Residential Mortgage Loans Chapter 10

Mortgage Market pg 226 loan secured by collateral of specified real estate property which obliges borrower to make predetermined series of payments lender has right of foreclosure if borrower defaults conventional mortgage – lender makes loan based on 1) credit of borrower and 2) collateral for the mortgage mortgage insurance FHA VA FmHA private FHA/VA/FmHA are all guaranteed by the gov’t MTG Insurance is paid to guarantor by originator – but passed along to borrower in form of higher rate

Mortgage Market participants mortgage originators – original lender thrifts mortgage bankers commercial banks 2 sources of profit to originators origination fee – specified in points (1% of borrowed funds) secondary marketing profit – selling loan for more than its original cost mortgage servicers mortgage insurers 2 main factors originators use to determine if loan can be made 1) PTI Ratio (payment to income) 2) LTV ratio (loan to value) How do mortgage servicers make $$ - see page 228 for 5 sources of revenue

Mortgage Market origination PTI (payment-to-income) ratio monthly payments to monthly income – lower ratio, greater likelihood applicant can meet payments LTV (loan-to-value) ratio ratio of amount of loan to market value of property – the lower the ratio, the more protection the lender has if default originators can hold mortgage in their portfolio sell mortgage to investor who wants to put in with pool of mortgages use mortgage themselves as collateral for issuance of security (securitization) conduit – when federally sponsored or private agency buy mortgages, pool, and sell to investors conforming mortgage vs. nonconforming mortgage

Mortgage Market pg 228 sources of revenue from mortgage servicing: servicing fee – primary source - % of mtg balance interest earned by servicer from escrow balance float earned on monthly mortgage payment ancillary income late fees commissions from cross-selling fees from selling mailing lists portfolio of borrowers is potential source for other loans (auto / credit cards)

Mortgage Market types of mortgage-related insurance PMI credit life not required by lender provides for continuation of payments after death of insured person PMI MTG Insurance is generally required for loans with LTV ratios greater than 80% - borrower pays for this Credit life – not required by lender – pays mtg upon death of borrower

Mortgage Loans Level-Payment Fixed-Rate Mortgage borrower pays interest and repays principal in equal installments over agreed-upon period of time – fully amortized over period example – 30 year $100,000 loan with 8.125% rate monthly interest rate is 0.0067708 interest for month 1 is $677.08 and monthly payment is $742.50 - $65.41 to reduce principal

Amortization Schedule

Monthly Mortgage Payment where MP = monthly mortgage payment n = # of months MB0 = original balance i = simple monthly note rate See page 232 for application of formula

ARMs mortgage where contract rate is reset periodically in accordance with reference rate reference rate categories market-determined rates (Treasury based) calculated rates based on cost of funds for thrifts (based on monthly weighted average interest costs for thrifts)

ARMs teaser rate usually offered periodic rate caps – can only go up certain amt per period lifetime rate caps and floors hybrid ARM rate fixed for period and then floats there-after 3/1 ARM means fixed for 3 years and then resets annually interest-only hybrid ARM reduce initial monthly payments – pmts first consist of only interest on loan with amortization of principal to start later balloon mortgage borrower given long-term financing but at set dates, contract rate is renegotiated Prepayment Penalty Mortgage lockout period during which prepayments are not permitted Reverse Mortgage for seniors who want to convert home equity into cash

Nonconforming Mortgages loan that does not satisfy one or more of underwriting standards of Fannie, Freddie, and Ginnie (amt of loan, credit worthiness, documentation of loan, purpose of loan) conventional nonconforming loan does not have any credit guarantee Jumbo loan – loan larger than conforming limit subprime – borrowers whose credit has been impaired Alt-a loan – loans to borrowers who have high credit scores but have variable incomes, are unable or unwilling to document stable income history, or are buying second homes or investment properties so reduced or alternate forms of documentation are used to qualify loans borrowers typically have excellent credit ratings High LTV loans – borrower with good credit quality has option of making a lesser or no down payment Why is there a limit on size of mtg to be “conforming”? Risk greater

Risks Associated with Investing in Mortgages credit risk liquidity risk interest rate risk prepayment risk

Credit Risk risk that borrower will default single mortgage credit risk is not as important if investing in pool of mortgages 10 of pool of 1,000 will default but which ones?? prime loan – 30 year FRM with 75% to 80% LTV ratio that is fully documented for the purchase of an owner-occupied single family detached home

Credit Risk factors associated with lower default rates LTV ratio – single most important determinant current LTV vs. original LTV mortgage term – credit risk is greater the longer the mortgage term (so 15 year < risk than 30 year) mortgage type – FRMs considered prime because everyone knows payment and amortization schedule transaction type – loans for purchases safer than those for cash-out refinancings documentation – income, employment, and asset verification occupancy status – less risk if borrower lives in home property type – single family detached homes least risky mortgage size/house price credit worthiness of borrower