Chapter Seven

Mortgage Markets

McGraw-Hill /Irwin

Copyright © 2001 by The McGraw-Hill Companies, Inc. All rights reserved.

and farm McGraw-Hill /Irwin Copyright © 2001 by The McGraw-Hill Companies. multifamily dwelling. Inc. or other real 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. All rights reserved. . commercial.Mortgages and Mortgage-Backed Securities ‡ Mortgages are loans to individuals or businesses to purchase a home. land.

. Inc. All rights reserved.Mortgage Loans Outstanding ($Bn) 5000 4500 4000 3500 3000 2500 2000 1500 1000 500 0 1992 Home McGraw-Hill /Irwin 1993 1994 1995 1996 1997 1998 1999 Farm Multifamily res Commercial Copyright © 2001 by The McGraw-Hill Companies.

Inc.Mortgage haracteristics ‡ Lien .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) McGraw-Hill /Irwin Copyright © 2001 by The McGraw-Hill Companies. All rights reserved.a portion of the purchase price of the property a FI requires the mortgage borrower to pay up front ‡ Private mortgage insurance . .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 .

‡ Federally insured mortgages . All rights reserved.originated by FIs with repayment guaranteed by either the Federal Housing Administration (FHA) or the Veterans Administration (VA) ‡ Conventional mortgages .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. Inc.issued by FIs that are not federally insured ‡ Amortized .to five-year period with full payment of the mortgage principal required at the end of the period (continued) McGraw-Hill /Irwin Copyright © 2001 by The McGraw-Hill Companies. .

locks in the borrower¶s interest rate and thus the required monthly payment over the life of the 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 . All rights reserved.schedule showing how the monthly mortgage payments are split between principal and interest McGraw-Hill /Irwin Copyright © 2001 by The McGraw-Hill Companies. regardless of market rate changes ‡ Adjustable-rate mortgage . Inc.interest payments made when the loan is issued (at closing).‡ Fixed-rate mortgage . One discount point = 1 percent of the principle value of the mortgage ‡ Amortization schedule . .

All rights reserved. n v 12) Where: PV = PMT = PVIFA = i = n= Principal amount borrowed through the mortgage Monthly mortgage payment Present value interest factor of an annuity Annual interest rate on the mortgage Length of the mortgage in years McGraw-Hill /Irwin Copyright © 2001 by The McGraw-Hill Companies.Ca cu ation o Month y Mortgage Pay ents PV = PMT(PVIFA i/12. . Inc.

78 McGraw-Hill /Irwin Copyright © 2001 by The McGraw-Hill Companies. 15 v 12 ) PMT = $120. . 30 v 12 ) PMT = $120.6406 = $1146.000 = PMT(PVIFA 8%/12.2835 = $880.000 = PMT(PVIFA 8%/12.52 $150.000 home with 30-year mortgage at 8%.000 home with 15-year mortgage at 8%. 0 points. 20% down $120. 0 points.000/136. 20% down $120. Inc. All rights reserved.000/104.Co parison o Month y Mortgage Pay ents $150.

where the lender automatically lowers the rate on an existing mortgage when prevailing rates fall ‡ Graduated-payment mortgages .where the initial payments are the same as a conventional mortgage but increase over a portion or the entire life of the mortgage (continued) McGraw-Hill /Irwin Copyright © 2001 by The McGraw-Hill Companies. All rights reserved.where borrowers make small payments early in the life of the mortgage. increased payments over the first 5-10 years and level off at the end of the mortgage period ‡ Growing-equity mortgages .Other Types o Mortgages ‡ Automatic rate-reduction mortgages . Inc. .

loans that let customers borrow on a line of credit secured with a second mortgage ‡ Shared-appreciation mortgage (SAM) . . All rights reserved.‡ Second mortgages . Inc.loans secured by a piece of real estate already used to secure a first mortgage ‡ Home equity loan .where mortgage borrower receives regular monthly payments from a FI McGraw-Hill /Irwin Copyright © 2001 by The McGraw-Hill Companies.similar to SAM except that an outside investor shares in the appreciation ‡ Reverse-annuity mortgage .allows a home buyer to obtain a mortgage at an interest rate below current rates in exchange for a share in any appreciation of the property ‡ Equity-participation mortgage .

. interest rate risk. Inc. All rights reserved. and credit risk of FIs portfolio ± FI retains income from origination fees and service fees ‡ FI¶s re ove ortgages ro their ba ance sheet through one o two echanis s ± pool recently originated mortgages together and sell them in the secondary market ± issue mortgage-backed securities that are backed by their newly originated mortgages McGraw-Hill /Irwin Copyright © 2001 by The McGraw-Hill Companies.Secondary Mortgage Market ‡ Advantages or FI to securitize ± reduces liquidity risk.

History o Secondary Mortgage Markets ‡ Federal National Mortgage Association (FNMA or ³Fannie Mae´) created during the Great Depression ‡ FHA and VA insured loans also created during this time ‡ Government National Mortgage Association (GNMA or ³Ginnie Mae´) and Federal Home Loan Mortgage Corp. All rights reserved. (FHLMC or ³Freddie Mac´) created during 1960¶s ‡ Wide variety of mortgage-backed securities have been developed and in 1999. approximately 50% of mortgages are securitized McGraw-Hill /Irwin Copyright © 2001 by The McGraw-Hill Companies. . Inc.

oreign banks. oreign banks. . and non inancia corporations ‡ Major se ers o ortgage oans are oney center banks. Inc. c osed end bank oan utua unds. All rights reserved. s a regiona or co invest ent banks McGraw-Hill /Irwin Copyright © 2001 by The McGraw-Hill Companies.sa e o a ortgage originated by a bank with or without recourse to an outside buyer ‡ A ow FIs to anage credit risk and achieve better asset diversi ication. unity banks. i proves their iquidity risk ‡ FIs encouraged to se oans or econo ic (generation o ee inco e) and regu atory reasons (reducing cost o reserve require ents) ‡ Major buyers o ortgage oans are do estic banks.Mortgage Sa es ‡ Mortgage sa e . insurance co panies and pension unds.

Securitization o Mortgages ‡ Pass-through mortgage securities . All rights reserved.Ginnie Mae (GNMA).000 beyond the minimum ‡ Three government owned or sponsored agencies involved .mortgage-backed securities that ³pass-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. Inc. .000 with increments of $5. Fannie Mae (FNMA. and Freddie Mac (FHLMC) McGraw-Hill /Irwin Copyright © 2001 by The McGraw-Hill Companies. usually $25.

Inc.Govern ent-Re ated Mortgage-Backed Pass-Through Securities Outstanding ($Bn) 1000 900 800 700 600 500 400 300 200 100 0 1995 1996 1997 1998 1999 GNMA McGraw-Hill /Irwin NMA MC Private Mortgages Copyright © 2001 by The McGraw-Hill Companies. . All rights reserved.

.a bond holder class associated with a CMO ‡ Created by packaging and securitizing whole mortgage loans or resecuritizing pass-through securities ‡ Attractive to secondary mortgage market investors because they can choose a particular CMO class that fits their maturity needs McGraw-Hill /Irwin Copyright © 2001 by The McGraw-Hill Companies. All rights reserved. Inc.a mortgage-backed bond issued in multiple classes or tranches ± tranches .Co atera ized Mortgage Ob igations ‡ CMO .