chapter 5

Chapter 5Chapter 5

Modern Modern Residential Residential

FinanceFinance

Chapter 5Chapter 5Learning ObjectivesLearning Objectives

Understand the major forces that have Understand the major forces that have changed and shaped the residential changed and shaped the residential mortgage market since the end of mortgage market since the end of World War IIWorld War II

Understand how changes in the Understand how changes in the inflationary environment forced inflationary environment forced changes in the types of institutions changes in the types of institutions that originated mortgages and in the that originated mortgages and in the types of mortgages they offeredtypes of mortgages they offered

History Of Real Estate History Of Real Estate FinanceFinance

1940s1940s– Preoccupied with World War TwoPreoccupied with World War Two– Veterans Administration createdVeterans Administration created

1950s1950s – Decade of S&L expansion and stabilityDecade of S&L expansion and stability– Maturity mismatch because of the wide Maturity mismatch because of the wide

acceptance of the 30-year fixed-rate acceptance of the 30-year fixed-rate mortgagemortgage

– Increased interest rate risk because of Increased interest rate risk because of fixed-rate mortgagesfixed-rate mortgages


1960s1960s – Creeping inflationCreeping inflation– DisintermediationDisintermediation– Maturity mismatchMaturity mismatch– Expansion of secondary mortgage Expansion of secondary mortgage

marketmarket– Government National Mortgage Government National Mortgage

Association (Ginnie Mae) created in Association (Ginnie Mae) created in 19681968

History Of Real Estate History Of Real Estate Finance Finance

1970s1970s– Inflation increased from 6% to 13%Inflation increased from 6% to 13%– Interest rate increases decreased housing Interest rate increases decreased housing

affordabilityaffordability– Development of Adjustable-Rate MortgagesDevelopment of Adjustable-Rate Mortgages– Creation of Federal Home Loan Mortgage Creation of Federal Home Loan Mortgage

Corporation (Freddie Mac) in 1970Corporation (Freddie Mac) in 1970– Approval of new mortgage designs: VRM, Approval of new mortgage designs: VRM,

GPM, and RAMGPM, and RAM


1980s1980s – Regulatory and tax law changesRegulatory and tax law changes– Economic Recovery Act in 1981 Economic Recovery Act in 1981

produces the Accelerated Cost produces the Accelerated Cost Recovery System (ACRS) of Recovery System (ACRS) of depreciationdepreciation

– Tax Reform Act in 1986 created the Tax Reform Act in 1986 created the Modified Accelerated Cost Recovery Modified Accelerated Cost Recovery System (MACRS)System (MACRS)


1980s1980s– S&L debacleS&L debacle– Due-on-sale and creative financingDue-on-sale and creative financing– Zombie theoryZombie theory– Financial Institutions Reform, Financial Institutions Reform,

Recovery, and Enforcement Act Recovery, and Enforcement Act (FIRREA) in 1989(FIRREA) in 1989

History of Real Estate History of Real Estate FinanceFinance

An Era of Creative FinancingAn Era of Creative Financing– Late 1970s and early 1980sLate 1970s and early 1980s– Advantages of FHA and VA LoansAdvantages of FHA and VA Loans– Assumable loansAssumable loans– Wraparound financingWraparound financing– Owner financingOwner financing


1990s1990s– Subsiding inflation resulted in lower Subsiding inflation resulted in lower

mortgage ratesmortgage rates– Refinancing crazeRefinancing craze– Baby boomers trading up increasing Baby boomers trading up increasing

demand for up-scale housingdemand for up-scale housing– Internet made mortgage lending Internet made mortgage lending

national in scopenational in scope


1990s1990s– Rapid growth of secondary mortgage Rapid growth of secondary mortgage

market, primarily Fannie Mae and Freddie market, primarily Fannie Mae and Freddie MacMac

– Tax Act of 1993 eased passive loss rules Tax Act of 1993 eased passive loss rules and extended non-residential depreciation and extended non-residential depreciation from 31.5 years to 39 yearsfrom 31.5 years to 39 years

– Taxpayer Relief Act of 1997 set long-term Taxpayer Relief Act of 1997 set long-term capital gains tax rate at 20% and maximum capital gains tax rate at 20% and maximum depreciation recovery rate at 25%depreciation recovery rate at 25%


2000s2000s– Housing craze – Single-family homes Housing craze – Single-family homes

entered the speculative investment marketentered the speculative investment market– Rapid rise in house prices through first half Rapid rise in house prices through first half

of decadeof decade– 2006 house prices up 87% from 2000 level2006 house prices up 87% from 2000 level– Mortgage lending standards relaxedMortgage lending standards relaxed– Rapid growth of secondary mortgage Rapid growth of secondary mortgage

market through Fannie Mae, Freddie Mac, market through Fannie Mae, Freddie Mac, and Wall Streetand Wall Street

– Massive bailouts of Fannie Mae, Freddie Massive bailouts of Fannie Mae, Freddie Mac, and Wall StreetMac, and Wall Street


2000s2000s– Housing bust of 2007 resulted in deluge of mortgage Housing bust of 2007 resulted in deluge of mortgage

defaultsdefaults– September 2008 U.S. Treasury took control of Fannie September 2008 U.S. Treasury took control of Fannie

Mae and Freddie MacMae and Freddie Mac– Changing market as house prices fell and lenders Changing market as house prices fell and lenders

tightened standardstightened standards– Borrowers began to show willingness to walk away Borrowers began to show willingness to walk away

from speculative housing investmentsfrom speculative housing investments– S&P downgraded large number of residential S&P downgraded large number of residential

mortgage securities as toxic mortgage debt poisoned mortgage securities as toxic mortgage debt poisoned the global financial systemthe global financial system

chapter 5

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