Mortgage as present value of resale worth

Question

I would like to ask someone who is knowledgeable in home loan and mortgage financing.

Consider a home with an appraisal value of $ 400k.

Let the down payment on this mortgage be $80k (i.e. 20% of $400k).

Then, I can borrow $320k for a fixed or float loan over a certain duration (e.g. 15, 20, 30yr).

• My question: Does a loan officer at a bank view the down payment as the appraisal value of the home minus the present value of the resale value of the depreciated home that the homeowner can pledge? Is this present value essentially the mortgage payment?

The way I view the mortgage financing is as follows: when I am convincing the loan officer to lend me the money to finance my home purchase, the officer is essentially assessing how much he or she would be able to borrow against the pledgeable portion of the estate. Is this a reasonable way to view down payment and mortgage in home financing?

Answer 1

Does a loan officer at a bank view the down payment as the appraisal value of the home minus the present value of the resale value of the depreciated home that the homeowner can pledge? Is this present value essentially the mortgage payment?

The lender gets an appraisal by a third party. That appraisal compares the property to others similar in size, type, and location that have sold recently. They return a report and a number.

That determines that maximum amount of money the property is worth. So if the value is determined to be as you stated in your question ($400K) then the largest loan you can get and still cap it at 80% is a loan of $320K.

At no time to they try and estimate "the present value of the resale value of the depreciated home". They would not know how far out to estimate the value. They would have no idea what will happen over the years. I have seen houses double in less than 5 years, then drop 25% over the next 5 years, and then spend a decade getting back to the previous high level. In other periods they didn't budge for almost a decade. In either cases this was driven 100% by the market, and location; it wasn't even considering remodeling, upkeep or anything else.

That down payment makes sure the borrower has skin-in-the-game. It also protects the lender from sudden drops in the value. They always want the value of the home to be more than the outstanding loan balance, that way if the borrower defaults on the mortgage the lender can get their money back.

Answer 2

Is this a reasonable way to view down payment and mortgage in home financing?

I don't know what you mean by "view" but - in terms of a strict definition - down payment is the fraction of the purchase price that's being paid (usually in cash) out of the buyer's pocket, as opposed to financed via loan. It's literally just that percentage of the purchase price. Assessed value, or prospects on pledging the loan, don't alter the definition of "down payment."

I've read your question over a few times and I'm not sure if that's what you're actually trying to ask or not. You're asking about the loan amount and the down payment, versus the purchase price and the "present value of the resale value" - I'm assuming by that you mean the assessed value of the home. It strikes me that the factor you're missing is the LTV, the loan to value ratio, which is what relates the purchase details (specifically, the portion of the purchase that is financed) to the "value" of the house, determined by assessment. That's the factor (expressed as a percent) that lenders look at when determining things like risk, and when determining "value" of the asset when pledging.

Answer 3

As a former banker, I can tell you that the bank is only interested in how much your house is worth TODAY. They want to know this because if you stop paying on your mortgage, they want to be able to foreclose on the property and resell it as quickly as possible.

Banks are in the money business. If you have a loan and you don't pay, they want to be able to get out of that loan and put the money into a new loan (with hopefully better results).

Answer 4

If you were to walk away from the house, the bank has essentially bought the house for $320k. So if you're familiar with put options, a mortgage is basically a put option with a strike price equal to the house price minus the down payment. The Efficient Market Hypothesis says that the present value of the future value of an asset plus its income stream is equal to its current price.

However, the value of a put option is much more complicated than just the value of the asset. You have to take into account not the risk discounting of the asset overall, but the risk of the asset dipping below the strike price (and with a mortgage, there's the added complication of the foreclosure price). When you're calculating the present value of the asset itself, you're taking the expected value with risk discounting. So a house that has a 50% chance of being worth $100k and a 50% chance of being worth $700k would have an expected value of $400k, which would then be discounted for risk. But the mortgage is asymmetrical: if the house plummets to $100k and you walk away, the bank is taking a huge loss. If it shoots up to $700k, the bank is getting very little of the windfall (it's getting some amount in that it's now getting a interest rate based on 20% down payment even though you have 54% equity). Because of this, the bank is looking at the loan as being secured by less than the present value, and the more valatile the housing market, the greater the discrepancy.