CHAPTER 9
MORTGAGE MARKETS
The Unique Nature of
Mortgage Markets
Mortgage loans are secured by the
pledge of real property as collateral.
Mortgage loans are made for varied
amounts -- no standard denomination.
Issuers of mortgages are usually small
family or business entities.
Copyright© 2003 John Wiley and Sons, Inc.
The Unique Nature of
Mortgage Markets (concluded)
Weak Secondary Market
Little standardization of contracts and
terms.
Traditionally issued and held by lender.
Mortgage markets are highly regulated
and supported by federal government
policies.
Copyright© 2003 John Wiley and Sons, Inc.
The Mortgage Contract
Borrower Signs a Note and Mortgage, and
Title Is Conveyed to Borrower
The note is the borrowing agreement.
Payments amortized over time.
Interest is usually computed on the declining
balance.
The mortgage is a lien on the property used
as collateral for the loan.
If the contract is broken, the lender may use
the property to pay the loan.
Copyright© 2003 John Wiley and Sons, Inc.
Mortgage Balance and Payments
A. Balance due on 15-year, 9%, $100,000 mortgage with payments of $1,015 per month
made promptly.
Balance after payment number:
1
2
3
4
5
6
99,735.00
99,468.01
99,199.02
98,928.02
98,654.98
98,379.89
84,377.69
83,995.52
83,610.49
83,222.57
82,831.74
82,437.97
55,553.05
54,954.70
54,351.86
53,744.50
53,132.58
52,516.07
10,422.85
9,486.03
8,542.17
7,591.24
6,633.17
5,667.92
7
98,102.74
82,041.26
51,894.94
4,695.43
Initial mortgage
Interest rate
Maturity
8
97,823.51
81,641.57
51,269.16
3,715.65
9
97,542.18
81,238.88
50,638.67
2,728.51
$100,000
9%
15 years
10
97,258.75
80,833.17
50,003.46
1,733.98
Monthly payments
First payment interest
First payment principal
11
96,973.19
80,424.42
49,363.49
731.98
$1,015
$750
$265
12
96,685.49
80,012.60
48,718.72
-277.53
Total payments
Total interest
Total principal
In
Year 1
Year 5
Year 10
Year 15
In
Year 1
Year 5
Year 10
Year 15
$182,400+
$82,400+
$100,000
Copyright© 2003 John Wiley and Sons, Inc.
Mortgage Balance and
Payments (continued)
Principal and interest Payments on a 9%, 15year, $100,000 mortgage with payments of
$1,015 per month
$1,200
Payment
$1,000
$800
Interest Payment
Principal Payment
$600
$400
$200
$0
0
12
24
36
48
60
72
84
96 108 120 132 144 156 168
Month
Copyright© 2003 John Wiley and Sons, Inc.
Mortgage Balance and
Payments, cont.
A. Balance due on 30-year, 9%, $100,000 mortgage with payments of $805 per month
made promptly.
Balance after payment number:
1
2
3
4
5
6
99,945.00
99,889.59
99,833.76
98,777.51
99,720.84
99,663.75
96,757.63
96,678.32
96,598.40
96,517.89
96,436.78
96,355.05
90,775.16
90,650.97
90,525.86
90,399.80
90,272.80
90,144.85
81,408.52
81,214.08
81,018.19
80,820.82
80,621.98
80,421.64
54,215.43
53,817.04
53,415.67
53,011.29
52,603.87
52,193.40
7,832.77
7,086.51
6,334.66
5,577.17
4,814.00
4,045.11
7
99,606.23
99,272.71
90,015.93
80,219.81
51,779.85
3,270.44
Initial mortgage
Interest rate
Maturity
8
99,548.28
96,189.76
89,886.05
80,016.45
51,363.20
2,489.97
9
99,489.89
96,106.18
89,755.20
79,811.58
50,943.42
1,703.65
$100,000
9%
30 years
10
99,431.06
96,021.98
89,623.36
79,605.16
50,520.50
911.42
Monthly payments
First payment interest
First payment principal
11
99,371.79
95,937.14
89,490.54
79,397.20
50,094.40
113.26
$805
$750
$55
12
99,312.08
95,851.67
89,356.71
79,187.68
49,665.11
-690.89
Total payments
Total interest
Total principal
In
Year 1
Year 5
Year 10
Year 15
Year 20
Year 30
In
Year 1
Year 5
Year 10
Year 15
Year 20
Year 30
$289,100+
$189,100+
$100,000
Copyright© 2003 John Wiley and Sons, Inc.
Mortgage Balance and
Payments
Principal and interest Payments on a 9%, 30year, $100,000 mortgage with payments of
$805 per month
$900.00
$800.00
Payment
$700.00
$600.00
$500.00
Interest Payment
Principal Payment
$400.00
$300.00
$200.00
$100.00
$0.00
0
36
72
108
144
180
216
252
288
324
Month
Copyright© 2003 John Wiley and Sons, Inc.
Conventional and Insured
Mortgages
Conventional mortgages represent
lending/borrowing in the private markets.
Insured and/or guaranteed mortgages are
supported by federal and state agencies.
Federal Housing Administration (FHA).
Veterans Administration (VA).
Down payment and rates may be lower.
Copyright© 2003 John Wiley and Sons, Inc.
Private Mortgage Insurance
Conventional mortgage borrowers with
low down payments must usually buy
private mortgage insurance (PMI).
PMI premiums are added to mortgage
payments until the value of the
mortgage is less than 75% of the value
of the house.
Copyright© 2003 John Wiley and Sons, Inc.
Private Mortgage Insurance
Uninsured conventional
mortgage
Equity
Uninsured
Mortgage
$25,000 down
payment
$100,000
mortgage at
10% APR.
Privately Insured
conventional mortgage
$12,500 down
Equity
payment
Insured Risk $12,500 mortgage
insurance
Uninsured
Mortgage
$112,500
mortgage at
10% plus
insurance
premium = 10¼
to 10½% APR
on $112,500
balance
Copyright© 2003 John Wiley and Sons, Inc.
Adjustable Rate Mortgage
(ARM)
Fixed-rate mortgages are not acceptable to
lenders in high inflation periods.
With adjustable rate contracts, borrowers'
costs vary with inflation and interest rate
levels.
Caps on ARM interest rates limit interest rate
risk to borrowers.
1 to 2 % cap per year.
5 % cap over the life of the loan.
Copyright© 2003 John Wiley and Sons, Inc.
Methods of Adjustment for
ARMs
Rate may vary in a prescribed range (caps) or
without limit.
Payments, maturity, or principal may vary.
Rates may vary based on a previously
determined interest rate index or the cost of
the funds of the lender.
The market prices (difference between fixed
and variable rates) the extent of interest rate
risk (impact of varying interest rates)
assumed by borrower and lender.
Copyright© 2003 John Wiley and Sons, Inc.
Other Mortgage Instruments
Began in high interest/inflation periods
Graduated Payment Mortgage (GPM) -Payments increase with income expectations.
Growing Equity Mortgage (GEM) -- Increasing
payments to pay off loan quickly.
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Other Mortgage Instruments
Reverse Annuity Mortgage (RAM) -- Borrower
receives monthly loan proceeds. Interest and
principal paid at time of sale of home.
Second Mortgage -- extended at time of
purchase or later as equity is borrowed from
property.
Home equity lines of credit became popular
after the 1986 federal tax law.
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Rate Difference Needed for
Borrowers to Take the Risk of
an Adjustable-Rate Mortgage
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Exhibit 9.4 Fixed and
Adjustable Mortgage Rates
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Mortgage-Backed Securities
One way to develop a secondary market for
mortgages
Mortgage pass-through securities pass
through payments of principal and interest on
pools of mortgages to holder of the
securities.
Other Mortgage backed securities use pools
of mortgages as collateral for debt securities.
Copyright© 2003 John Wiley and Sons, Inc.
Types of Pass-Through
Securities
Ginnie Mae Pass-Throughs - pools of
government insured mortgages.
Freddie Mac Participation Certification pools of conventional mortgages.
Freddie Mac Guaranteed Mortgage
Certificates - promises regular
repayment of principal and interest.
Copyright© 2003 John Wiley and Sons, Inc.
Types of Pass-Through
Securities (concluded)
Collateralized mortgage obligations (CMOs) -fixed maturity date and interest payments
similar to bonds.
REMICS -- real estate mortgage investment
conduit; Investor pays taxes. Type of CMO.
Fannie Mae pass-throughs - pools of
conventional or insured mortgages.
Privately issued pass-throughs (PIP).
Copyright© 2003 John Wiley and Sons, Inc.
Advantages of Mortgagebacked Securities over
Individual Mortgages
Issued in standardized denominations
and are negotiable.
Issued or backed by quality borrowers.
Usually insured and highly
collateralized.
Repayment schedules vary, but many
are similar to other bonds.
Copyright© 2003 John Wiley and Sons, Inc.
Participants in the Mortgage
Markets
Thrifts -- dominated and increased share of
market until 1970s.
Banks -- Increased share of market and
increased powers to make mortgage loans.
Insurance Companies and Pension Funds.
Pools -- Pass-through certificates have
become an important source of funds. Pools
represented the largest component of
mortgage investment in 2001.
Copyright© 2003 John Wiley and Sons, Inc.
Participants in the Mortgage
Markets (concluded)
Government Holdings -- All Levels of
Government
FNMA, FHLMC, Federal Land Banks (now Farm
Credit), Farmers Home Administration.
State and local housing authorities issue bonds
and buy subsidized, lower-rate mortgages, often
for first-time home-buyers.
Copyright© 2003 John Wiley and Sons, Inc.
Other Participants
Mortgage Insurers
Developed in 1930s to enhance acceptability of
mortgages and to encourage more risky low
equity/loan lending.
FHA insurance guaranteed payment to lender in
case of default.
VA guarantee (1944) for mortgage loans to
veterans.
Private mortgage insurance covered low down
payment conventional mortgages.
Mortgage insurance has enhanced the
development of secondary markets.
Copyright© 2003 John Wiley and Sons, Inc.
Other Participants (concluded)
Mortgage bankers originate mortgages,
sell them, and often service the
mortgage
Mortgage origination, servicing, and
funding are three separate components
bought and sold
Mortgage servicing very competitive—
economies of scale
Copyright© 2003 John Wiley and Sons, Inc.