Yields
The percentage of profit is called the yield of the loan. Yields on loans are increased by points paid at closing. Each point charged has the effect of raising the interest rate 1/8 percent.
- The First Bank lends $100,000 to the borrower and charges 3 points at closing. The interest rate on the loan is 12% for 25 years. What is the bank’s effective yield on the loan?
Solution Step 1 — Each point raises Yield by 1/8% – Multiply 3 points by 118%
Calculation — 3 x 1/8 = 3/8%
Solution Step 2 — Convert 3/8 fraction to decimals — Divide 3 by 8
Calculation — 3/8 = 0.375%
Solution Step 3 — Add original Interest and Point Equivalent interest to get total interest —
Yield
Calculation — 12% + .375% = 12.375% Yield
Answer: 12.375% Yield
Qualifying for a Loan
The typical housing debt-to-income ratio for conventional loans is 25-28%. The typical total debt-to-income ratio for conventional loans is 33-36%. The 25-28% means that for the borrower to qualify, PITI (principal, interest, taxes, insurance) must not be more than 25-28% of the borrower’s monthly gross income. The 33-36% means that for the borrower to qualify, the total monthly expenses (including housing expense) must not be more than 33-36% of the borrower’s monthly gross income.
- Mr. and Mrs. Jones have a combined total monthly income of $2,500. If the lender requires a debt-to-income ratio of 25:33 for housing and total expenses, what is the maximum house payment the Joneses will qualify for? What is the maximum total monthly expenses besides PM that will be allowed?
Solution Step 1 — Calculate 25% of the Gross monthly Income for PITI
Calculation – $2,500 x 25% (.25 ) = $625 PITI
Solution Step 2 — Calculate 33% of the Gross Monthly Income for Total Debt
Calculation – $2,500 x 33% (.33) = $825 — Total Debt
Solution Step 3 — Subtract the PITI Dollars from the Total Debt Dollars = Other Debt
Calculation – $825 – $625 = $200 for other debt
Answer: $200 for other debt
Appraisal Calculations
Capitalization, income approach, Cap Rate Approach
Under the income approach, the estimate of value is arrived at by capitalizing the annual net income. The solution to these problems is based on the following formula:
Value X Capitalization rate = Net Operating Income
- An apartment building produces a net income of $4,320 per annum. The investor paid $36,000 for the apartment building. What is the owner’s rate of return (cap rate) on the investment?
Solution Step 1 — Value X Cap Rate = Net Operating Income so
Net Operating Income/Value = Cap Rate
Calculation – $4,320/$36,000 = 12% Cap Rate
Answer: 12% annual rate of return on investment — cap rate
- An investor is considering the purchase of an office building for $125,000. The investor insists upon a 14% return on investment. What must be the amount of the annual net income from this investment to return a profit to the owner at a rate of 14%?
Solution Step 1 – Value X Cap Rate = Net Operating Income
Calculation – $125,000 x 14% (.14) = $17,500 Net Operating Income
Answer: $17,500 net operating income needed
- In appraising a shopping center, the appraiser establishes that the center produces an annual net income of $97,500. The appraiser determines the capitalization rate to be 13%. What should be the appraiser’s estimate of market value for this shopping center?
Solution Step 1 – Value X Cap Rate = Net Operating Income so
Value = Net Operating Income/Cap Rate
Calculation — $97,500/13%(.13) = $750,000
Answer: $750,000 market value
Basis
- Mr. and Mrs. Swift purchased their home 15 years ago for $32,500. During their ownership, they made capital improvements totaling $19,400. They sold the home for $72,900. What amount of gain did they make on the sale?
Solution step 1 — Purchase Price Plus Improvements = Basis
Calculation – $32,500 + 19,400 = $51,900 Basis
Solution Step 2 — Selling Price less Basis = Gain/Profit
Calculation – $72,900 less $51,900 = $21,000 Gain/Profit
Answer: $21,000 gain/Profit
