Transcript Stone Arch Village

Fundamentals of Real Estate
Lecture 20
Spring, 2003
Copyright © Joseph A. Petry
www.cba.uiuc.edu/jpetry/Fin_264_sp03
Chapter 16: Sources of Funds for
Residential Mortgages
Market for Residential Financing
The residential (home) mortgage debt exceeds $4.6trl, and
represents 75% of total mortgage debt (‘99).
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US debt in 1999 was $5.6trn
US corporate bond debt was $2.0trn
US consumer debt was $1.3trn
Depository Lenders in the Primary Market
Depository lenders--S&Ls, savings banks, credit unions,
commercial banks—are financial intermediaries
because they bring together depositors and borrowers
A. Savings Institutions
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S&Ls were highly specialized home mortgage lending institutions, they
have evolved toward more general financial institutions.
Chapter 16: Sources of Funds for
Residential Mortgages
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In the late 1980s, S&Ls originated ~50% of all conventional mortgage
loans. By the early 1990s, this had fallen to about 25%.
The Financial Reform, Recovery, and Enforcement Act (FIRREA) was
passed in 1989 to cope with the massive losses and closure of S&Ls.
It affected aspects of mortgage lending, lender regulation, and real
estate appraiser licensing requirements.
Saving Banks used to have wider investment powers than S&Ls, but
now are indistinguishable from S&Ls.
Credit Unions charter restricts them to serving a group of people who
can show a common bond (such as employees of a corporation), but
have the same authority to make all kinds of loans.
B. Commercial Banks involvement in housing market
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Originate and sell home mortgage loans (have picked up the slack of
S&Ls in this area), buy mortgage backed securities, provide shortterm funds to mortgage banking companies, make short-term
construction loans.
Chapter 16: Sources of Funds for
Residential Mortgages
Non-depository Lenders in the Primary Market
A. Mortgage Bankers
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1.
Full service mortgage companies—processing, closing,
funding, servicing, and selling the loans they originate.
Increasingly displacing depository lenders as the dominant
source of home mortgage loans.
Loan commitments and funds
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2.
Servicing
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Primary source of funds are bank lines of credit
Lock-in period occurs once the lender commits to a specific rate
Includes collecting monthly payments and managing escrow
accounts. Most mortgage bankers reserve the right to provide this
service to the loan purchaser (for a fee of 0.25-0.5% of loan amnt)
Chapter 16: Sources of Funds for
Residential Mortgages
Non-depository Lenders in the Primary Market
3. Sales of mortgage loans
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Mortgage banks continually originate loans, take on short-term
loans to finance their commitment, sell the originated loans, pay
off the warehouse loans, and restart the process
If interest rates rise after they have made their loan commitment,
but prior to closing, they will have to sell the newly originated loan
at a discount
Forward commitments give mortgage bankers the right to sell a
pre-specified amount of a certain type of loan at a pre-specified
price to a secondary mortgage purchaser
Standby forward commitments give mortgage bankers the right,
but not the obligation, to sell a pre-specified dollar amount of a
certain loan type to the seller of the standby commitment
Chapter 16: Sources of Funds for
Residential Mortgages
Non-depository Lenders in the Primary Market
4. Sources of Revenues
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Mortgage bankers earn revenues from application fees, origination
fees, and servicing fees. Servicing fees have been the most
profitable aspect of the mortgage banking business.
B. Mortgage Brokers
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Serve as intermediaries between borrowers and lenders. They
receive compensation for finding low cost loans for borrowers,
or borrowers for lenders.
C. Other Nongovernment-sponsored Lenders
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As the secondary mortgage market has grown, a wide variety
of non-depository lending firms have entered the market
(GMAC, AT&T Capital, and some Wall Street Firms)
Chapter 16: Sources of Funds for
Residential Mortgages
Government Sponsored Mortgage Programs
A. FHA-Insured Loans
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FHA loans are made by private lenders
FHA insurance protects lenders from all losses experienced
after foreclosure and conveyance of title to HUD
FHA borrowers pay an up-front insurance premium equal to
2.20% of the loan amount, plus a monthly premium
FHA loan amounts are limited to a max of $115,200 to 208,800
depending upon the area
For properties costing < $50,000 or less, 3% downpayment is
required
For properties > $50,000, 3% is required for first 25,000, with
5% required for the remaining amount of property value
Chapter 16: Sources of Funds for
Residential Mortgages
Government Sponsored Mortgage Programs
B. VA-Guaranteed Loans
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VA loans are made by private lenders (available to US vets)
VA guarantees the lender against loss up to 100% of property’s
value
VA charges a fee depending upon the LTV (2.0% w/ no downpayment, 1.5% w/ 5-9.99% down, and 1.25% with a 10% or
higher down payment)
Funding fee can be financed
Closing costs cannot be included in the amount of the loan
Lenders cannot charge points; however, sellers may pay points
to help enable the veterans qualify
VA sets maximum loan limits
Chapter 16: Sources of Funds for
Residential Mortgages
Purchasers of Residential Mortgages in Secondary Mkt
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Fannie Mae, and Freddie Mac are largest purchasers of
residential mortgages in the secondary market
They are also the largest issuers of MBSs
A. Federal National Mortgage Association (FNMA), Fannie
Mae
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Originated in 1938 to provide secondary mkt for FHA, then VA
loans
Reorganized in 1968 into a semi-private corporation
Authorized to purchase conventional loans in 1970
Obtains funding from sale of its stock, its MBSs, bond
issuances and from its earnings
Mortgages and MBSs owned by Fannie Mae = 23% of res mkt
Chapter 16: Sources of Funds for
Residential Mortgages
Purchasers of Residential Mortgages in Secondary Mkt
B. Federal Home Loan Mortgage Association (FHLMC),
Freddie Mac
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Originally created in 1970 to provide secondary market for
savings and loan association products
Currently buys both government-underwritten and conventional
loans
Freddie Mac, and Fannie Mae now operationally similar
MBSs and mortgages of Freddie Mac = 17% of residential mkt
C. Importance of Fannie Mae, Freddie Mac
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2 of the country’s largest financial institutions
Forward commitments they make to buy conventional loans
Served to standardize loan docs, and underwriting procedures
Chapter 16: Sources of Funds for
Residential Mortgages
D. Government National Mortgage Association (GNMA),
Ginnie Mae
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Created in 1968, when Fannie Mae was reorganized
Guarantees timely payment of principal on MBSs (primarily
FHA and VA pools)
Does not buy and sell large numbers of mortgages
Purchases below-market mortgages, at par value, from
originating lenders. These mortgages generally designed by
the FHA for low- and moderate-income buyers
E. Life Insurance Companies
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One of the largest sources of funds for commercial mortgages,
almost non-existent in the home market (<1% of originations)
they do provide funds indirectly through purchase of MBSs
Chapter 16: Sources of Funds for
Residential Mortgages
F. Other Secondary Market Purchasers
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A variety of other government sponsored entities also active
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Farm credit system
Federal Agricultural Mortgage Corporation (Farmer Mac)
Farmers Home Administration (FmHA)
Financing Corporation (FICO)
Federal Financing Bank (FFB)
Chapter 16: Sources of Funds for
Residential Mortgages
The Lender’s Mortgage Loan Decisions
A. Underwriting Standards
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When making a mortgage loan, lenders face two types of risk
with respect to the borrower and collateral:
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The loan application process begins with the completion of an
application from and the payment of a mortgage application
fee.
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The borrower will be unwilling or unable to meet their debt
payment obligations
The value of the security for the loan (the home) is not adequate to
pay off the balance in the event of default or foreclosure
The application form asks the applicant for information regarding
the property, the borrower’s income and net worth, judgments and
credit references.
Chapter 16: Sources of Funds for
Residential Mortgages
The Lender’s Mortgage Loan Decisions
A. Underwriting Standards (cont’d)
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To judge the acceptability of the application, underwriters look
at:
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Security adequacy
Credit history
Employment outlook
Income adequacy, and
These items are frequently referred to as the three Cs
Collateral, credit, and capacity
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Chapter 16: Sources of Funds for
Residential Mortgages
The Lender’s Mortgage Loan Decisions
B. Affordability Ratios
1.
Conventional Loans
PITI*/Gross Income < = 28 percent
(PITI + Other Debt Obligations) / Gross Income < = 36 percent
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2.
FHA Loans
3.
PITI / Gross Income < = 29 percent
(PITI + Other Debt Obligations) / Gross Income < = 41 percent
VA Loans
The VA does not employ the front-end ratio when qualifying borrowers;
however, it uses the same back-end ratio as the FHA.
*Note: PITI=Principal, Interest, Taxes and Insurance
Chapter 16: Sources of Funds for
Residential Mortgages
The Lender’s Mortgage Loan Decisions
C.
The Effects of Federal Programs and Regulations
The Home Mortgage Disclosure Act (HMDA) of 1975 provides
disclosure of loan applications and approvals. This act serves to
discourage lenders from “redlining” certain neighborhoods.
The Community Reinvestment Act (CRA) of 1977 encourages
lenders to actively lend in their community and evaluate their
lending practices.
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