of 22.3%. Therefore, they do
qualify for the mortgage under this alternative. They can also expect to use
$52,421 of their savings.

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BUYING DOWN THE LOAN
Please see Excel workbook for calculations.

Henry and Leslie qualify for the mortgages based on the initial payments
from the buydown. For the first year, the housing expense ratio is 19.2%
while for the second year, the housing expense ratio is 20.8%. For the first
year, the long term debt ratio is 33.7% while for the second year, the long
term debt ratio is 35.4%. This is a viable alternative for Henry and Leslie be-
cause they are able to now qualify for the mortgage they were not able to in
problem 3 (base case) due to the buydown alternative.

DECISION: BEST WAY TO STRUC-

TURE THE DEAL
There are 4 terms under which they would qualify for the loan for 707 Cayu-
ga Heights Road:
1. No reduction in the offer price (pay 100% of List Price) with a 90% LTV
loan. Pay down current VISA debt by $3,000.
2. No reduction in the offer price (pay 100% of List Price) and increase the
down payment to 20%.
3. 5/1 hybrid arm loan
4. FHA 2-1 buydown

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 Under all four of these options, their housing expense ratio and long-term
debt ratios are lower than 28% and 36%, respectively.

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