A term frequently identified with
mortgages whereby funds are paid to the
mortgagee by the mortgagor to increase the
yield on the mortgage.
Bonuses can be applied in two different
ways essentially producing the same result.
Example 1 illustrates a
negotiated amount as an incentive to a
mortgagee to permit a discharge (interest
penalty). Such bonuses are less common given
competitive mortgage markets in which
lenders offer open provisions (no penalty),
permitting partial prepayment or full
discharge prior to the end of the mortgage
term.
A bonus also refers to an extra
obligation by a mortgagor at the point of
arranging a mortgage to increase the
mortgagee’s yield.
Example 2 details how
mortgagee yield is increased by means of an
initial bonus. While the discharge bonus
increases yield at termination, the
arranging bonus accomplishes a similar
result at mortgage inception. The use of
bonuses is particularly attractive to
lenders during tight money situations, in
high risk ventures, and in financing unique
properties/enterprises.
Example 1 of Bonus
Seller Watson wants to discharge an
amortized, blended payment mortgage with a
four-year term during the second year. The
lender does not provide for early discharge
unless two months’ interest penalty is paid.
If the balance owing on this 7.75% mortgage
is $100,000, the bonus is calculated by
using an applicable two-month interest
factor of .0127533647. The interest owing to
discharge the mortgage early is $1,275.34
(.0127533647 x $100,000). (Detailed interest
tables are not included in this texts.)
Example 2of
Bonus
Borrower McKay is having difficulty
arranging financing for a speculative
venture. Assume that a lender is prepared to
advance $60,000 amortized over 20 years at
an 8% interest rate and a bonus of $5,000.
The mortgagor will only receive $55,000 with
the face value on the mortgage showing
$60,000. The net impact is an increased
yield to the mortgagee. The yield amount
will vary based on the term of the
mortgage—the shorter the term (assuming the
mortgage would not be renewed), the greater
the yield.
Effective yield calculation based on an
upfront bonus is complicated and
practitioners use a rule-of-thumb for
approximation purposes, but caution is
always advised. The repayment of the $60,000
mortgage, according to mortgage payment
factors, (see the Appendix) would produce a
monthly payment of $497.01 [(8.283575 x
60(000)]. However, McKay only received
$55,000. The salesperson would review
monthly payment factors for successively
higher rates to see what interest payment
factor with a 20-year amortization and
principal of $55,000 closely approximates
the monthly payment of $497.01. A payment
factor of 9.046598 (9.25%, 20-year
amortization) produces a payment of $497.56.
Without establishing the exact yield, the
bonus has resulted in an increase of
approximately 1.25% over the nominal 8% rate
stated in the mortgage. The exact yield can
be readily calculated using a financial
calculator.
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