Chapter 12

The Mortgage Markets

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Chapter Preview

We identify characteristics of typical residential mortgages and the usual term and types of mortgages available. We then review who provides and services the loans, along with the growth in the secondary mortgage market. Topics include: What Are Mortgages? Characteristics of Residential Mortgages Types of Mortgage Loans Mortgage-Lending Institutions

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Chapter Preview (cont.)

Loan Servicing

Secondary Mortgage Market

Securitization of Mortgages

The Impact of Securitized Mortgages on the Mortgage Market

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12.1 What Are Mortgages?

A long-term loan secured by real estate

An amortized loan whereby a fixed payment pays both principal and interest each month

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12.1.1 What Are Mortgages?

The next slide shows the total amount of mortgage debt outstanding in the U.S. during 2004. It further delineates by type of property.

The table shows roughly $9.4 trillion outstanding. How does this compare to the value of all the stock on the NYSE (as on July 2002, NYSE has a total market value $9.385trillion!)?

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12.1.2 What Are Mortgages?Mortgage Loan Borrowers

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12.1.3 What Are Mortgages? History

Mortgages were used in the 1880s, but massive defaults in the agricultural recession of 1890 made long-term mortgages difficult to attain.

Until post-WWII, most mortgage loans were short-term balloon loans ( 期末整付贷款 ) with maturities of five years or less.

Balloon loans: the borrowers paid only interest for three to five years, at which time the entire loan amount became due.

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12.1.4 What Are Mortgages? History

Balloon loans, however, caused problems during the depression. Typically, the lender renews the loan. But, with so many Americans out of work, lenders could not continue to extend credit.

As a part of the depression recovery program, the federal government assisted in restructuring the mortgage market by taking over delinquent ( 拖欠债务的 ) balloon loans and allowed borrowers to repay over longer periods of time.

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12.2 Characteristics of the Residential Mortgage

Mortgages can be roughly classified along the following three dimensions: Mortgage Interest Rates

Loan Terms

Mortgage Loan Amortization

10A variety of fun mortgage calculatorshttp://interest.com/calculators/index.shtml

12.2.1 Mortgage Interest Rates

The stated rate on a mortgage loan is determined by three rates: Market Rates: general rates on

Treasury bonds Term: longer-term mortgages have

higher rates Discount Points: a lower rates negotiated for cash

upfront (the percentage of the loan which is paid at closing, the moment when the borrow signs the loan paper and receives the proceeds of the loan )p297

11A variety of fun mortgage calculatorshttp://interest.com/calculators/index.shtml

12.2.2 Mortgage Interest Rates

The next slide shows the relationship between mortgage rates and long-term treasury rates.

As can be seen, mortgage rates are typically higher than Treasury rates, but the spread (difference) between the two varies considerably.

12Current mortgage interest rateshttp://www.interest.com/

12.2.3 Mortgage Interest Rates

Figure 12.1 Mortgage Rates and Long-Term Treasury Interest Rates, 1985–2004

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A variety of fun mortgage calculatorshttp://interest.com/calculators/index.shtml

12.2.4 Mortgage Interest Rates & Points A difficult decision when getting a mortgage is

whether to pay points (cash) upfront in exchange for a lower interest rate on the mortgage.

Suppose you had to choose between a 12% 30-year mortgage or a 11.5% mortgage with 2 discount points. Which should you choose? Assume you wished to borrow $100,000.

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12.2.4.1 Mortgage Interest Rates & Points

First, examine the 12% mortgage. Using a financial calculator, the required payments is:

n = 360, I/Y=12, PV = 100,000,

Calculate the PMT. PMT = $1,028.61

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12.2.4.2 Mortgage Interest Rates & Points

Now, examine the 11.5% mortgage. Using a financial calculator, the required payments is:

n = 360, i = 11.5, PV = 100,000,

Calculate the PMT. PMT = $990.29

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12.2.4.3 Mortgage Interest Rates & Points So, paying the points will save you $38.32

each month. However, you have to pay $2,000 upfront.

You can see that the decision depends on how long you want to live in the house, keeping the same mortgage.

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12.2.4.4 Mortgage Interest Rates & Points If you only want to live there 12 months,

clearly the $2,000 upfront cost is not worth the monthly savings.

Let’s see how to determine the answer.

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12.2.4.5 Mortgage Interest Rates & Points

You need to determine when the present value of the savings ($38.32) equals the $2,000 upfront. Using a financial calculator, this is:

i = 12, PV = -2,000, PMT = 38.32

Calculate n. n = 74 months, or about 6.2 years.

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12.2.4.6 Mortgage Interest Rates & Points

So, if you think you will stay in the house and not refinance for at least 6.2 years, paying the $2,000 for the lower payment is a sound financial decision.

Otherwise, you should accept the 12% loan.

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12.2.4.7 Mortgage Interest Rates & Points

The next table further illustrates this point, showing the effective rate on the 11.5% mortgage if the mortgage is paid in full at various points.

Note that right around year 6, the effective annual rate on the 11.5% mortgage is about the same as effective annual rate on the 12% mortgage (12.68%).

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12.2.4.8 Effective Rate of Interest (case on p298)

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12.2.5 Characteristics of the Residential Mortgage: Loan TermsMortgage loan contracts contain many legal

terms that need to be understood. Most protect the lender from financial loss.

Collateral: usually the real estate being finance

Down payment: a portion of the purchase price paid by the borrower

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12.2.5.1 Characteristics of the Residential Mortgage: Loan Terms PMI (Private Mortgage Insurance): insurance

against default by the borrower Qualifications: includes credit history,

employment history, etc., to determine the borrowers ability to repay the mortgage as specified in the contract

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12.2.5.2 Characteristics of the Residential Mortgage: Loan AmortizationMortgage loans are amortized loans. This means that a fixed, level payment will pay interest due plus a portion of the principal each month. It is designed so that the balance on the mortgage will be zero when the last payment is made.

The next table shows a typical amortization table for a 30-year mortgage at 8.5%.

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12.2.5.3 Characteristics of the Residential Mortgage: Loan Amortization Schedule

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12.3 Types of Mortgage Loans Insured vs. Conventional Mortgages: if the

down payment is less than 20%, insurance is usually required

Fixed-Rate Mortgages: the interest rate is fixed for the life of the mortgage

Adjustable-Rate Mortgages: the interest rate can fluctuate within certain parameters

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12.3.1 Types of Mortgage Loans Other Types

Graduated-Payment Mortgages (GPMs)- payments increase gradually;

Growing Equity Mortgages (GEMs) – permits early pay off Shared-Appreciation Mortgages (SAMs) – enjoy lower rate by

giving up part of the appreciation of real estate Equity Participation Mortgages – lower loan burden by giving up

part of the equity of the real estate Second Mortgages – junior to the first loan Reverse Annuity Mortgages (RAMs)

The following table lists additional characteristics on all the loans.

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12.3.2 Types of Mortgage Loans

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12.4 Mortgage Lending Institutions Originally, thrift industry ( 美國儲蓄機構 )

were the primary originator of mortgages in the U.S. and, therefore, the primary holder of mortgage loans.

As the next figure illustrates, this is not the case anymore.

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Figure 12.2 Share of the Mortgage Market Held by Major Mortgage-Lending Institutions

12.4.1Mortgage Lending Institutions

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12.4.2 Loan Servicing ( 贷款服务 ) Most mortgages are immediately sold to

another investor by the originator. This frees cash to originate another loan and generate additional fee income.

Still, someone has to collect the monthly payments and keep records. This is known as loan servicing, and servicers usually keep a portion of the payments received to cover their costs.

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12.4.3 Loan Servicing

In all, there are three distinct elements in mortgage loans:

The originator packages the loan for an investor

The investor holds the loan

The servicing agent handles the paperwork

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12.4.4 Secondary Mortgage Market

The secondary mortgage market was originally established by the federal government after WWII when it created Fannie Mae (The Federal National Mortgage Association) to buy mortgages from thrifts.

The market experienced tremendous growth in the early to mid-1980, and has continued to remain a strong market in the U.S.

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12.4.5 Securitization of Mortgages

The securitization of mortgages developed because of problems dealing with single mortgages: risk of either default or prepayment and servicing. Pools of mortgages eliminated part of this problem through diversification.

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12.4.6 Securitization of Mortgages: MBS( 按揭證券 ) The mortgage-backed security was created.

Pools including hundreds of mortgages were gathered, and the rights to the cash flows generated by the mortgages were sold as separate securities.

At first, simple pass-through securities were designed.

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12.4.7 Securitization of Mortgages: The Mortgage Pass-Through Definition: A kind of MBS that has the

borrower’s mortgage payments pass through the trustee before being disbursed to the investors

This design did eliminate some risk, but investors still faced prepayment risk ( 提前偿还风险 ).

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12.4.9 Securitization of Mortgages: CMOs 債券抵押證券 CMOs: Collateralized mortgage obligation

Definition: A CMO is a structured MBS (mortgage-backed security ). Investors have different rights to different sets of cash flows.

This design structured the prepayment risk. Some classes had little, while other had a lot.

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12.4.10 The Impact of Securitization on the Mortgage Market As the next figure shows, the value of

mortgages held in pools is reaching $5 trillion near the end of 2003.

The securities compete for funds along with all other bond market participants.

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Figure 12.3 Value of Mortgage Principal Held in Mortgage Pools, 1984–2004

Mortgage Pools

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12.4.11 The Impact of Securitization on the Mortgage Market Benefits

1. Reduces the problems caused by regional lending institution’s sensitivity to local economic fluctuations

2. Borrowers have access to a national capital market

3. Investors have low-risk and long-term investments in mortgages without having to service the loan

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12.4.12 The Impact of Securitization on the Mortgage MarketHowever, this is not without its costs.

Because of securitization, mortgage rates have become more national in nature, and this has lead to increased volatility in mortgage rates.

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Chapter Summary

What Are Mortgages? Loans made for the purchase on real property, and usually collateralized by the purchased property.

Characteristics of Residential Mortgages: includes the length of the mortgage, the terms, and the rate charges for the loan

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Chapter Summary (cont.)

Types of Mortgage Loans: includes conventional, insured, fixed and variable rate, and a variety of other designs.

Mortgage-Lending Institutions: the primarily originator and holder of mortgages is no longer thrift institutions as other attempt to generate fees

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Chapter Summary (cont.)

Loan Servicing: the fees generated by collecting, distributing, and recording payments

Secondary Mortgage Market: the active market for mortgages after the mortgage has been originated

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Chapter Summary (cont.)

Securitization of Mortgages: growing in popularity, causing mortgages to complete with both Treasury and corporate debt

The Impact of Securitized Mortgages on the Mortgage Market: although many benefits can be noted, increased rate volatility is also a side-effect