Finance chapter X

1. Chapter 10
Residential Mortgage Types
and Borrower Decisions
Real Estate
FIN 331
Fall 2018

2. Primary and Secondary
Mortgage Markets
A. The primary mortgage market is the loan
origination market
B. Numerous institutions supply capital to
borrowers
C. Mortgage originators can either hold loans in
their portfolios or sell them in the secondary
mortgage market
D. The principal buyers in the secondary
mortgage market are Fannie Mae and
Freddie Mac

3. 30-Year Fixed Rate Mortgages
1970-2020

4. Prime Conventional
Mortgage Loans
A. Fixed-rate level payment mortgage
B. Over 64% of loans in 2020 were conventional mortgages
1. Compared to 85% IN 2011
C. Conventional mortgages typically require 20% down (0.80
loan to value)
D. Conforming conventional loan: meets requirements for
purchase in secondary markets for Fannie Mae or Freddie
Mac
E. Nonconforming Loans
1. Exceed loan limits (currently $417,000 for most areas of the
continental US)
2. May require private mortgage insurance (PMI
F. Adjustable Rate Mortgages (ARM): rates reflect changes in
lending rates over time

5. FHA Mortgages
(Federal Housing Administration)
A. Primary Objective of 1949 Act: provide good
housing
1. FHA is a loan insurance program
a. Loans made by private lenders
b. Mortgage payment includes insurance premiums
(included in loan)
c. FHA insures 100% of loan and makes payments if
borrower defaults
d. If foreclosed, title passes to HUD
e. Various types of mortgages covered by FHA
programs
2. Veterans Administration has similar program

6. Other Mortgage Types
A. Purchase money mortgage: Mortgage given by a
property buyer simultaneous with receipt of title
1. Among real estate brokers: refers to a second
mortgage loan from a seller to reduce the buyer’s
down payment (Amounts to installment payments
with interest)
2. Among government agencies: any loan that
finances a purchase
B. Piggyback loan:
1. A second mortgage paired with an underlying 1st
mortgage
2. Keeps the 1st below 80 percent LTV, thus avoiding
required mortgage insurance

7. Other Mortgage Types
C. Home Equity Loans (HEL)
1. Some home equity loans are closed-end, fixed-
term loans
2. Mostly open-end or line-of-credit loans (HELOC)
3. Interest is Tax deductible
4. Strength of the house as security provides
favorable rate and longer term
5. Usually limited to total mortgage debt (sum of all
mortgage loans) of 75% to 80% of value

8. Other Mortgage Types
D. Reverse Mortgage
1. Many older households are income constrained
2. Over 80% own their home
3. Most have little or no mortgage debt
4. Most do not want to sell
5. Converts home equity into income
6. Owners not be forced to move except if owner fails
to maintain insurance & taxes
7. Two major problems:
a. Owner may outlive cash flows
b. Loans may exceed value of home (if property values
decline over time)

9. Other Mortgage Types
E. Interest-Only:
1. No amortizing of principal.
2. Frequently involves a balloon payment
F. Sub-Prime Loans
1. Extending credit to high risk borrowers
2. High default rates due to poor or no creditworthiness
background checks
3. Serious problems occurred for borrower when rates adjusted
(always up)
G. Alt-A Loans
1. Minimal or no down payments
2. Very weak credit scores
3. Bank not required to verify information provided by borrowers
4. The “NINJA” loans

10. Loan Cost Measures
A. Annual Percentage rate (APR)
1. APR converts regular interest expense and up-
front loan fees into a single equivalent interest
expense
2. APR is far superior to interest rate alone in
comparing the cost of loans
3. APR has a bias for most applications:
a. APR assumes that up-front fees are spread over the
full maturity of the loan
b. Since most loans are prepaid before maturity, APR
will tend to understate the true cost of borrowing
when up-front fees are charged
4. Final APR affected by prepayments

11. Loan Cost Measures
A. Motives for Refinancing
1. Lowering loan costs (lower APR)
2. Reduce the term of the loan (30 to 20 or 15 year
mortgage)
3. Lower total amount of interest paid
4. Net Benefit = Total Savings – Cost of
Refinancing
5. Lower rate results in lower interest deduction –
slightly higher tax due
6. Spread should be ~ 2%: Old – new: Recoup
costs over 18 to 24 months

12. Homework Assignment
A. Key terms: Alt-A Loan, Conforming
Conventional Loan, Conventional
Mortgage, Fannie Mae, Freddie Mac,
FHA, GSE, Home Equity Loan, Jumbo
Loans, Primary Mortgage Market,
Secondary Mortgage Market, Reverse
Mortgage, Subprime Loan
B. Study questions: 1, 2, 3, 4, 6