The document discusses mortgages and mortgage-backed securities. It provides an overview of different types of mortgages, including their key characteristics. It also describes the primary and secondary mortgage markets. In the secondary market, financial institutions can sell mortgages to other parties or pool them together to back mortgage-backed securities like pass-throughs and collateralized mortgage obligations. This allows originators to improve liquidity and manage interest rate risk.

1. SECURITIES
MARKET:
MORTGAGE
MARKET
REPORTER: MICHELLE JEAN S.
SALIGAN

2. MORTGAGESAND MORTGAGE-BACKED
SECURITIES: CHAPTER OVERVIEW
Mortgage- Loans to individuals or businesses to
purchase a home, land, or other real property.
*March 2010, there were $14.2 trillion of primary mortgages
outstanding, held by various financial institutions such as
banks and mortgage companies.

4. Difference of Mortgage from bonds and stocks
Mortgage Bonds Shares
Mortgages are backed
by a specific piece of
real property
All other corporate
bonds give the holder
a general claim to a
borrower’s assets
All other corporate
stock give the holder
a general claim to a
borrower’s assets
There is no set size
or denomination for
primary mortgages.
Bonds generally have a
denomination of $1,000
or a multiple of
$1,000 per bond
Shares of stock are
generally issued in
(par value)
denominations of $1
per share

5. Difference of Mortgage from bonds and stocks
Mortgage Bonds Shares
Primary mortgages generally
involve a single investor
(e.g., a bank or mortgage
company)
Generally held by many
(sometimes thousands
of) investors
Generally held by many
(sometimes thousands
of) investors
Primary mortgage borrowers
are often individuals,
information on these
borrowers is less extensive
and unaudited
Bonds are issued by publicly
traded corporations that are
subject to extensive rules
and regulations regarding
information availability and
reliability.
Stocks are issued by
publicly traded corporations
that are subject to
extensive rules and
regulations regarding
information availability and
reliability.

6. Four Basic Categories of
Mortgages
Home Multifamily dwelling
($10.75 trillion
outstanding in 2010)
Used to purchase
one-to-four family
dwellings
($0.85 trillion outstanding)
Used to finance the purchase
of apartment complexes,
town-houses, and
condominiums
Commercial Farm
($2.46 trillion
outstanding)
Used to finance the
purchase of real estate for
business purposes
($0.14 trillion
outstanding) used to
finance the purchase
of farms

7. Mortgage
Characteristics
02

8. COLLATERAL- all mortgage loans are backed by a
specific piece of property that serves as collateral
to the mortgage loan and as part of the mortgage
agreement, the financial institution will place a
lien against a property that remains in place until
the loan is fully paid off
DOWN PAYMENT- a financial institution
requires the mortgage borrower to pay a portion
of the purchase price of the property at (the
day the mortgage is issued). The size of the
down payment depends on the financial situation
of the borrower. Generally, a 20 percent down
payment is required (i.e., the loan-to-value
ratio may be no more than 80 percent).

9. INSURED VERSUS CONVENTIONAL
MORTGAGES
*Federally insured mortgages
-are originated by financial institutions,
but repayment is guaranteed (for a fee of 0.5
percent of the loan amount) by either the
Federal Housing Administration (FHA) or the
Veterans Administration (VA). Federally insured
mortgages are originated by financial
institutions, but repayment is guaranteed (for
a fee of 0.5 percent of the loan amount) by
either the Federal Housing Administration (FHA)
or the Veterans Administration (VA).

10. INSURED VERSUS CONVENTIONAL
MORTGAGES
*Conventional Mortgage are mortgages held
by financial institutions and are not
federally insured (but as already
discussed, they generally are required to
be privately insured if the borrower’s
down payment is less than 20 percent of
the property’s value).

11. MORTGAGE MATURITIES- A mortgage generally
has an original maturity of either 15 or 30
years. Until recently, the 30-year mortgage was
the one most frequently used. However, the
15-year mortgage has grown in popularity.
Financial institutions find the 15-year
mortgage attractive because of the lower degree
of interest rate risk on a 15-year relative to
a 30-year mortgage. To attract mortgage
borrowers to the 15-year maturity mortgage,
financial institutions generally charge a lower
interest rate on a 15-year mortgage than a
30-year mortgage.

12. INTEREST RATES- Possibly the most important
characteristic identified in a mortgage contract is
the interest rate on the mortgage. Mortgage borrowers
often decide how much to borrow and from whom solely
by looking at the quoted mortgage rates of several
financial institutions. In turn, financial
institutions base their quoted mortgage rates on
several factors.
FIXED VS. ADJUSTABLE-RATE MORTGAGE
A fixed-rate mortgage locks in the borrower’s
interest rate and thus required monthly payments over
the life of the mortgage, regardless of how market
rates change. In contrast, the interest rate on an
adjustable-rate mortgage (ARM) is tied to some market
interest rate or interest rate index. Thus, the
required monthly payments can change over the life of
the mortgage

13. DISCOUNT POINTS- More often just called points)
are fees or payments made when a mortgage loan is
issued (at closing). One discount point paid up
front is equal to 1 percent of the principal value
of the mortgage. In exchange for points paid up
front, the financial institution reduces the
interest rate used to determine the monthly
payments on the mortgage.
MORTGAGE REFINANCING
-occurs when a mortgage borrower takes out a new mortgage
and uses the proceeds obtained to pay off the current
mortgage. Mortgage refinancing involves many of the same
details and steps involved in applying for a new mortgage
and can involve many of the same fees and expenses.
Mortgages are most often refinanced when a current
mortgage has an interest rate that is higher than the
current interest rate

14. OTHER FEES- In addition to interest, mortgage contracts generally require the
borrower to pay an assortment of fees to cover the mortgage issuer’s costs of
processing the mortgage. These include such items as:
*Application fee- Covers the issuer’s initial costs of processing the mortgage
application and obtaining a credit report.
*Title search- Confirms the borrower’s legal ownership of the mortgaged property
and ensures there are no outstanding claims against the property.
*Title insurance- Protects the lender against an error in the title search.
*Appraisal fee- Covers the cost of an independent appraisal of the value of the
mortgaged property.
*Loan origination fee- Covers the remaining costs to the mortgage issuer for
processing the mortgage application and completing the loan.
*Closing agent and review fees- Cover the costs of the closing agent who actually
closes the mortgage.

15. MORTGAGE
AMORTIZATION
The fixed monthly payment made
by a mortgage borrower generally
consists partly of repayment of
the principal borrowed and partly
of the interest on the outstanding
(remaining) balance of the
mortgage. In other words, these
fixed payments fully amortize (pay
off) the mortgage by its maturity
date.
An amortization schedule shows
how the fixed monthly payments are
split between principal and
interest.

16. Problem:
You plan to purchase a house for $150,000 using a 30-year mortgage obtained from your local
bank. The mortgage rate offered to you is 8 percent with zero points. In order to forgo the purchase
of private mortgage insurance, you will make a down payment of 20 percent of the purchase price
($30,000 .20 $150,000) at closing and borrow $120,000 through the mortgage.
EXAMPLE: MONTHLY MORTGAGE PAYMENTS
Formula:

17. SOLUTION:

18. AMORTIZATION SCHEDULE FOR A 30-YEAR MORTGAGE:

19. COMPARISON OF INTEREST PAID ON A 15-YEAR VS. 30-YEAR MORTGAGE
Computation:

20. Amortization Schedule for a 15-Year Mortgage

21. Example: Analyzing the Choice between Points and
Monthly Payments of Interest

22. Solution:

23. Other Types
of Mortgages
03

24. Jumbo Mortgages
Those mortgages that exceed
the conventional mortgage
conforming limits. Typically,
the spread in interest rates on
jumbo versus conventional
mortgages is about 0.25 to 0.50
percent. However, during
periods of high economy-wide
risk (e.g., during the late
2000s), the spread can be
greater than 1.50 percent.
Further, to reduce the risk of
these loans, lenders will often
require a higher down payment
on jumbo mortgages than
conventional mortgages.

25. Subprime Mortgages
-are mortgages to borrowers who do
not qualify for prime mortgages because
of weakened credit histories. Have a higher
rate of default than prime mortgage loans
and are thus riskier loans for the mortgage
lender. As a result, these mortgages have
higher interest rates than prime
mortgages.

26. Alt-A Mortgages
-short for Alternative
A-paper, are mortgages
that are considered more
risky than a prime
mortgage and less risky
than a subprime mortgage.

27. OptionARMs
-also called pick-a-payment or
pay-option ARMs, are 15- or 30-year
adjustable rate mortgages that offer
the borrower several monthly
payment options.

28. FOUR MAJOR TYPES OF PAYMENT OPTIONS
Minimum Payment Option- lowest of the four payment options and carries the
most risk. The monthly payment is set for 12 months at an initial interest
rate. After that, the payment changes annually, and a payment cap limits how
much it can increase or decrease each year (generally 7.5 percent)
Interest-Only Payment- requires the borrower to pay only the interest on the
loan during the initial period of the loan, no principal must be repaid. After
the interest-only period, the mortgage must amortize so that the mortgage will
be paid off by the end of its original term.
30-Year Fully Amortizing Payment- the borrower pays both principal and
interest on the loan
15-Year Fully Amortizing Payment- is similar to the 30-year fully
amortizing payment option ARM, with a full principal and interest payment, but
with a larger amount of principal paid each month.

29. Second Mortgage
-are loans secured by a
piece of real estate
already used to secure a
first mortgage. Should a
default occur, the second
mortgage holder is paid
only after the first
mortgage is paid off. As a
result, interest rates on
second mortgages are
generally higher than on
first mortgages.

30. Reverse-Annuity Mortgages
-a mortgage borrower receives
regular monthly payments from a
financial institution rather than making
them. RAMs were designed as a way for
retired people to live on the equity they have
built up in their homes without the necessity
of selling the homes.

31. Secondary
Mortgage
Market
01
PROJECT #123

32. The secondary mortgage markets were created by
the federal government to help boost U.S. economic
activity during the Great Depression. In the 1930s,
the government established the Federal National
Mortgage Association (FNMA or Fannie Mae) to buy
mortgages from thrifts so that these depository
institutions could make more mortgage loans. The
government also established the Federal Housing
Administration (FHA) and the Veterans Administration
(VA) to insure certain mortgage contracts against
default risk (described earlier). This made it
easier to sell/securitize mortgages.
History and Background of
Secondary Mortgage Markets

33. By the late 1960s, fewer veterans were
obtaining guaranteed VA loans. As a result,
the secondary market for mortgages
declined. To encourage continued expansion
in the housing market, the U.S. government
created the Government National Mortgage
Association (GNMA or Ginnie Mae) and the
Federal Home Loan Mortgage Corporation
(FHLMC or Freddie Mac), which provide
direct or indirect guarantees that allow
for the creation of mortgage-backed
securities
History and Background of
Secondary Mortgage Markets

34. - occurs when a financial
institution originates a
mortgage and sells it with or
without recourse to an
outside buyer. It allow
financial institutions to
improve their liquidity risk
and interest rate risk
situations
Mortgage Sales
Five major buyers of Primary
Mortgage loans
1) Domestic banks
2) Foreign banks,
3) Insurance companies and
pension funds,
4) Closed-end bank loan mutual
funds
5) Nonfinancial corporations.
Major sellers of Mortgage loans
1) Money Center banks
2) Small Regional or Community
Banks
3) Foreign banks
4) Investment banks.

35. Mortgage-Backed Securities
Mortgage-backed securities allow mortgage
issuers to separate the credit risk exposure from
the lending process itself. That is, FIs can
assess the creditworthiness of loan applicants,
originate loans, fund loans, and even monitor and
service loans without retaining exposure to loss
from credit events, such as default or missed
payments. Securitization of mortgages results in
the creation of mortgage-backed securities (e.g.,
government agency securities, collateralized
mortgage obligations), which can be traded in
secondary mortgage markets.

36. MAJOR TYPES OF MORTGAGE-BACKED SECURITIES
Pass-through
Security
Collateralized
Mortgage Obligation
(CMO)
Mortgage-backed
bond
❖ GNMA
❖ FNMA
❖ FHLMC

37. 1. Pass-through Securities
“pass through” promised payments of principal and interest on pools of mortgages
created by financial institutions to secondary market investors (mortgage-backed
security bond holders) holding an interest in these pools.
*Government National Mortgage Association (GNMA), or Ginnie Mae
-is a government-owned agency with two major functions: sponsoring
mortgage-backed securities programs of financial institutions such as banks, thrifts, and
mortgage bankers and acting as a guarantor to investors in mortgage-backed securities
regarding the timely pass-through of principal and interest payments from the financial
institution or mortgage servicer to the bond holder.
*Federal National Mortgage Association (FNMA or Fannie Mae)
-has operated as a private corporation owned by shareholders, in the minds of many
investors, it has had implicit government backing, which makes it equivalent to a
government-owned enterprise (GSE)

38. -FNMA creates mortgage-backed securities (MBSs) by purchasing packages of
mortgage loans from banks and thrifts; it finances such purchases by selling MBSs to
outside investors such as life insurers or pension funds.
*Federal Home Loan Mortgage Corporation (FHLMC), or Freddie Mac (FMAC)
-is a stockholder-owned corporation, yet it is currently in conservatorship with the
FHFA.
-it buys mortgage pools from financial institutions and swaps MBSs for loans and
sponsors conventional mortgage pools and mortgages that are not federally insured.

39. Private Mortgage Pass-Through Issuers
-Private mortgage pass-through issuers (such as commercial banks, thrifts,
and private conduits) purchase nonconforming mortgages (e.g., mortgages that
exceed the size limit set by government agencies, pool them, and sell
pass-through securities on which the mortgage collateral does not meet the
standards of a government-related mortgage issuer.

40. Pass-Through Securities Quote Sheet

41. 2. Collateralized Mortgage Obligations
-is a device for making mortgage-backed securities more attractive to certain
types or classes of investors.
-give investors greater control over the maturity of the mortgage-backed
securities they buy.
3. Mortgage-Backed Bond
-Bonds collateralized by a pool of assets.
-the relationship for MBBs is one of collateralization rather than securitization; the
cash flows on the mortgages backing the bond are not necessarily directly connected
to interest and principal payments on the MBB.
-Financial institutions back most MBB issues by excess collateral.

42. PARTICIPANTS
IN THE
MORTGAGE
MARKETS
01

43. *Some financial institutions (e.g., banks, savings institutions) contribute mainly to the
primary mortgage markets. Others (e.g., mortgage companies) contribute to both the
primary and secondary markets.
*Mortgage companies, or mortgage bankers, are financial institutions 9 that originate
mortgages and collect payments on them.
*They sell the mortgages they originate but continue to service the mortgages by
collecting payments and keeping records on each loan.
*Mortgage companies earn income to cover the costs of originating and servicing the
mortgages from the servicing fees they charge the ultimate buyers of mortgages.

44. Mortgages Outstanding by Type of Holder, 1992 and
2010

45. INTERNATIONAL
TRENDS IN
SECURITIZATION
International investors
participate in U.S. mortgage and
mortgage-backed securities markets.
After the United States, Europe is the
world’s second-largest and most
developed securitization market. The
original growth of “modern”
securitization in Europe was based
largely upon the activities of a small
number of centralized lenders in the
booming U.K. residential mortgage
market of the late 1980s.

46. INTERNATIONAL
TRENDS IN
SECURITIZATION
Despite the world economic crisis
in 1998, the European securitization
market fell only slightly to $38.4
billion. More than $22 billion of
securitized vehicles were issued in
just the first half of 1999 alone,
including $3.5 billion in
international deals from Japan. Japan
and Europe accounted for $16 billion
of the first quarter total. Latin
America and the emerging markets
(still struggling with economic
crises) lagged behind, with issues
totaling $7.0 billion.

47. INTERNATIONAL
TRENDS IN
SECURITIZATION
The United Kingdom was the
biggest issuer of
mortgage-backed securities in
2009, with over 20 percent of
the European market. Italy was
second, with 16 percent of the
European market.

48. ❑ The largest banks in the Netherlands, Switzerland, and the United Kingdom had net losses
for the year.
❑ Banks in Ireland, Spain, and the United Kingdom were especially hard hit as they had large
investments in “toxic” mortgages and mortgage-backed securities, both U.S. and domestic.
❑ Because they focused on domestic retail banking, French and Italian banks were less
affected by losses on mortgage-backed securities
❑ During the last week of September and the first week of October 2008, the German
government guaranteed all consumer bank deposits and arranged a bailout of Hypo Real
Estate
❑ During the last week of September and the first week of October 2008, the German
government guaranteed all consumer bank deposits and arranged a bailout of Hypo Real
Estate
❑ Ireland guaranteed the deposits and debt of its six major financial institutions.

49. ❑ Iceland rescued its third largest bank with a $860 million purchase of 75 percent of the
bank’s stock and a few days later seized the country’s entire banking system.
❑ The Netherlands, Belgium, and Luxembourg central governments together agreed to inject
$16.37 billion into Fortis NV
❑ Central banks in Asia injected cash into their banking systems as banks’ reluctance to lend
to each other
❑ South Korean authorities offered loans and debt guarantees to help small and midsize
businesses with short-term funding.
❑ The Bank of England lowered its target interest rate to a record low of 1 percent, hoping to
help the British economy out of a recession.
❑ The Bank of Canada, Bank of Japan, and Swiss National Bank also lowered their main
interest rate to 1 percent or below.

50. THANK YOU