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Chapter 11 Sources of Funds for Residential Mortgages REAL ESTATE FINANCE 331.

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Presentation on theme: "Chapter 11 Sources of Funds for Residential Mortgages REAL ESTATE FINANCE 331."— Presentation transcript:

1 Chapter 11 Sources of Funds for Residential Mortgages REAL ESTATE FINANCE 331

2 THE MARKET FOR HOME MORTGAGE LOANS A.Mortgage borrowers must compete to borrow funds in the credit markets B.Total mortgage debt at the end of 2013Q2 approached $ trillion C.There are four major types of mortgage debt (Board of Governors Fed. Res. Sys.) 2013Q2 nd/current.htm 1.Residential (1 to 4 family)$ 9,82276% 2.Multifamily apartments$ 885 7% 3.Commercial$ 2,14116% 4.Farm$ 167 1% $13,003100%

3 Mortgage Debt Outstanding

4 Thrifts (S&L, SB)

5 Evolution of Mortgage Finance A.Thrifts and Savings and Loans 1.Dominated mortgage lending: 46% or more y mid 1970s, 3.5% by 2013Q3 2.Extremely localized market 3.Fatal flaw: Funded long-term loans with short-term savings 4.Cocoon of regulations restricted ability to adapt to changing market conditions 5.Disintermediation in financial markets led to widespread Thrift/S&L failures B.Banking Deregulation and Consolidation 1.Effects of the Depository Institutions Deregulation and Monetary Control Act a.Money center banks begin to enter the mortgage business b.Many create mortgage banking subsidiaries

6 Evolution of Mortgage Finance

7 Pipeline Risk: Signature Risk of Mortgage Banking A.Pipeline risk: Risk between loan commitment and loan sale 1.Two components a.Fallout risk: Risk that loan applicant backs out b.Interest rate/price risk: Risk that closed loans will fall in value before sold 2.Mortgage bankers highly leveraged a.Very sensitive to pipeline risk b.Hedging necessary for survival B.Management Tools for Pipeline Risk 1.Good pipeline information 2.Forward commitment: Sale of loan at a preset price for future delivery a.Price set now b.Delivery and payment are, 60 to 90 days away c.Analogous to futures contract 3.Standby forward commitment: Optional forward sale a.Same as “forward commitment” except that mortgage banker has option to use or not b.More costly than forward commitment

8 SECONDARY MORTGAGE MARKET A.Mortgage-Backed Securities (MBS) 1.Multiple mortgage loans in a single pool or fund 2.Security entitles investor to pro rata share of all cash flows 3.Loans in a given pool will be similar: a.FHA/VA; conventional b.Same vintage (new or recent loans) c.Similar interest rates 4.Nearly two-thirds of all new home loans have been securitized in recent years B.Fannie Mae (Federal National Mortgage Association, 1938) 1.Secondary market for FHA/VA 2.Funded through both debt issues and mortgage securitization 3.Has securitized and sold, or owns, about 23% of outstanding home loans 4.Taken into conservatorship by U.S. in 2008

9 SECONDARY MORTGAGE MARKET C.Ginnie Mae (Government National Mortgage Association, 1968) 1.Created first major pass-through MBS program 2.Does not buy mortgages 3.Guarantees timely payment of interest and principal to holders of GNMA securities 4.Guarantees only securities based on FHA/VA loans D.Freddie Mac (Federal Home Loan Mortgage Corporation, 1970) 1.Chartered by Congress to expand secondary market for mortgages 2.Deals exclusively in conventional loans 3.Securitized all loans purchased until recent years 4.Financially similar to Fannie Mae 5.Has securitized and sold, or owns, about 15% of outstanding home loans 6.Taken into conservatorship by U.S. in 2008

10 SECONDARY MORTGAGE MARKET E. Importance of Fannie Mae and Freddie Mac 1.Have brought about standardization in: a.Mortgages and mortgage notes b.Appraisal forms and practices c.Underwriting procedures and standards d.Also, influence practices and standards in nonconforming mortgage markets 2.Have increased liquidity of mortgage markets a.No interstate differentials in mortgage interest rates b.No home lending disruptions when interest rates rise c.New sources of mortgage funds in security investors 3.Heavily influence what type loans lenders make

11 SECONDARY MORTGAGE MARKET F. Major Problems with Fannie and Freddie 1.Not capitalized to withstand declining home values 2.Said to wield too much political influence 3.Said to unsuccessfully mix private enterprise with housing subsidy programs 4.Said to divert the benefits of their efficiency advantage into the pockets of their management 5.Said to be unnecessary in a financial world now dominated by a few giant banks 6.Said to be part of an unnecessary mortgage lending system – for the level-payment fixed rate mortgage

12 SECONDARY MORTGAGE MARKET G. Private Mortgage Conduits 1.Primarily a conduit for jumbo (nonconforming) loans 2.Briefly active in sub-prime loan market H.US Mortgage System basically has 4 Channels 1.Local depository lending (very limited) 2.FHA/VA – GNMA securitization process 3.Conforming conventional – GSE process 4.Non-conforming conventional – private security process

13 Lenders’ Underwriting Decisions A.Underwriting: Process of determining whether the risks of a loan are acceptable B.Three “Cs” of traditional underwriting: 1.Collateral: importance of Uniform Residential Appraisal Report (URAR) 2.Creditworthiness: Credit report – FICO score 3.Capacity: Ability to pay (payment ratios)

14 Lenders’ Underwriting Decisions

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16 D.Recent Underwriting Failures 1.Problems were due not adhering to procedures and standards described above a.Half of sub-prime loans had limited documentation b.Most of Alt-A loans had limited or no documentation (Came to be called “liar loans”) c.Private securitization firms widely suppressed loan underwriting 2.Underwriting focuses on comparative risk among borrowers 3.Recent regulatory proposals by Fed and 5 other Agencies to create QRM (Qualified Residential Mortgage, 2013) a.Calls for lenders to keep a 5% stake in the credit risk for certain securitized loans that don’t meet “qualified residential mortgage” standards. b.Designed to be particularly safe by making sure that borrowers can afford their mortgages. c.Lower retention standards for Fannie (2.44%) and Freddie (2.68%)

17 EMERGING MORTGAGE CLASSIFICATIONS A.Qualified Mortgage (QM) 1.Fully amortizing (generally) 2.No longer than 30 years 3.Fees of no more that 3 percent (generally) 4.Debt-to-income ratio no more than 43 percent 5.Strong verification of borrower income and assets 6.If ARM, must underwrite to highest possible rate in first five years 7.Gives lender legal advantage in case of default

18 HOMEWORK ASSIGNMENT A.Key terms: Collateral, Credit Scoring, Disintermediation, Housing Expense ratio, Interest rate Risk, Loan Underwriting, Pipeline Risk, Qualified Mortgage, Total Debt Ratio B.Study Questions: 1, 2, 4, 9 (all parts)


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