Chapter 37 — Exercises

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Chapter 37 — Exercises

Forty items, graduated. Items marked † have worked solutions in the answers appendix. Everything here is constructed for teaching; verify any current guideline, factor, or limit at the source before using it on a real file.

A standing instruction for every calculation in this set: show your arithmetic, and state which of the three break-even errors from §37.5 you have avoided. A correct number arrived at by an unstated method is worth nothing on a desk where somebody has to defend it.

Recall and definition

1. Define rate-and-term refinance and cash-out refinance, and state the single test that distinguishes them. Then explain why a borrower who receives no money at closing can still be doing a cash-out refinance.

2. Name the four inputs the refinance calculation requires (§37.2). Which one cannot be looked up anywhere, and what happens to the analysis if it is guessed?

3. State the net position test in one sentence, then say what it is that makes it different from the payment-based formula.

4. † List the three ways a refinance break-even is computed wrong. For each, state the direction of the error and say, in one clause, why all three point the same way.

5. What is burnout in the refinance pool, and why does it make refinance volume behave as a step rather than a slope?

6. Why does a streamline refinance carry a stricter net tangible benefit test than a fully underwritten refinance? Answer from the investor's side, not the borrower's.

7. Distinguish application volume from closed volume, and say why a shop that watches only the second is watching a rear-view mirror.

Applied reasoning

8. † A competitor advertises a refinance with "no closing costs at all." Explain what has almost certainly happened, name the two documents you would compare to prove it, and state the one circumstance in which such an offer is genuinely the borrower's best choice.

9. Why is the same 100-basis-point rate improvement worth proportionally more, net of costs, to a borrower with a \$500,000 balance than to one with a \$150,000 balance? State the implication for who receives marginal refinance advice, and what a responsible originator does about it.

10. In under sixty words, explain to a borrower how a lower payment can be a higher cost. No jargon, no formula.

11. Your borrower refinanced fourteen months ago and financed \$5,600 of closing costs. They now want to refinance again for a 40-basis-point improvement. Name three things you must establish before you take the application, and say what each one would have to show for you to proceed.

12. A short appraisal in a purchase and a short appraisal in a refinance produce different problems with different remedies. State each, and say which one the borrower has more power to fix.

13. Why is funding a new escrow account not a cost in the refinance break-even? What is the correct treatment of the old escrow account, and what does a loan officer owe the borrower in the way of explanation about the timing?

14. † FULL REFINANCE ANALYSIS. A borrower holds a loan originally written at \$250,000, 7.000%, thirty-year fixed, P&I \$1,663.26. Forty-eight payments have been made; the servicer reports a balance of \$238,686; 312 payments remain. Today's achievable rate is 6.000% and total closing costs are \$5,400, which the borrower intends to finance.

(a) Compute the payment on a new thirty-year loan.
(b) Compute the payment on a new loan whose term ends on the same date as the existing loan.
(c) Compute total principal and interest under all three choices: keep, refinance to thirty years, refinance to the matched term.
(d) State which choice is best and by how much, and state what the payment-based break-even formula would have told the borrower to do.

15. † Using the file from Exercise 14, price the financed closing costs. Compute the payment on the same thirty-year loan without the \$5,400 financed, take the difference, and state (i) the monthly cost of financing, (ii) the total paid over 360 months for \$5,400 of closing costs, and (iii) the multiple.

16. CASH-OUT ANALYSIS. A household carries \$30,000 of revolving balances at a blended 21.0% and pays \$800 a month against them. They are offered a cash-out refinance that adds \$30,000 to a thirty-year mortgage at 6.000%.

(a) Roughly how many months does the \$800 payment take to retire \$30,000 at 21.0%, and what is the approximate total paid?
(b) What is the marginal monthly payment for \$30,000 added to a thirty-year loan at 6.000%, and what is the total over 360 months?
(c) State the trade in one sentence: what is being bought, at what price, and what changes about the character of the debt.
(d) Name the one fact about the household that would flip your recommendation, and how you would verify it.

17. † MORTGAGE INSURANCE RESET. A borrower is at payment 110 of a schedule whose mortgage insurance terminates automatically at payment 137. Their current monthly mortgage insurance is \$142.50. A proposed refinance would land at 92% loan-to-value with mortgage insurance of \$138.00 a month on a schedule that reaches the 78% threshold at payment 116 of the new loan.

(a) Compute the mortgage insurance still owed under each choice.
(b) State the cost of the reset in dollars.
(c) State the general rule this file illustrates, and name the circumstance in which the same reset would be nearly free.

18. Using the four term options in §37.10 (360, 346, 300, and 240 months at 5.125% on \$361,066.50), state which minimizes the payment, which minimizes total principal and interest, the monthly difference between those two, and the total difference. Then say, in one sentence, why the refinance industry markets only one of them.

19. NET POSITION. Take the Linden Street recommended structure: a new loan of \$365,750.00, \$1,311.17 paid at closing, P&I \$1,991.46, mortgage insurance \$176.78. The existing loan is P&I \$2,341.94 plus \$176.78 of mortgage insurance. At month 24 the balances are \$352,148.01 under the existing loan and \$354,921.96 under the new one. Compute the net position under each choice at month 24 and state which is ahead and by how much.

Find the error in this break-even

Each worksheet below contains exactly one dominant flaw. Name it, say which of the three errors in §37.5 it belongs to (or that it is a fourth kind), and state the one additional figure you would demand before letting the worksheet go to a borrower.

20. Worksheet A. Closing costs \$4,800. Payment reduction \$240.00. Break-even 20 months. Elsewhere on the page, in small type: "Current remaining term 264 months. Proposed term 360 months."

21. Worksheet B. Closing costs \$7,200, financed. Cash required at closing: \$0. Break-even: "immediate — no out-of-pocket cost."

22. † Worksheet C. "Your payment today: \$1,840. Your new payment: \$1,540. You save \$300 a month." The footnote discloses that the \$1,840 is principal, interest, and \$118 of mortgage insurance, and that the \$1,540 is principal and interest only. The new loan is at 91% loan-to-value.

23. Worksheet D. "Total interest saved over the life of the loan: \$94,050." The figure was computed as (7.500% − 6.750%) × \$418,000 × 30 years. Verify the arithmetic first, then find the error in the method.

24. † Worksheet E. Costs \$4,100. Payment reduction \$293. Break-even 14.0 months. In the notes field: "Borrower mentioned a possible transfer to the Denver office next summer."

25. Worksheet F. The comparison column headed "your current loan" shows 360 payments of \$2,104.55 for a total of \$757,638. The borrower took that loan six years ago.

Clear the condition, and write the document

26. Underwriting returns a condition: "Provide evidence that the transaction satisfies the investor's net tangible benefit requirement." Draft the response. Assume a rate-and-term refinance, a 125-basis-point improvement, a term reduced from 348 remaining months to 300, and \$4,900 of costs paid at closing.

27. † Write the one-sentence net tangible benefit statement you would place in the Linden Street file at application, for the recommended structure in §37.10. Then write the second sentence naming the single fact that would make the first sentence false.

28. A processor sends you a refinance file in which the borrower's stated horizon is blank. Write the two questions you would ask the borrower, and state what you would do with each of the two most likely answers.

29. † Your manager circulates a list of every borrower the shop closed thirty months ago with the note: "Rates are down 40 basis points — call them all." Write your reply. Identify which subset of that list you would actually call, name the two data points you would need for each borrower before calling, and say what you would tell the borrowers you do not call.

30. A borrower with a 96% loan-to-value conventional loan wants to refinance specifically to remove their mortgage insurance. Explain what you would tell them on the phone. Name every condition that would have to be true for this to work, and name the cheaper path they should consider first.

Judgment and ethics

31. You are compensated per closed loan. A borrower's refinance clears every program rule, every investor overlay, and your state's net tangible benefit test, and produces a net benefit of roughly \$40 a month over a horizon the borrower describes as "two, maybe three years." What do you do, what do you say, and what do you write in the file?

32. A borrower asks you to structure a cash-out refinance to consolidate \$52,000 of revolving debt. Their credit report shows the same balances were consolidated into a cash-out refinance four years ago and have since rebuilt. Write what you would say. Do not refuse the file in your first sentence and do not approve it in your last.

33. An originator in your office tells a borrower that refinancing will let them "skip a payment." Is the statement false? Write the correction you would give the borrower and the different correction you would give the originator.

NMLS-style exam questions

34. Which of the following transactions carries a right of rescission under Regulation Z?

(a) A purchase-money first mortgage on the borrower's primary residence
(b) A rate-and-term refinance with a new lender, secured by the borrower's primary residence
(c) A cash-out refinance secured by the borrower's investment property
(d) A purchase-money first mortgage on a second home

35. A borrower refinances their first mortgage and simultaneously pays off a home equity line of credit that was drawn two years after purchase to fund a kitchen remodel. The borrower receives no money at closing. The new loan is best characterized as:

(a) a rate-and-term refinance
(b) a cash-out refinance
(c) a streamline refinance
(d) a limited cash-out refinance

36. † Which single input, if omitted from a refinance break-even calculation, makes the result unfalsifiable — that is, incapable of being shown wrong?

(a) the closing costs
(b) the new note rate
(c) the borrower's expected holding period
(d) the current mortgage insurance factor

37. Under the Homeowners Protection Act, "original value" for purposes of mortgage insurance termination on a refinance transaction means:

(a) the value of the property when the borrower originally purchased it
(b) the appraised value relied upon at consummation of the refinance
(c) the lesser of the original purchase price or the current appraised value
(d) the tax-assessed value in the year of the refinance

The Loan File

38. † Complete the net position test for the Linden Street refinance at three horizons — 24 months, 62 months, and to payoff — using the recommended structure from §37.10. State the answer at each horizon in one sentence, and identify the horizon at which the recommendation would flip.

39. Recompute §37.10's recommendation at an appraised value of \$372,000. State the new loan-to-value on a balance-only refinance, state what happens to the maximum financeable costs, and state whether the recommendation survives. Name the two figures you would need from your mortgage insurance provider before answering definitively.

40. Two parts.

(a) Write the call. You are recommending the twenty-year term at \$2,407.88 — a payment higher than the borrowers make today — to a household that called you because they heard they could lower their payment. Script it: your opening sentence, the one number you lead with, the objection you will get, and your answer to it. Under 250 words.
(b) On that same call, the borrowers ask whether they could instead take \$25,000 of cash out for a kitchen renovation. Using the frozen figures — \$385,000 value, \$361,066.50 balance — and the conventional cash-out benchmark from §37.3, show the loan-to-value arithmetic and give them a definitive answer. Then name two products you would point them toward instead, and the chapter that covers each.