Data processing: financial – business practice – management – or co – Automated electrical financial or business practice or... – Finance
Reexamination Certificate
1999-04-23
2002-02-05
Hafiz, Tariq R. (Department: 2163)
Data processing: financial, business practice, management, or co
Automated electrical financial or business practice or...
Finance
C705S035000
Reexamination Certificate
active
06345262
ABSTRACT:
BACKGROUND OF THE INVENTION
Mortgages, i.e., liens on land and improvements thereon, given as security for the payment of debts, are time-honored instruments for financing the purchase of real estate. A highly developed market exists for traditional real estate mortgages where lenders are compensated with interest on the principal amount extended. Fundamental aspects of traditional real estate mortgage lending at interest: 1) create a large prospective financial burden for borrowers in the form of total interest paid over the life of the instrument that normally exceeds the original principal extended, 2) constrain the borrowing, and ultimately, purchasing capacity of borrowers, and 3) subject lenders to risks stemming from, among other factors, variations in future interest rates. These fundamental aspects of traditional real estate mortgage lending have become firmly entrenched, with relatively little variation in the mortgage plan approach.
Nonconventional residential mortgage plans have been proposed and used, however. The most widely used nonconventional mortgage plan, perhaps, is the adjustable rate mortgage (ARM), which attempts to shift the interest rate risk to borrowers in return for providing lower initial interest rates. Other alternative instruments which have seen limited use in the past include the graduated payment mortgage (GPM), the price level adjusted mortgage (PLAM), and the shared appreciation mortgage (SAM). Each of these mortgage plans was developed to address specific problems with the vulnerability by traditional mortgage lenders to higher interest rates. The first was developed to expand the number of potential homeowners eligible for mortgage financing. This is a particular concern in inflationary times when high rates depress the borrowing capacity of potential homeowners. By skewing the payment burden toward later in the amortization period, the GPM allowed borrowers to obtain mortgage financing based on their prospects for increased future income.
The PLAM addressed the different problem of the lender's exposure to subsequent inflationary environments. Under this plan, the borrower's payments, consisting of principal and interest, varied according to fluctuations in an outside index of inflation, such as the Consumer Price Index.
The first residential SAM was offered in 1980 and required a one-third share in any appreciation of the value of the securing home in exchange for a one-third reduction in the current interest rate. SAM's had a fixed maturity date when all principal and compensation were due. They never achieved popularity for a variety of reasons, as explained in U.S. Pat. No. 5,644,726 to Oppenheimer:
First of all, the SAM required a costly and uncertain specific house appraisal to determine the lender's share, if any, of appreciation after forced refinancing in ten years. Secondly, the homeowner had to refinance, not only the remaining mortgage principal, but original lender's share of appreciation. Finally the homeowner had no way of fixing, at the inception of the SAM mortgage, his monthly mortgage payments after the initial ten year refinancing.
(Oppenheimer, col. 2, lines 7-14).
Another example of a nonconventional mortgage is disclosed in U.S. Pat. No. 5,819,230 to Robert A. Christie, incorporated herein by reference, which references the Merrill Lynch Mortgage 100 program. There, the home buyer initially places marketable securities having a value of at least 39% of the home's purchase price in an account pledged as collateral on the mortgage loan, and appreciation of the securities over the life of the loan helps compensate for risk associated with any depreciation in home value. Similarly, U.S. Pat. No. 5,852,811 to Charles Agee Atkins discloses a mortgage plan in which money normally used to amortize the mortgage is placed into other asset accounts, so that as the home increases in value, additional loans may be made to the borrower to keep the loan-to-value ration constant at 80%.
Yet another example of a nonconventional mortgage plan approach is disclosed in the '726 Oppenheimer patent, also incorporated herein by reference. This discloses the use of a two-part principal allocation, a traditional interest bearing portion “A” and an equity portion “B”, in which the principal is not repaid on portion B until portion A is completely amortized. An outside housing index is used to annually calculate the amount of equity participation to be realized by the lender at sale or maturity, regardless of changes in the actual home's value. Under this plan, the lender shares not only in the appreciation in the house above its initial purchase price, but also has a claim against the equity (above the loan balance at maturity) created by the borrower's repayment of principal. Also under this plan, there is a fixed maturity date when all principal and compensation are due.
A basic characteristic in common with all traditional and alternative mortgage instruments is that interest paid currently on outstanding principal is the dominant form of compensation to the lender. This must be the case when the two traditional sources of mortgage capital, portfolio lending by financial institutions and securitization in the secondary market, each have their own current liability finding costs to meet. This practice, as a byproduct, returns principal to the lender in a back-loaded, non-linear manner so that the average principal balance outstanding during the amortization period remains significantly above 50% of the original amount, as illustrated in FIG.
3
. For instance, the midpoint in principal reduction during the amortization period of the traditional 30-year fixed rate loan in
FIG. 3
is approximately 23 years.
This slow, back-loaded return of principal makes it difficult to reliably generate a sufficient return on investment where home appreciation, instead of periodic interest, is to be the dominant or sole form of compensation.
The return on a mortgage, or any investment, can be measured as:
Average Annual Profit
Average Annual Principal
What former mortgage plans ignore is the value of maximizing the return by manipulating the denominator, annual average principal, so that it is repaid much more rapidly, and on or near a straight line amortization basis. This can only be done by removing current interest paid on outstanding principal or making it an inconsequential component of investor compensation. When this is done, even a relatively small average annual profit generation, which would be insufficient for mortgages with back-loaded returns of principal, produces a satisfactory return.
Under existing mortgage plans, the only way to speed the return of principal to the lender is by drastically increasing the size of the monthly payment, or conversely, drastically lowering the initial mortgage principal lent. Doing so either creates an unaffordable monthly payment burden, or substantially diminishes the borrower's purchasing capacity. In either case, the principal return remains significantly back-loaded and non-linear so that the average principal outstanding during the amortization period is a larger percentage of the original balance.
Currently, there is a traditional “triangular” approach to the implementation of mortgages on the lender's side, using a mortgage originator, a mortgage lender, and a servicer of the mortgage. The “originator”, which may be a bank, a savings and loan/thrift institution, or a mortgage broker, initially obtains the client/borrower and also typically performs underwriting duties (e.g., verifying income, credit approvals, providing documentation at closing, including the loan agreement (the “note”) and the mortgage agreement). The “lender” is the entity providing the mortgage funds, which are typically wired at closing. The “servicer” is the entity that services the mortgage during its life (e.g., periodic mortgage payments are sent by the borrower to the servicer). Those of ordinary skill in the art will understand that, within the spirit and scope of th
Hafiz Tariq R.
Jeanty Romain
Niro Scavone Haller & Niro
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