Mortgage market is the market for the sale of securities or bonds collateralized by the value of mortgage loans.

1. MORTGAGE MARKETS
CHAPTER 23
1Dr.Ismat Ara Huq

2. 2
• Definition: The mortgage market is a collection of
markets, which includes a primary(or origination)
and a secondary market where mortgages trade. A
mortgage is a pledge of property to secure payment
of a debt.
– Property pledged as collateral is real estate, which
is often in the form of a house.
– Debt is the loan given to the buyer of the house by
a lender.
– If a homeowner (the mortgagor) fails to pay the
lender (the mortgagee), the lender has the right
to foreclose the loan and seize the property in
order to ensure that is repaid.
MORTGAGE MARKETS
Dr.Ismat Ara Huq

3. Unique Nature of the Mortgage Market
• Secured by the pledge of real property.
• Made for varying amounts and maturities.
• Issuers are typically small, unknown entities.
• Secondary market growing
• Highly regulated and supported by the federal
government.
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MORTGAGE MARKETS
Dr.Ismat Ara Huq

4. Mortgages and Mortgage-Backed
Securities
• Mortgages are loans to individuals or businesses
to purchase a home, land, or other real property
• A mortgage is a form of debt that finances
investment in property.
• Many mortgages are securitized
– securities are packaged and sold as assets backing a
publicly traded or privately held debt instrument
• Four basic categories of mortgages issued
– home, multifamily dwelling, commercial, and farm
• Mortgages are loans to individuals or businesses
to purchase a home, land, or other real property
• A mortgage is a form of debt that finances
investment in property.
• Many mortgages are securitized
– securities are packaged and sold as assets backing a
publicly traded or privately held debt instrument
• Four basic categories of mortgages issued
– home, multifamily dwelling, commercial, and farm
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5. Conventional Mortgage
• Financial institutions provide conventional
mortgage.
• Conventional Mortgages means when the loan
is based is solely on the credit of the borrower
and on the collateral for the mortgage.
• It is not federally insured, they can be privately
insured so that the lending financial institutions
can still a void exposure to credit risk.
• The insurance premium paid for such private
insurance will likely be passed on to the
borrowers.

6. Insured Mortgage
• Insured mortgages guarantee loan repayment
to the lending financial institution, thereby
covering it against the possibility of default by
the borrower.
• An insurance fee of 0.5 percent of the loan
amount is applied to cover the cost of insuring
the mortgage.

7. • Mortgage Insurance
• U.S. Government Mortgage Insurers: There
are three forms of mortgage insurance :
– Federal Housing Administration (FHA)
– Veterans Administration (VA)
– Rural Housing Service (RHS)
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MORTGAGE MARKETS
Dr.Ismat Ara Huq

8. 8
Mortgage Insurance
• Private Mortgage Insurers (PMI) – insures against
default for borrowers with less than a 20% down
payment. Historically, there has been no penalty for
prepayment. However, this is not always the case.
– Mortgage Guarantee Insurance Company (owned
by Northwestern Mutual)
– PMI Mortgage Insurance Company (owned by
Sears, Reobuck)
The cost of mortgage insurance is paid to the
guarantor by the mortgage originator but passed
along to the borrower in the form of higher
mortgage payments.
Dr.Ismat Ara Huq

9. • The real estate properties that can be mortgage can be
divided into two broad categories :
 Single family (one – to –four – family) residential
- house,
- Condominiums
- cooperatives,
- apartments
 Commercial properties:
⁻ Multifamily properties e.g.- apartment buildings,
⁻ Office buildings, industrial properties, warehouse,
shopping centers, hotels, and health care facilities etc.
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Acceptable Collateral for
Mortgages
Dr.Ismat Ara Huq

10. Mortgage Characteristics
• Collateral /Lien - a public record attached to the title of
the property that gives the FI the right to sell the
property if the mortgage borrower defaults
• Down payment - a portion of the purchase price of the
property a FI requires the mortgage borrower to pay up
front
• Private mortgage insurance - insurance contract
purchased by a mortgage borrower guaranteeing to pay
the FI the difference between the value of the property
and the balance remaining on the mortgage
• Collateral /Lien - a public record attached to the title of
the property that gives the FI the right to sell the
property if the mortgage borrower defaults
• Down payment - a portion of the purchase price of the
property a FI requires the mortgage borrower to pay up
front
• Private mortgage insurance - insurance contract
purchased by a mortgage borrower guaranteeing to pay
the FI the difference between the value of the property
and the balance remaining on the mortgage
(continued)
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11. • Federally insured mortgages - originated by FIs with
repayment guaranteed by either the Federal Housing
Administration (FHA) or the Veterans Administration
(VA)
• Conventional mortgages - issued by FIs that are not
federally insured
• Amortized - when the fixed principal and interest
payments fully pay off the mortgage by its maturity
date
• Balloon payment mortgages - requires a fixed
monthly interest payment for a three- to five-year
period with full payment of the mortgage principal
required at the end of the period
• Federally insured mortgages - originated by FIs with
repayment guaranteed by either the Federal Housing
Administration (FHA) or the Veterans Administration
(VA)
• Conventional mortgages - issued by FIs that are not
federally insured
• Amortized - when the fixed principal and interest
payments fully pay off the mortgage by its maturity
date
• Balloon payment mortgages - requires a fixed
monthly interest payment for a three- to five-year
period with full payment of the mortgage principal
required at the end of the period
(continued) 11Dr.Ismat Ara Huq

12. • Fixed-rate mortgage - locks in the borrower’s interest
rate and thus the required monthly payment over the life
of the mortgage, regardless of market rate changes
• Adjustable-rate mortgage - where the interest rate is
tied to some market interest rate with potential for
change in required monthly payments over the life of
the mortgage
• Discount points - interest payments made when the loan
is issued (at closing). One discount point = 1 percent of
the principle value of the mortgage
• Amortization schedule - schedule showing how the
monthly mortgage payments are split between principal
and interest
• Fixed-rate mortgage - locks in the borrower’s interest
rate and thus the required monthly payment over the life
of the mortgage, regardless of market rate changes
• Adjustable-rate mortgage - where the interest rate is
tied to some market interest rate with potential for
change in required monthly payments over the life of
the mortgage
• Discount points - interest payments made when the loan
is issued (at closing). One discount point = 1 percent of
the principle value of the mortgage
• Amortization schedule - schedule showing how the
monthly mortgage payments are split between principal
and interest
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13. Mortgage Originator
• The original lender is called mortgage
originator. Principal originators of residential
mortgage loans are:
– Thrifts
– Commercial banks
– Mortgage banks
• Other private mortgage originators
– Life insurance companies
– Pension funds
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14. Revenue Sources
• Mortgage originators may generate income from
mortgage activity . The origination Functions are:
– Origination fee: expressed in terms of points,
where each point represents 1% of the borrowed
funds. Originators may also charge application
fees and certain processing fees.
– Secondary marketing profits: profits that might
be generated from selling a mortgage at a higher
price than it originally costs.
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15. Other Revenue Sources
– Servicing fee: servicing of the mortgage involves
the collecting monthly payments from mortgagors
and forwarding proceeds to owners of the loan ,
sending payment notices to mortgagors,
reminding mortgagors when payments are
overdue, etc.
– Income from holding mortgages in an investment
portfolio.
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16. Various types of Fees of Mortgage
Application fee
• Title search fee
• Title insurance fee
• Appraisal fee
• Loan origination fee
(usually 1% of the loan
amount)
• Closing agent/review fee
Costs to obtain mortgage
insurance (FHA, VA or
private) if needed
• Closing costs average
from 3%-5% of the
mortgage amount
(excluding points), with
3% the most common
Dr.Ismat Ara Huq 16
A homebuyer will normally face a host of fees (payable at
closing or before) including:

17. Mortgage Origination Process
• Evaluating Credit Risk
– Payment-To-Income Ratio
– Loan-To-Value Ratio
• Commitment Letter form Lender
• Choice of Type of Mortgage
– Fixed-rate mortgage
– Adjustable-rate mortgage

18. Mortgage Origination Process
• At first the potential homeowner completes an
application form, which provides financial
information about the applicant and pays an
application fee;
• Then the mortgage originator evaluating Credit Risk
by using the following ratios:
– Payment-To-Income Ratio (PTI) = monthly
payments/monthly income- measures the ability
of the applicant to make monthly payments,
– So, the lower the ratio, the greater the applicant
will be able to meet the required payments.

19. Mortgage Origination Process
– Loan-To-Value Ratio (LTV) : the ratio of the amount
of the loan to the market (or appraised) value of the
property.
– So, the lower the ratio, the greater the protection for
the lender if the applicant defaults on the payments
and the lender must repossess and sell the property.
Commitment Letter form Lender: If the lenders
decides to lend the funds it sends a commitment
letter to the applicant.
The length of time of the commitment varies
between 30 to 60 days.
 commitment latters obligates the lender not to the
applicant.

20. Choice of Type of Mortgage
At the time the application is submitted , the
mortgage originator will give the applicant a choice
among the various types of mortgages. These are:
–Fixed-rate mortgage
–Adjustable-rate mortgage
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21. Fixed rate Mortgage
• A fixed rate mortgage looks in the borrower’s interest
rate over the life of the mortgage. Thus the periodic
interest payment received by the lending financial
institution is constant, regardless of how market
interest rates change over time. (Balloon Payment
mortgage)
• The lender typically gives the applicant a further choice
of when the interest rate on the mortgage will be
determined.

22. Fixed rate Mortgage
• The three choices are:
– At the time the loan application is submitted.
– At the time a commitment letter is issued and
– At the date when the property is purchased.
• These choices granted the applicant – the right to
decide whether or not to close on the property and the
right to select when to set the interest rate

23. Adjustable rate mortgage (ARM)
• An adjustable rate mortgage allows the
mortgage interest rate to adjust to market
conditions.
• Its contract will specify a precise formula for
this adjustment.
• The formula and the frequency of adjustment
can vary among mortgage contracts. (Capital
recovery)

24. • Now, mortgage originator can either
• - i) hold the mortgage in their portfolio,
• -ii) sell the mortgage to an investor that
wishes to hold the mortgage in its portfolio or
that will place the mortgage in a pool of
mortgages to be used as collateral for the
issuance of the security , or
• -iii) use the mortgage themselves as collateral
for the issuance of the security.
Dr.Ismat Ara Huq 24
Mortgage Origination Process (contd.)

25. Securitization of Mortgages
• Pass-through mortgage securities - mortgage-backed
securities that “pass-through” promised payments of
principal and interest on pools of mortgages created
by financial institutions to secondary market
participants holding interests in the pools
• Issued in standard denominations, usually $25,000
with increments of $5,000 beyond the minimum
• Three government owned or sponsored agencies
involved - Ginnie Mae (GNMA), Fannie Mae
(FNMA, and Freddie Mac (FHLMC)
• Pass-through mortgage securities - mortgage-backed
securities that “pass-through” promised payments of
principal and interest on pools of mortgages created
by financial institutions to secondary market
participants holding interests in the pools
• Issued in standard denominations, usually $25,000
with increments of $5,000 beyond the minimum
• Three government owned or sponsored agencies
involved - Ginnie Mae (GNMA), Fannie Mae
(FNMA, and Freddie Mac (FHLMC)

26. REAL ESTATE MORTGAGES
• Desirable Features for a Mortgage (Lender)
– Yield flexibility: Responsiveness to changing market
rates
– Constant real payments; keeping pace with inflation
– Payment stability; minimize late payment/default
problems
– Full security: market value greater than loan
amount
– Servicing simplicity
• Collecting principal and interest when rates are
changing
• For mortgages allowing negative amortization,
tracking changing principal and interest
payments can be difficultDr.Ismat Ara Huq 26

27. • Desirable Features for a Mortgage (Lender)
– Marketability
• Ability to sell in a secondary market
• Sales of mortgage backed securities (MBS) help
control total lender risk
• Substituting capital market funds for financial
institution's funds
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REAL ESTATE MORTGAGES

28. Calculation of Monthly Mortgage
Payments
PV = PMT(PVIFA i/12, n × 12)
Where:
PV = Principal amount borrowed through the mortgage
PMT = Monthly mortgage payment
PVIFA = Present value interest factor of an annuity
i = Annual interest rate on the mortgage
n = Length of the mortgage in years
PV = PMT(PVIFA i/12, n × 12)
Where:
PV = Principal amount borrowed through the mortgage
PMT = Monthly mortgage payment
PVIFA = Present value interest factor of an annuity
i = Annual interest rate on the mortgage
n = Length of the mortgage in years

29. Comparison of Monthly Mortgage Payments
$150,000 home with 30-year mortgage at 8%, 0 points,
20% down
$120,000 = PMT(PVIFA 8%/12, 30 × 12 )
PMT = $120,000/136.2835 = $880.52
$150,000 home with 15-year mortgage at 8%, 0 points,
20% down
$120,000 = PMT(PVIFA 8%/12, 15 × 12 )
PMT = $120,000/104.6406 = $1146.78
$150,000 home with 30-year mortgage at 8%, 0 points,
20% down
$120,000 = PMT(PVIFA 8%/12, 30 × 12 )
PMT = $120,000/136.2835 = $880.52
$150,000 home with 15-year mortgage at 8%, 0 points,
20% down
$120,000 = PMT(PVIFA 8%/12, 15 × 12 )
PMT = $120,000/104.6406 = $1146.78

30. Risk from investing in Mortgages
In mortgages three types of risk. That are-
• 1. Interest rate risk:
• Financial institutions that hold mortgages are
subject to interest rate risk because the
values of mortgages tend to decline in
response to an increase in interest rates.
• 2. Prepayment risk:
• Prepayment risk is the risk that a borrower
may prepay the mortgage in response to a
decline in interest rates.

31. • 3. Credit risk:
• Credit risk or default risk is the possibility that
borrowers will make late payments or even
default. Whether investors sell their
mortgages prior to maturity or hold them until
maturity, they are subject to credit risk.
Dr.Ismat Ara Huq 31
Risk from investing in Mortgages

32. The various sources of default risk can be classified into
the following four broad categories
1. Normal (or auctorial) risks:
• Insurers expect that a certain percentage of the
borrowers will default due to unique circumstances
not directly attributable to any of the other
categories of default risk.
2. Originator underwriting risk:
• At one time mortgage originators such as banks and
thrifts would retain the mortgage loan in their
portfolio. As a consequence they kept underwriting
standards tight.
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Default risks associated with mortgage
insurance underwriting

33. 3. National economic risks:
• Default rates are positively related to national
economic conditions. As national unemployment
levels increase claims increase.
4. Local economic risks:
• While the national economy may be thriving regions
within the United States may suffer high levels of
unemployment and depressed property values.
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Default risks associated with mortgage
insurance underwriting