MORTGAGE MARKETS     Finance 421                   Mortgage Markets-1
The Unique Nature of MortgageMarketsMortgage loans are secured by the pledge of real propertyas collateral.Mortgage loans ...
Standard Fixed-Rate Mortgage(FRM) Amortized loan with periodic payments that exceed the interest due. Payment in excess of...
FRM Balance and Payments                Principal and interest Payments on a 9%, 15-                 year, $100,000 mortga...
FRM Balance and Payments(concluded)               Principal and interest Payments on a 9%, 30-                year, $100,0...
Conventional and InsuredMortgages Conventional mortgages represent lending/borrowing in the private markets. Insured and/o...
Private Mortgage Insurance Conventional mortgage borrowers with low downpayments must usually buy private mortgage insuran...
Private Mortgage Insurance Uninsured conventional Privately Insured     mortgage                   conventional mortgage  ...
Adjustable Rate Mortgage (ARM)Fixed-rate mortgages are not attractive to lenders in highinflation periods.With adjustable ...
Methods of Adjustment forARMsRate may vary in a prescribed range (caps) or withoutlimit.Payments, maturity, or principal m...
Fixed and Adjustable Mortgage Rates                         Mortgage Markets-11
Other Mortgage InstrumentsBalloon Payment Mortgages– Traditional loan where interest is paid until a time when the  princi...
Other Mortgage Instruments (continued)Renegotiated Rate Mortgages (RRMs)– Loan terms renegotiated periodically at terms pr...
Other Mortgage Instruments (continued)Construction-to Permanent Mortgages– Bridge financing is provided by lender over the...
Other Mortgage Instruments(continued)Reverse Annuity Mortgages (RAMs)– RAMs allow homeowners to borrow against the  equity...
Other Mortgage Instruments(continued)Second Mortgage - extended at time ofpurchase or later as equity is borrowed fromprop...
What Does it Take to Buy aHome?Several factors influence a home buyer’sability to secure a mortgage loans.– Borrower Incom...
Payment to Income Ratio             Examples                         30-year Fixed                           Rate (5%)Annu...
Mortgage Origination The original lender in a mortgage is called the mortgage originator. They generate income in one or m...
The Mortgage OriginationProcess A potential homeowner applies for a loan from a mortgage originator. He/she specifies: – t...
The Mortgage OriginationProcess (continued) If the lender decides to lend the funds, it sends a commitment letter to the a...
Pipeline Risk is the risk associated with mortgage origination  – Price risk  – Fallout risk                              ...
Hedging Pipeline Risk Obtain a commitment from a conduit to buy the mortgage Obtain an agreement for the optional delivery...
Mortgage Holdings Over Time                                             1978    1985     1995       2005    2008       201...
Mortgage Markets-25
Mortgage Markets-26
Risks of Investing in Mortgages Credit Risk Marketability Risk Price Risk Prepayment (or cash flow uncertainty) risk      ...
Prepayment Risk and thePrice/Yield Relationship forMortgagesPrice               Yield                        Mortgage Mark...
Refinancing and Mortgage Rates                       Mortgage Markets-29
Mortgage-Backed Securities --One way to develop a secondary marketfor mortgages. Mortgage pass-through securities pass thr...
Types of Pass-ThroughSecurities Ginnie Mae Pass-Throughs - pools of government insured mortgages. Freddie Mac Participatio...
Types of Pass-ThroughSecurities (concluded) Fannie Mae pass-throughs - pools of conventional or insured mortgages. Private...
Other Mortgage-backed Securities Unit investment trusts -- Mortgage pools assembled by investment bankers in unit "trusts....
Derivative Mortgage Securities Collateralized mortgage obligations (CMOs) -- fixed maturity date and interest payments sim...
Derivative Mortgage Securities Floating rate CMOs Inverse floating rate CMOs                              Mortgage Markets...
Derivative Mortgage Securities(continued) Stripped MBSs  – IO Strips  – PO Strips                       Mortgage Markets-36
Advantages of Mortgage-backedSecurities over IndividualMortgages Issued in standardized denominations and are negotiable. ...
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421 mortmkts 2012 set 5

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421 mortmkts 2012 set 5

  1. 1. MORTGAGE MARKETS Finance 421 Mortgage Markets-1
  2. 2. The Unique Nature of MortgageMarketsMortgage loans are secured by the pledge of real propertyas collateral.Mortgage loans are made for varied amounts - nostandard denomination.Issuers of mortgages are usually small family or businessentities.Weak Secondary Market for Original Mortgages– Little standardization of contracts and terms.– Traditionally issued and held by lender.Relatively strong secondary for mortgage-backedsecuritiesMortgage markets are highly regulated and supported byfederal government policies. Mortgage Markets-2
  3. 3. Standard Fixed-Rate Mortgage(FRM) Amortized loan with periodic payments that exceed the interest due. Payment in excess of interest is credited toward repayment of the principal. Interest is usually computed on the declining balance. The mortgage is a lien on the property used as collateral for the loan. If the contract is broken, the lender may use the property to pay the loan. When mortgage is fully paid, the lien is removed and the borrower obtains a clear title to the property. Mortgage Markets-3
  4. 4. FRM Balance and Payments Principal and interest Payments on a 9%, 15- year, $100,000 mortgage with payments of $1,015 per month $1,200 $1,000 $800 Payment Interest Payment $600 Principal Payment $400 $200 $0 0 12 24 36 48 60 72 84 96 108 120 132 144 156 168 Month Mortgage Markets-4
  5. 5. FRM Balance and Payments(concluded) Principal and interest Payments on a 9%, 30- year, $100,000 mortgage with payments of $805 per month $900.00 $800.00 $700.00 $600.00 Payment $500.00 Interest Payment $400.00 Principal Payment $300.00 $200.00 $100.00 $0.00 0 36 72 108 144 180 216 252 288 324 Month Mortgage Markets-5
  6. 6. Conventional and InsuredMortgages Conventional mortgages represent lending/borrowing in the private markets. Insured and/or guaranteed mortgages are supported by federal and state agencies. – Federal Housing Administration (FHA). – Veterans Administration (VA). – Downpayment and rates may be lower. Mortgage Markets-6
  7. 7. Private Mortgage Insurance Conventional mortgage borrowers with low downpayments must usually buy private mortgage insurance (PMI). PMI premiums are added to mortgage payments until the value of the mortgage is less than 75% of the value of the house. Mortgage Markets-7
  8. 8. Private Mortgage Insurance Uninsured conventional Privately Insured mortgage conventional mortgage $12,500 down $25,000 down Equity payment Equity payment Insured Risk $12,500 mortgage insurance Uninsured $100,000 Uninsured $112,500 Mortgage mortgage at Mortgage mortgage at 10% APR. 10% plus insurance premium = 10¼ to 10½% APR on $112,500 balance Mortgage Markets-8
  9. 9. Adjustable Rate Mortgage (ARM)Fixed-rate mortgages are not attractive to lenders in highinflation periods.With adjustable rate contracts, borrowers costs vary withinflation and interest rate levels.Lenders shift interest rate risk to the borrower.Caps on ARM interest rates limit interest rate risk to borrowers. – Capped ARMs may have a “payment cap”, “rate cap”, or both. – Payment caps limit the maximum amount the payment can go up by in any year and over the life of the loan. – Interest rate caps or rate caps limit the size of the increase in the loan rate in any year and over the loan’s life. Typically, the annual cap is 1-2%, and the lifetime cap is 5%. Mortgage Markets-9
  10. 10. Methods of Adjustment forARMsRate may vary in a prescribed range (caps) or withoutlimit.Payments, maturity, or principal may vary.Rates may vary based on a previously determined interestrate index or the cost of the funds of the lender.The market prices (difference between fixed and variablerates) the extent of interest rate risk (impact of varyinginterest rates) assumed by borrower and lender.Common rate indices include Treasury rates, fixed ratemortgage indices, prime rate, and the LIBOR rate. Mortgage Markets-10
  11. 11. Fixed and Adjustable Mortgage Rates Mortgage Markets-11
  12. 12. Other Mortgage InstrumentsBalloon Payment Mortgages– Traditional loan where interest is paid until a time when the principal was due.– Terms can be 3, 5 or 7 years.– Loan is amortized over 15 or 30 year period so that monthly payments are no different than a FRM of equal maturity.– Rate is fixed over the contract term.– Popular with borrowers who may either sell or refinance prior to maturity.Rollover Mortgage (ROMs)– Refinanced at new rate every few years.– Adjustment period is longer than traditional ARMs.– Payment is fixed Mortgage Markets-12
  13. 13. Other Mortgage Instruments (continued)Renegotiated Rate Mortgages (RRMs)– Loan terms renegotiated periodically at terms prevailing in the market.– Adjustment period is longer than traditional ARMs.– Payment is fixed.Interest Only Mortgages– Low payments in initial years (10 to 15 years) – only includes interest on borrowed amount.– After initial period, payments increase such that entire loan amount is amortized by the end of 30 years.– Borrower pays interest for a considerable period on the entire loan balance, but avoids having to pay down balance in initial years. Mortgage Markets-13
  14. 14. Other Mortgage Instruments (continued)Construction-to Permanent Mortgages– Bridge financing is provided by lender over the time frame required by the borrower to purchase land and construct the house.– Only interest payment is made until construction is completed.– Loan is financed in increments as construction payments have to be made.– On completion of the construction, loan balance is rolled over into the type of mortgage contract desired by borrower. Mortgage Markets-14
  15. 15. Other Mortgage Instruments(continued)Reverse Annuity Mortgages (RAMs)– RAMs allow homeowners to borrow against the equity on their homes at low rates.– Typically obtained by older people whose home loans have been paid off, but can use income of the real estate investment they own.– Typical term is no more than 20 years and could be for borrower’s lifetime as an annuity.– Homeowners’ equity declines by amount borrowed. Mortgage Markets-15
  16. 16. Other Mortgage Instruments(continued)Second Mortgage - extended at time ofpurchase or later as equity is borrowed fromproperty.Home equity lines of credit became popularafter the 1986 federal tax law.Home equity loans and lines of credit allow homeowners to borrow against the equity built up intheir homes because of paying down the loanand/or because of the appreciation of theproperty. Mortgage Markets-16
  17. 17. What Does it Take to Buy aHome?Several factors influence a home buyer’sability to secure a mortgage loans.– Borrower Income from all sources gives the lender an idea of the ability of the borrower to meet the monthly mortgage commitment.– Down Payment refers to the amount of cash the borrower can contribute towards the cost of the house as their equity.– Mortgage Insurance is necessary for borrowers who are unable to come up with a 20 percent down payment. Mortgage Markets-17
  18. 18. Payment to Income Ratio Examples 30-year Fixed Rate (5%)Annual Gross 28% of Mortgage 36% of income monthly Qualification monthly $20,000 $467 $59,985 $600 $30,000 $700 $89,913 $900 $40,000 $933 $119,841 $1,200 $50,000 $1,167 $149,897 $1,500 $60,000 $1,400 $179,826 $1,800 $80,000 $1,867 $239,810 $2,400 $100,000 $2,333 $299,667 $3,000 $150,000 $3,500 $449,564 $4,500 Mortgage Markets-18
  19. 19. Mortgage Origination The original lender in a mortgage is called the mortgage originator. They generate income in one or more of the following ways: – They charge an origination fee – They may sell the mortgage – They may service the loan for the eventual owners of the loan in exchange for a servicing fee – They may sell the servicing of the mortgage to another party. – They may hold the mortgage in their investment portfolio. Mortgage Markets-19
  20. 20. The Mortgage OriginationProcess A potential homeowner applies for a loan from a mortgage originator. He/she specifies: – type of mortgage (FRM,ARM,etc.) – when the interest rate is set The mortgage originator then performs a credit evaluation of the applicant Mortgage Markets-20
  21. 21. The Mortgage OriginationProcess (continued) If the lender decides to lend the funds, it sends a commitment letter to the applicant, and the applicant pays a commitment fee. If the mortgage originator intends to sell the mortgage, it may obtain a commitment from the potential buyer. At the closing date, if the borrower does not back out, the loan is made. If the borrower backs out, he loses the commitment fee. Mortgage Markets-21
  22. 22. Pipeline Risk is the risk associated with mortgage origination – Price risk – Fallout risk Mortgage Markets-22
  23. 23. Hedging Pipeline Risk Obtain a commitment from a conduit to buy the mortgage Obtain an agreement for the optional delivery of the mortgage Mortgage Markets-23
  24. 24. Mortgage Holdings Over Time 1978 1985 1995 2005 2008 2010Amount Outstanding $1,169.4 $2,312.3 $4,602.7 $11,942.2 $14,619.0 $14,020.1($ in billions)Percentage HeldThrift institutions 45.1% 33.1% 13.0% 9.6% 5.9% 4.4%Commercial banks 18.3 18.6 23.7 24.8 26.3% 26.4%Insurance companies and pension funds 10.1 8.8 5.3 2.6 2.5% 2.4%U.S. government 2.4 2.3 1.3 0.7 0.7% 0.8%Government agencies (GSEs) 6.2 5.9 5.4 4.0 4.8% 35.9%Mortgage pools, govt. agency 6.0 16.0 34.1 30.8 33.9% 7.6%Mortgage pools, private — 0.6 6.4 18.0 17.7% 14.5%Households 8.7 5.4 2.5 1.5 0.8% 0.7%State and local governments 1.4 3.2 2.5 1.2 1.2% 1.3%REITs 0.5 0.3 0.3 1.4 0.5% 0.4%Credit unions 0.3 0.5 1.4 2.1 2.2% 2.3%Finance companies — 1.2 1.6 2.4 3.1% 2.6%Other 1.0 4.1 2.5 0.9 0.6% 0.5% Mortgage Markets-24
  25. 25. Mortgage Markets-25
  26. 26. Mortgage Markets-26
  27. 27. Risks of Investing in Mortgages Credit Risk Marketability Risk Price Risk Prepayment (or cash flow uncertainty) risk Mortgage Markets-27
  28. 28. Prepayment Risk and thePrice/Yield Relationship forMortgagesPrice Yield Mortgage Markets-28
  29. 29. Refinancing and Mortgage Rates Mortgage Markets-29
  30. 30. Mortgage-Backed Securities --One way to develop a secondary marketfor mortgages. Mortgage pass-through securities pass through payments of principal and interest on pools of mortgages to holder of the securities. Other Mortgage backed securities use pools of mortgages as collateral for debt securities. Mortgage Markets-30
  31. 31. Types of Pass-ThroughSecurities Ginnie Mae Pass-Throughs - pools of government insured mortgages. Freddie Mac Participation Certification - pools of conventional mortgages. Freddie Mac Guaranteed Mortgage Certificates - promises regular repayment of principal and interest. Mortgage Markets-31
  32. 32. Types of Pass-ThroughSecurities (concluded) Fannie Mae pass-throughs - pools of conventional or insured mortgages. Privately issued pass-throughs (PIP). Mortgage Markets-32
  33. 33. Other Mortgage-backed Securities Unit investment trusts -- Mortgage pools assembled by investment bankers in unit "trusts." Claims on trust is sold to investor. Mortgage-backed mutual funds -- offer GNMA insurance but at yields higher than treasuries. FHLMC, FNMA, and private mortgage-backed debt. State/local government revenues bonds -- type of muni, tax-free bond. Mortgage Markets-33
  34. 34. Derivative Mortgage Securities Collateralized mortgage obligations (CMOs) -- fixed maturity date and interest payments similar to bonds. REMICS -- real estate mortgage investment conduit; Investor pays taxes. Type of CMO. Mortgage Markets-34
  35. 35. Derivative Mortgage Securities Floating rate CMOs Inverse floating rate CMOs Mortgage Markets-35
  36. 36. Derivative Mortgage Securities(continued) Stripped MBSs – IO Strips – PO Strips Mortgage Markets-36
  37. 37. Advantages of Mortgage-backedSecurities over IndividualMortgages Issued in standardized denominations and are negotiable. Issued or backed by quality borrowers. Usually insured and highly collateralized. Repayment schedules vary, but many are similar to other bonds. Mortgage Markets-37

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