Examples of Variable Rate Mortgage in the following topics:
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- Prepayment risk is the risk that the buyer goes ahead and pays off the mortgage.
- Interest rate risk refers an asset whose terms can change over time, such as a Variable Rate Mortgage payment.
- The mortgages often featured variable rate annuities, meaning that the interest rate terms of the mortgage started low and increased over time.
- Buyers worried about an adjustment to their interest rate, and all of a sudden a 1500 monthly payment became 2000.
- When interest rates climbed 2 percentage points and the mortgage climbed to $2000, some owners had to default (stop making payments) .
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- Interest rates became volatile during the 1980s, forcing banks to become more concerned with interest-rate risk.
- Interest-rate sensitive items are short-term securities, variable interest-rate loans, and short-term deposits.
- If the interest-rate sensitive liabilities equal the interest-rate sensitive assets, then fluctuating interest rates do not affect bank profits.
- Some banks grant loans to borrowers with variable interest rates.
- For example, a variable interest rate mortgage is an adjustable-rate mortgage (ARM).
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- For example, a bank granted a mortgage for $60,000 at an interest rate of 12% APR.
- If a mortgage is monthly, then you divide the interest rate by 12 and multiply the number of years by 12.
- Interest rate, i, is the APR interest rate divided by 12.
- Amortization table can also handle balloon payments and variable interest rate mortgages.
- Moreover, variable-interest rate loan is the bank can adjust the loan's interest rate as market interest rates change.
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- Floating rate bonds are bonds that have a variable coupon equal to a money market reference rate (e.g., LIBOR), plus a quoted spread.
- Floating rate bonds (FRBs) are bonds that have a variable coupon, equal to a money market reference rate, like LIBOR or federal funds rate, plus a quoted spread (i.e., quoted margin).
- In the United States, government sponsored enterprises (GSEs), such as the Federal Home Loan Banks, the Federal National Mortgage Association (Fannie Mae), and the Federal Home Loan Mortgage Corporation (Freddie Mac), are important issuers.
- FRBs carry little interest rate risk.
- Thus, FRBs differ from fixed rate bonds, whose prices decline when market rates rise.
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- Banks persuaded homeowners to accept adjustable-rate mortgages (ARMs).
- Thus, a mortgage payment changes as the interest rate changes.
- At the beginning, homeowners paid low mortgage payments, but payments would explode in size as interest rates reset to higher levels.
- Credit agencies always rated CDOs with an AAA credit rating, even though some CDO's funds contained subprime mortgages.
- Unemployment rate soared to 10%, and households, especially the subprime market, began defaulting on their mortgages in record numbers.
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- Floating rate debt is loans with a variable interest rate.
- If the interest rate increases, then borrowers must pay more interest on their payments.
- Securitization is the bundling of illiquid assets like mortgages into a fund.
- A fund offers different tranches with different credit ratings and rates of return.
- If banks retained their rigid lending standards and the creditrating agencies accurately rated the CDOs and ABS, then the housing bubble would still form but at a slower rate.
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- Many borrowers seek bank loans for mortgages, car loans, or credit cards.
- Originally, these institutions accepted deposits and granted low-cost mortgages for homebuyers.
- For example, if you borrowed $10,000 at a 5%, interest rate and loaned it out at 10%, then you earn a profit.
- However, if you borrowed $10,000 at 10% interest rate and loaned it out at 5%, subsequently, you earn a loss.
- Interest rates rose during the 1980s as the savings institutions paid a greater interest rate to thedepositors than the amount of these institutions earned on the mortgages. mortgages are usually 30-year loans, and savings institutions were locked into low interest rates from the 1960s.
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- Federal, state, and local governments in the United States create government financial institutions that lend funds to the public.First, The U.S. government uses direct financing, when it creates a public corporation that sells bonds and commercial paper to investors in the financial markets.Then the public company uses the investors' money to lend to borrowers directly.For example, the Farm Credit System, a U.S. government agency, lends to farmers.Farmers use these loans to finance growing crops, equipment, or mortgage loans.Second, the U.S. government lends money to students who pursue a college education.For example, the Student Loan Market Association, known as Sallie Mae, lends directly to students or buys student loans from banks.Finally, the Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac) grant mortgages to low-income households.They also buy and sell mortgages to boost the liquidity of the mortgage loan market.For the second method, a government can lend to the public through loan guarantees, which is similar to insurance.For example, a bank lends to a student to pay for an education, and the U.S.
- Some people question a government's role in financing.When a government directly lends, the government squeezes the financial institutions out of the loan market.Furthermore, the federal government loan guarantees increase the problem of moral hazard.Financial institutions receiving the loan guarantees might not screen borrowers as much, lending to borrowers with a high default risk.For example, the effects of the 2007 Great Recession continue to linger in the U.S. economy, even in 2014.Recession caused mass layoffs and doubled the unemployment rate.Then the housing values continue to plummet while foreclosures continue soaring.Consequently, the U.S. government might be liable for trillions of dollars in loan guarantees and bailout of public corporations.We explain several examples below:
- Department of Education, SallieMae, and commercial banks granted college student loans that had surpassed $1 trillion in 2012.Unfortunately, college graduates continue to enter an abysmal job market in 2013.Student-loan default rate hovers around 24%.College students, on average, owe approximately $24,000 while law school graduates accumulate loans exceeding a $100,000.Unfortunately, a stagnant economy would force the U.S. government to pay billions in loan guarantees.
- Fannie Mae and Freddie Mac hold roughly $6 trillion in mortgages, comprising half the mortgages in the United States.The U.S. government had seized these two institutions in 2008, and it has spent billions of dollars to bail them out.Bailout cost will continue to soar if the U.S. economy does not recover.Unfortunately, the U.S. government helped create this mess because it encouraged Fannie Mae and Freddie Mac to grant mortgages to low income households, who become vulnerable to downturns in the economy.
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- Fixed rate bonds have a coupon that remains constant throughout the life of the bond.
- Floating rate notes (FRNs, floaters) have a variable coupon that is linked to a reference rate of interest, such as LIBOR or Euribor.
- It is one type of floating rate bond.
- The interest rate is normally lower than for fixed rate bonds, with a comparable maturity.
- Examples of asset-backed securities are mortgage-backed securities (MBS's), collateralized mortgage obligations (CMOs), and collateralized debt obligations (CDOs).
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- Financial analysts use the present value formula to price financial securities or calculate mortgage payments.
- We use algebra to solve for unknown variables.
- Your interest rate must be 14.4% annually, or 72 รท 5.
- We could apply the Rule of 72 to economic variables other than financial securities.
- We cannot use the Rule of 72 for negative growth rates.