Transcript Introduction to Bond Markets, Analysis, and Strategies

Residential Mortgage Loans
Chapter 10
Mortgage Market

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
credit of borrower and on collateral for mortgage
mortgage insurance




FHA
VA
FmHA
private
Mortgage Market

participants

mortgage originators – original lender




thrifts
mortgage bankers
commercial banks
sources of profit to originators




origination fee – specified in points (1% of borrowed)
secondary marketing profit – selling loan for more than
original cost
mortgage servicers
mortgage insurers
Mortgage Market

origination
 PTI (payment-to-income) ratio


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




monthly payments to monthly income – lower ratio, greater likelihood
applicant can meet payments
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

sources of revenue from mortgage servicing:




servicing fee
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
Mortgage Market

types of mortgage-related insurance


PMI
credit life


not required by lender
provides for continuation of payments after death of
insured person
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
M onth
B alance
M onthly P m t
Interest
P rin. R ed. E nding B al
1
100,000.00
742.5
677.08
65.41
99,934.59
2
99,934.59
742.5
676.64
65.86
99,868.73
3
99,868.73
742.5
676.19
66.3
99,802.43
4
99,802.43
742.5
675.75
66.75
99,735.68
25
98,301.53
742.5
665.58
76.91
98,224.62
26
98,224.62
742.5
665.06
77.43
98,147.19
27
98,147.19
742.5
664.54
77.96
98,069.23
74
93,849.98
742.5
635.44
107.05
93,742.93
75
93,742.93
742.5
634.72
107.78
93,635.15
76
93,635.15
742.5
633.99
108.51
93,526.64
141
84,811.77
742.5
574.25
168.25
84,643.52
142
84,643.52
742.5
573.11
169.39
84,474.13
143
84,474.13
742.5
571.96
170.54
84,303.59
184
76,446.29
742.5
517.61
224.89
76,221.40
185
76,221.40
742.5
516.08
226.41
75,994.99
186
75,994.99
742.5
514.55
227.95
75,767.04
233
63,430.19
742.5
429.48
313.02
63,117.17
234
63,117.17
742.5
427.36
315.14
62,802.03
235
62,802.03
742.5
425.22
317.28
62,484.75
289
42,200.92
742.5
285.74
456.76
41,744.15
290
41,744.15
742.5
282.64
459.85
41,284.30
291
41,284.30
742.5
279.53
462.97
40,821.33
321
25,941.42
742.5
175.65
566.85
25,374.57
322
25,374.57
742.5
171.81
570.69
24,803.88
323
24,803.88
742.5
167.94
574.55
24,229.32
358
2,197.66
742.5
14.88
727.62
1,470.05
359
1,470.05
742.5
9.95
732.54
737.5
360
737.5
742.5
4.99
737.5
0
Monthly Mortgage Payment

where




MP = monthly mortgage
payment
n = # of months
MB0 = original balance
t = simple monthly note
rate
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
lifetime rate caps and floors
hybrid ARM
 rate fixed for period and then floats 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
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