RE2706 Real Estate and Infrastructure Finance

Week 3

Mingxuan FAN

Department of Real Estate

NUS Business School

January 27, 2023

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Last lecture

▶ Price Level Adjusted Mortgage (PLAM)

▶ Adjustable Rate Mortgage (ARM)

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Interactive questions
▶ Go to: PollEv.com/re2706
▶ OR use the QR code

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Interactive questions

Which of the following is a disadvantage of PLAMs?

▶ Lenders face high levels of interest rate risk under PLAMs.
▶ Fewer homebuyers are likely to qualify for financing using PLAMs in
comparison to CPMs.
▶ The price level used to index PLAMs is measured on an ex post basis
and historic prices may not be an accurate reflection of future price.
▶ All of the above.

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Interactive questions

Which is NOT a component of an ARM?

▶ A margin
▶ An index
▶ A chapter
▶ Caps

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Common questions on Lecture 2

▶ Would the outstanding principal necessarily come down if inflation is

always positive?
▶ What if the loan if not fully paid off at the end of 30 years?

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Common questions on Lecture 2

▶ How to apply the periodic and lifetime cap/floor?

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Common questions on Lecture 2

▶ How to apply the periodic and lifetime cap/floor?

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Common questions on Lecture 2

▶ How is the nominal payment deflated calculated?

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Learning objectives

1 More on ARM

2 Mortgage products in Singapore

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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

2 Mortgage products in Singapore

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ARM terms

▶ ARM contract terms have so many dimensions

▶ Difficult for borrowers to understand especially those without financial
knowledge
▶ Understand teaser rate?
▶ Understand the possibility of negative amortization?
▶ Understand the possibility of payment shocks?

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Loan Closing Costs

Additional Finance Charges

▶ Loan origination fees
▶ Loan discount – “points”
▶ Used to raise the yield on the loan
▶ Borrower trade-off: points versus contract rate
▶ 1 point = 1% of loan amount
Why Points?
▶ Sticky mortgage rates
▶ Price in the risk of the borrower
▶ Early repayment of a loan does not allow recovery of origination costs
▶ Earn a profit on loans sold to investors at a yield equal to the loan
interest rate

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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

▶ Loan amount: $60,000

▶ Less origination fee (3%): $1,800
▶ Net cash disbursed: $58,200
▶ Monthly payment: PV=60,000, I/Y=12/12, N=360, FV=0; CPT
PMT=-617.17

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Loan Closing Costs: Example

What is the effective interest cost?

▶ PV=58,200
▶ N=360
▶ PMT=-617.17
▶ CPT I/Y=1.03
Effective interest rate: 1.03% × 12=12.36%

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ARM calculation example

▶ Loan amount = $150,000

▶ Index = 1 year TB yield (4% now)
▶ Adjustment period: One year
▶ Margin = 200 bp (1 basis point = 0.01%)
▶ Maturity = 30 years
▶ Caps and Floors: ±2%/ year, ±6% life time
▶ Monthly payment
▶ Teaser Rate = 4.5%
▶ Discount points=2%

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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?

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ARM calculation example

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ARM calculation example

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ARM calculation example

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ARM calculation example

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ARM calculation example

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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

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Learning objectives

1 More on ARM

2 Mortgage products in Singapore

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Types of loans

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.

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Types of loans
Differences between loans from HDB and financial institutions:

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

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SORA

▶ Singapore Overnight Rate Average

▶ SORA is the volume-weighted average rate of borrowing transactions
in the unsecured overnight interbank SGD cash market in Singapore
between 8.00am and 6.15pm.
▶ SORA index is published daily
▶ 1-month, 3-month and 6-month Compounded SORA
source:https://www.mas.gov.sg/monetary-policy/sora

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SORA

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Examples from DBS

“Fixed” vs floating rate:

▶ As at 3 January 2023, 3M SORA 3.0294% p.a.

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Examples from DBS

Two-in-one:

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Examples from DBS
Fees

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Examples from UOB

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Examples from CitiBank

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Examples of loan document

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Examples of loan document

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Mortgage loans worldwide

Source: Badarinzaet al. (2018).

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Mortgage loans worldwide

▶ 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

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