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Chapter Objectives
Describe characteristics of residential
mortgages
Describe the common types of creative
mortgage financing
Explain how mortgage-backed securities
are used
What Is a Mortgage?
Mortgages are loans that are made for the
purpose of allowing the borrower to
purchase real estate.
They are used to finance residential home
purchases, office buildings, and even large
complexes such as shopping centers.
Flow of Savings
Residential Mortgage
Characteristics
The mortgage contract should specify:
Mortgage Basics
A mortgage is a long-term loan secured by real estate.
Often for 15 or 30 years
The longer the term the higher the interest rate and the
greater the dollar amount of total interest paid.
Generally amortized
Equal payments, usually each month.
Amount of each payment that is principal repayment rises
each month.
A major factor to borrowers is the size of the interest payment.
The final rate that is applied to the mortgage loan depends on
three factors:
1) the current level of long-term interest rates,
2) the life of the mortgage, with longer terms having a higher rate,
and 3) the number of discount points paid at closing .
Mortgage Basics
Discount points are interest payments made at
the beginning of the loan.
They are expressed as a percent of the value
of the loan.
For example, two points on a $100,000
mortgage is 2 percent of the $100,000 or
$2,000.
The higher the points the lower the interest
rate, but points increase the amount of cash
that the buyer must have available at the time
the loan is made.
Financial Markets and
15-year
30-year
1992
7.96
8.39
1993
6.83
7.31
1994
7.86
8.36
1995
7.48
7.93
1996
7.13
7.81
1997
7.13
7.60
1998
6.59
6.94
1999
7.06
7.44
2000
7.50
7.83
2001
6.09
6.61
Writing an Amortization
Schedule
Consider a 15-year (180-month) $200,000
mortgage at an annual interest rate of 9
percent. Develop an amortization schedule for
this mortgage showing all appropriate columns.
Show the first three payments and the last two
payments on the schedule. The monthly
.mortgage payment is $2,028.53
Writing an Amortization
Schedule (contd)
Payment
Number
Payment
of Interest
Payment
of Principal
Total
Payment
Remaining Loan
Balance
$1,500.00
$528.53
$2,028.53
$199,471.47
1,496.04
532.50
2,028.53
198,938.97
1,492.04
536.49
2,028.53
198,402.48
179
30.09
1,998.44
2,028.53
2,013.43
180
15.10
2,013.43
2,028.53
0.00
Graduated-payment mortgages
Growing-equity mortgages
Second mortgages
Shared-appreciation mortgages
Reverse annuity mortgage
Securitization
Pool and repackage loans for resale
Allows resale of loans not easily sold on an
individual basis
Financial Markets and
Mortgage companies
The differences among Fannie Mae, Ginnie
Mae, and Freddie Mac are primarily the
specific loan markets they serve.
Fannie Mae (1930) - secondary market for
mortgages held by thrift organizations.
Ginnie Mae (1968) - secondary market for
insured mortgages held by commercial
banks and mortgage companies.
Freddie Mac (1970) assists savings and
loans with their mortgage market needs.
Financial Markets and
Valuation of Mortgages
Market price of mortgages is present value of cash flows
PM =
T=1
C + Prin
( 1+k)t
Where:
Valuation of Mortgages
Periodic payment commonly includes payment
of interest and principal
Required rate of return determined by risk-free
rate, credit risk and liquidity
Risk-free interest rate components and affects
+ inflationary expectations
+ economic growth
- change in the money supply
+ budget deficit
Financial Markets and
Valuation of Mortgages
Economic growth affects the risk premium
Strong growth improves borrowers income
and cash flows and reduces default risk
Weak growth has the opposite affect
Mortgage-Backed Securities
Securities that are secured by a portfolio of
mortgages.
Why do they exist?
Banks often dont want to hold these long term
assets (not safe to fund them with short term
deposits).
Reduce problems caused by regional lending
institutions sensitivity to local economic conditions.
Give borrowers access to a national capital market.
Give investors low-risk, long-term investments
without loan servicing cost
Financial Markets and
Mortgage-Backed Securities
Secondary market for mortgages
Mortgage pass-through securities pass through payments of principal and
interest on pools of mortgages to holders of MBS.
Other MBS use pools of mortgages as collateral for debt securities.
Advantages
Issued in standardized denominations and are negotiable.
Issued or backed by quality borrowers.
Development of secondary mortgage mkt
1934: U. S. Congress initiated development of secondary market for
mortgages by creating Federal Housing Admin (FHA).
1938: Federal National Mortgage Assoc (FNMA) created; authorized to buy
FHA insured loans.
1968: FNMA was split up into FNMA and GNMA (Government National
Mortgage Assoc). GNMA authorized to guarantee mortgage pools insured by
FHA, VA, and other federal agencies.
1970: Federal Home Loan Mortgage Corp (FHLMC) created to help
develop secondary market for conventional mortgages.
Mortgage Pass-Through
A security that has the payments from the
mortgages in the pool pass through the
trustee before being disbursed to investors.
All payments are passed through as they are
made by borrowers.
This creates reinvestment risk for investors.
Advantages
Can purchase in secondary market without
purchasing the need to service loans
Insured
Liquid
Financial Markets and