REAL ESTATE FINANCE W/ACCESS
16th Edition
ISBN: 9781266527746
Author: BRUEGGEMAN
Publisher: MCG
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Chapter 5, Problem 1Q
Summary Introduction
To discuss: The reason behind the development of fixed interest rate mortgage with numerous patterns of payment did not address the problem faced by the lenders. And also discuss the lenders approach to overcome these problem.
Expert Solution & Answer
Explanation of Solution
The fixed interest rate mortgage with various payment patterns does not adjust to the changes in economic condition and also does not address the inflationary effect on the expected rate of interest, the rate of interest is fixed on the date of origination and leftovers until the loan is reimbursed. Thus, moneylenders are underwriting the risk of any important variations in the implicit component of the mortgage interest rates – real rate of interest (r), the premium for expected inflation (f) and the risk premium (p) , this would result in lender’s financial loss.
To address such inflationary expectations on interest rate, the lender came with adjusted rate mortgage especially used to finance the single family residence. The ARM or adjusted rate mortgage are designed to adopt the change in the economic condition which help the lenders and borrowers share the interest rate risk which enables the lender to match cost of the interest with the changes in interest revenue more effectively and also helps borrower to get low cost financing.
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REAL ESTATE FINANCE W/ACCESS
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