Monday, June 29, 2009

Finance Terms

This is the basic finance formula to determine the amount of interest owed, your mortgage payment, or even your mortgage balance.

P*R = I

I - Interest
R - The rate of interest (APR)
P - Principal (the amount you borrowed)

The interest on John's loan was $675 per month at an interest rate of 10.5%. If the loan amount was 80% of the value of the home, how much is John's home worth?
Remember again that you must first establish the annual interest and then divide by the interest rate. Watch out for the detractor in this question! The question is asking you for the total value, not just the loan amount; so be sure to finish the problem!
a) $77,143
b) $96,429
c) $110,642
d) $115,839
Again establish the annual interest first.
Step 1 - $675.00 month X 12 =$8,100.00 interest a year.
Step 2 - $8,100.00 divided by 10.5% = $77,142.86 loan amount.
Step 3 - $77,142.86 divided by 80% = $96,429 – Answer B

The seller must always pay the mortgage balance and interest back to the first of the month. This would be a debit to the seller only. If the buyer assumes the loan then both the loan and the interest would be a debit to the seller and a credit to the buyer. If a buyer gets a new loan, interest must be paid to the end of the month. If the closing takes place on the 15th, the buyer must pay interest forward to the end of the month 16 days. (Remember: The seller had to pay interest back to the first of the month on the loan being paid off.)

Remember: Loan balances do not change the entire month. The loan balance only changes when another payment is made the 1st of the next month because principal and interest are paid in arrears.

Example: If the loan balance on the 1st of the month was $42,300, and the property sold on the 31st; then, the loan balance stays the same until another payment is made, which would be on August 1. The loan balance owed at closing is $42,300, and it is a debit to the seller.

Prepayment Penalty
A prepayment penalty is charged to a seller who is paying a loan off at closing prior to the maturity date. For example, the seller has owned a property for 5 years and owes the lender $60,000 on the day of closing. The lender is charging a 1% prepayment penalty: $60,000 X 1% = $600. Debit the seller only.

Loan Origination
Lenders sometimes charge a loan origination fee-- the finance fee charged by a lender for making a mortgage or deed of trust. An origination fee covers initial costs, such as preparation of documents and credit, inspection, and appraisal fees. In our previous example, if the buyer received an $80,000 loan and the lender charges a 1% loan origination fee (points or discount points), the buyer would be debited $800 at closing.

A lender often charges a borrower some service-charge for making a loan. Each point (discount) is equal to 1 percent of the loan amount. Points are used to increase the lender's yield or to "buy down" the rate.

1 comment:

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