REAL ESTATE FINANCE
Ninth Edition
John P. Wiedemer and J. Keith Baker
Chapter 3
Mortgage Money: Regulated Lenders
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LEARNING OBJECTIVES
At the conclusion of this chapter, students will be able to:
• Describe the mortgage credit market and its common sources of
funding.
• Differentiate between the primary and secondary mortgage markets.
• Understand the roles of the various regulated mortgage lenders and
their sources of funding.
• Explain the differences between mortgage lenders funded by FDICinsured deposits and those not funded by insured deposits.
• Understand the role of the federal regulation commonalities and the
evolution of government policies encouraging home ownership.
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Introduction
• Most of the money that funds mortgages comes from private sources.
• There is a common misconception that most funding for mortgages
came from the federal government.
• The federal government direct-loan programs are mostly directed
toward farmers.
• Most states and some cities have housing agencies that offer direct
loans and subsidy assistance, primarily for low-income home buyers.
• Federal government agencies offer loan guarantees rather than money.
• The federal underwriting agencies charge fees for their guarantees with
the expectation of making a profit and not burdening taxpayers.
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The Mortgage Credit Market
• In the credit market, the demand for mortgage money competes with all
other demand for borrowed funds.
• The mortgage share of this market normally commands 20% to 25% of
the total credit available each year.
• Total mortgage debt outstanding at the end of 2010 totaled almost $14
trillion, the second largest single class of debt in this country.
• Only the total U.S. federal debt exceeds this demand for credit.
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Analysis of Mortgage Debt
• The term mortgage debt includes all kinds of loans secured by
mortgages and all types of lenders handling these loans.
• Mortgage debt includes long-term residential, short-term construction
loans, and warehouse lines of credit used by mortgage companies.
• Residential loans dominate
the market with more than
three-fourths of the total
debt outstanding.
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Analysis of Loan Sources
• We must distinguish between those making mortgage loans and those
holding mortgage loans.
• Loan originators make the loans.
• Some originators hold these loans in portfolio.
• Most sell their loans to secondary market investors who hold them.
• Now the major source for residential loans is mortgage pools, which
serve as collateral for the issuance of mortgage-backed securities.
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The Mortgage Money Market
• The market for mortgage money functions at two separate levels:
- the loan origination market, called the primary market.
- the secondary market, consisting of investors who buy mortgages.
• For the borrower the source of funds is the primary market, where
many lending companies compete for business.
• The secondary market is where loan originators sell their loans, thus
recovering cash to originate more loans.
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The Primary Market
• The loan primary market is composed of borrowers and lenders.
• Negotiation involves a discussion of the interest rate and discount.
• The requirements for loan qualification depends on who the lender is
and whether or not the loan will be sold to secondary-market investors.
• Regulated lenders must adhere to the rules of their regulatory authority.
• Unregulated lenders are not as restricted.
• If a loan is intended for sale rather than to be held by the lender as its
own investment (held “in portfolio”), the loan must meet the secondarymarket purchaser’s requirements.
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Regulated Lenders
• Regulated lenders are subject to government regulatory agencies.
• About 75% of residential loans came from regulated lenders.
• Most regulated lenders retain the loan servicing function.
• The four major classes of regulated lenders are:
(1) savings institutions
(2) commercial banks
(3) credit unions
(4) life insurance companies
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Savings Institutions
• Include both savings associations and (mutual) savings banks, both
referred to as thrifts.
• Initially limited to holding only time deposits.
• A time deposit is one that does not permit withdrawal on demand, but
instead usually requires a waiting period of 14 to 30 days.
• This includes savings certificates and certificates of deposit as well as
all passbook savings accounts.
• This access to more stable time deposits has provided justification for
the practice of savings institutions making long-term mortgage loans.
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Savings Associations
• The original purpose of savings associations was to provide a source
of money for home loans.
• The Federal Home Loan Bank Board required all federal charters to
keep at least 80 percent of their deposit assets in residential loans.
• In 1980 Congress passed the Depository Institutions Deregulation and
Monetary Control Act. No longer were savings associations committed
to making mostly residential loans.
• In 1989 the Financial Institutions Reform, Recovery, and Enforcement
Act (FIRREA), overhauled banking practices with the primary goal of
restructuring the savings and loan association system.
• In 1996 Congress passed legislation that set the stage for elimination of
savings institutions, which would be re-chartered as banks.
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Savings Association Regulatory Authorities
Office of Thrift Supervision (OTS)
• The OTS is an arm of the Treasury Department under the Office of the
Comptroller of Currency.
• Its authority extended to both federal- and state-chartered institutions
that carried federal deposit insurance.
Federal Housing Finance Board (FHFB)
• The new Federal Housing Finance Board was assigned as overseer of
mortgage lending for the 12 regional Federal Home Loan Banks.
• In addition, the FHFB is responsible for handling statistical data for the
housing industry.
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Federal Deposit Insurance Corporation (FDIC)
• The FDIC has authority to manage both the bank deposit insurance
fund and the savings association insurance fund.
• In 2008 the basic limit on federal deposit insurance coverage was
raised from $100,000 to $250,000 per depositor.
• In 2010 the coverage became unlimited for noninterest-bearing
accounts until the end of 2013.
• This temporary unlimited coverage is separate from the coverage of at
least $250,000 available under FDIC’s general deposit insurance rules.
• “Noninterest-bearing transaction account” includes a checking
account or demand deposit account on which no interest is paid.
• It does not include checking or demand deposit accounts that may earn
interest, NOW accounts, and money-market deposit accounts.
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Resolution Trust Corporation (RTC)
• The RTC filled an important role in handling the liquidation of failed
savings associations in the late 1980s and into the mid 1990s.
• RTC was given authority to take the necessary steps to sell or liquidate
failing thrifts.
• The remaining problems of this agency were transferred to the FDIC in
July 1995 and the RTC was dissolved.
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Savings Banks
• Originated during the early years of the U.S. when most people traded
in cash and needed a place to deposit their surplus for safekeeping.
• Savings banks operated with good success in the northeastern part of
the country.
• Many savings banks favored FHA and VA loans.
• The 1980 Depository Institutions Deregulation Act altered the way the
banking system could serve the public.
• The result was that savings banks could offer services very similar to
those of commercial banks.
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Commercial Banks
• Originally served the business community and government.
• They provided checking accounts and transfers of money.
• States chartered their own banks and, prior to the Civil War, granted
commercial banks the authority to issue their own currency.
• In 1913 nationally chartered banks were brought under the Fed.
• The regulatory authority over commercial banks is a separate system
from those regulating savings associations and is also a dual system,
with both federal and state governments issuing charters and regs.
• FIRREA placed all depository institutions that carry federal deposit
insurance under federal regulation.
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Limits on Real Estate Loans
• There is no ceiling on one- to four-family loans except that loans over
80% of the market value must have private mortgage insurance.
• Certain loans are exempt from limits, such as those guaranteed by the
federal government; problem loans that must be renewed, refinanced, or
restructured; and loans to facilitate the sale of foreclosed properties.
• Other limits are:
Loan Category
Improved property
One to four family construction
Nonresidential construction
Land development
Raw land
Loan-to-Value
85%
85%
80%
75%
65%
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Investment Policies
• A banks’ lending policies favor short-term loans for business purposes.
• Banks have not been very active in the long-term home loan market.
• Some make mortgage loans through subsidiary mortgage companies.
• A commercial bank’s deposits are demand-type (checking accounts)
and banks are limited in allowing such money to fund long-term loans.
• This is changing through the ability of banks to originate long-term
residential loans and then fund them through the sale of securities.
• Shorter-term mortgage loans are more suited to commercial banks, as
are lines of credit for mortgage companies and construction loans.
• Banks may handle some medium-term mortgage loans as needed by
their business customers.
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Investment Policies
The four kinds of lending activities that can be found in a commercial
bank’s mortgage operations are as follows.
Direct loans. 10 to 15 year loans for good commercial customers.
Construction loans. Shorter-term, two- to three-year construction loans.
Warehouse lines of credit. A short-term revolving line of credit secured by
recently closed residential loans that allows mortgage bankers to fund
loans in their own names.
Loan origination. Banks can initially fund these loans with their own
deposit assets and then sell them to secondary-market investors.
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Regulation of Commercial Banks
• Banks can be chartered by states or the federal government.
• National charters must belong to the FDIC.
• State-chartered banks may join the FDIC system if they qualify and
accept federal regulations.
• Banks are also under the jurisdiction of the Federal Reserve.
• The Federal Reserve is responsible for setting reserve requirements
and monitors compliance with the Truth-in-Lending through its Reg Z.
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Credit Unions
• Credit unions may be chartered by any group of people who can show
a common bond.
• The bond has generally been that of a labor union, a company’s
employees, or a trade association.
• However, a recent interpretation of this rule allowed the American
Association of Retired Persons (AARP), which has some 28 million
members, to form a credit union.
• Credit unions pay no income taxes since they are classed as nonprofit
organizations.
• The larger unions do make long-term mortgage loans.
• These institutions have expanded the services to include safe deposit
boxes, credit cards, and money market accounts.
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Regulation of Credit Unions
• Credit unions can be either state or federally chartered.
• The National Credit Union Administration (NCUA) charters, regulates,
and supervises federal credit unions.
• State charters adhere to their own state rules and laws.
• The federally chartered National Credit Union Share Insurance Fund
covers deposits up to $250,000.
• Federal charters must offer this coverage and state charters that
qualify are eligible to join.
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Reserve Requirements for Depository Institutions
• Depository institutions are required to hold a certain percentage of
their deposits in reserve.
• State-chartered institutions followed state laws governing reserve
requirements, and national charters adhered to federal requirements.
• These regulations often differed on amount and if interest was allowed.
• The FED could alter reserve requirements for its own member banks,
but not for nonmember state charters.
• Consequently, the application of reserve requirements was not uniform.
• Members of the Fed can borrow from the Fed at the discount rate.
• But the money cannot be used for ordinary lending purposes.
• Many exceptions to this last guideline have been made
during the recent financial crisis.
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Deposit Insurance
• Savings associations, savings banks, commercial banks, and credit
unions are all classed as depository institutions.
• Governments treat this activity as a special kind of trust.
• The Great Depression of the 1930s destroyed depositor confidence.
• To restore trust the federal government created a deposit insurance
system.
• In 1934 Congress established the FDIC to insure deposits in banks.
• As well as FSLIC to insure deposits in savings associations.
• Later the National Credit Union Share Insurance Fund was set up to
insure credit union deposits.
• Life insurance companies are not considered depository
institutions and are not federally insured.
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Reorganization of Deposit Insurance Funds
• In 1989 a new Deposit Insurance Fund (DIF) was created.
• Under the DIF there are two separate insurance funds.
• The Savings Association Insurance Fund (SAIF), replaced FSLIC.
• The Bank Insurance Fund (BIF) is the old FDIC fund under a new name.
• In 1994, Congress prohibited the FDIC from reimbursing depositors for
accounts in excess of the $100,000 limit.
• In 2008 the limit was temporarily raised to $250,000 per depositor.
• Congress merged BIF and SAIF retaining the FDIC as administrator.
• In addition savings associations are re-charted as banks.
• This provision simplified some of the regulatory confusion.
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COMMUNITY REINVESTMENT ACT (CRA)
• Ensures depository institutions serve the needs of their communities.
• The act requires that each institution undertake four procedures:
1. Define the lender’s community.
2. List types of credit offered.
3. Post public notice and public comments.
4. Report on efforts to meet community needs.
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CRA Amended by FIRREA
• Sharpening the performance ratings for regulated institutions and
requiring public disclosure of what each is doing to meet local needs.
• Also amended the Home Mortgage Disclosure Act, expanding reporting
requirements to include all mortgage lenders, regulated & unregulated.
• The purpose is to encourage greater participation in buyer assistance
programs through increased publicity of lenders’ performance.
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CRA Grading of Regulated Lenders
CRA ratings be made public, evaluating how well the entity:
1. Knows the credit needs of its community.
2. Involves its board of directors in CRA programs.
3. Informs the community about its credit services.
4. Offers residential mortgages, housing rehab & small business loans
5. Participates in government insured/guaranteed/subsidized loans.
6. Distributes credit apps/approvals/rejections over geographic areas.
7. Avoids discrimination in its lending practices.
The CRA grading consists of four categories:
1) outstanding
2) satisfactory
3) needs to improve
4) substandard compliance
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Additional Federal Regulation of Home Mortgage Lending
• The Home Mortgage Disclosure Act requires financial institutions to
disclose the number and dollar amount of loans by geographic area.
• The 1992 Federal Housing Enterprises, Financial Safety, and
Soundness Act requires federal secondary-market agencies to
purchase at least 30% of their mortgages in central city areas.
• The Housing and Economic Recovery Act, or “HERA,” enacted in July
2008 authorized the FHA to guarantee up to $300 billion in new 30-year
fixed-rate mortgages for subprime borrowers if lenders write-down
principal loan balances to 90% of current appraisal value.
• It also gave states the authority to refinance subprime loans using
mortgage revenue bonds.
• HERA was passed with the intention of restoring confidence in Fannie
Mae and Freddie Mac but did not achieve this aim.
• Fannie Mae and Freddie Mac were put into conservatorship.
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Housing and Economic Recovery Act of 2008 FAQs
Q: How will the law help struggling homeowners keep their homes?
A: Through the Federal Housing Administration (FHA), an estimated
400,000 borrowers in danger of losing their homes will be able to
refinance into more affordable government-insured mortgages. The
program offers government insurance to lenders who voluntarily reduce
mortgages for at-risk homeowners to at least 90 percent of a property’s
current value.
Q: Who is eligible for the new program?
A: To be eligible to participate in this program, a borrower must:
• Have a loan on an owner-occupied principal residence; investors,
speculators, and borrowers who own second homes cannot
participate in this program
• Have a monthly mortgage payment greater than at least 31 percent
of the borrower’s total monthly income as of March 1, 2008
• Certify that he or she has not intentionally defaulted on an existing
mortgage and did not obtain the existing loan fraudulently
• Not have been convicted of fraud
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Life Insurance Companies
• Not considered depository institutions but are fully regulated by the
various states that charter them.
• The cash that life insurance companies hold are not subject to demand
withdrawal so life insurance companies have long favored the longterm nature of mortgage loans as investments.
• At one time life insurance companies and savings associations held
equal total investments in mortgage loans.
• But life insurance companies were not chartered for the purpose of
providing mortgage money.
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Investment Policies
• Although insurance companies invest most of their reserves in highgrade securities, they also make mortgage loans.
• Larger companies have confined their real estate activity to large
commercial ventures in which they acquire a participating interest.
• Smaller companies look upon individual home loans as good business
and a way to make contacts for the sale of life insurance.
• This kind of loan held in the insurance company’s own portfolio.
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Regulation of Life Insurance Companies
• All insurance companies are chartered and operate under state
regulatory authorities.
• State regulations usually set limits on the types of investment; the
percentage of total portfolio that may be kept in stock, bonds, or
mortgage loans; and the amount of liquidity that must be maintained.
• Most states establish limits on the maximum amount of any one loan
or for any one property.
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Questions for Discussion
1. How would you define the term primary mortgage market?
2. Identify the classes of regulated lenders.
3. How does the government intend to simplify the banking system?
4. What is the present status of federal deposit insurance?
5. Explain why the Federal Reserve Bank places reserve requirements on
depository institutions.
6. In what way has the Community Reinvestment Act affected the
operation of regulated institutions?
7. What is the general policy of life insurance companies toward mortgage
lending?
8. Identify the basic responsibility of each of the following four banking
regulators: the Federal Reserve Bank Board, the Office of Thrift
Supervision, the Comptroller of the Currency, and the Federal Deposit
Insurance Corporation.
9. What advantages do credit unions have that banks consider unfair?
10. Identify at least two kinds of shorter-term mortgage loans made by
commercial banks.
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