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					Chapter 12
The Mortgage Markets
Part A

Chapter Preview
Part of the American Dream is to own your own home. But the average price of a home is well over $140,000 (and quite a bit higher is some areas, like California). For most of us, home ownership would be impossible without borrowing most of the cost of a home.

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Chapter Preview
• In this chapter, we identify characteristics of typical residential mortgages and the usual term and types of mortgages available. We then review who provides and services the loans, along with the growth in the secondary mortgage market. Topics include:
– What Are Mortgages? – Characteristics of Residential Mortgages – Types of Mortgage Loans

– Mortgage-Lending Institutions
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Chapter Preview (cont.)
– Loan Servicing

– Secondary Mortgage Market
– Securitization of Mortgages – The Impact of Securitized Mortgages on the Mortgage Market

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What Are Mortgages?
• A long-term loan secured by real estate

• An amortized loan whereby a fixed payment pays both principal and interest each month

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What Are Mortgages?
• The next slide shows the total amount of mortgage debt outstanding in the U.S. during 2006. It further delineates by type of property.

• The table shows roughly $13 trillion outstanding. How does this compare to the value of all the stock on the NYSE?

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What Are Mortgages? Mortgage Loan Borrowers

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What Are Mortgages? History
• Mortgages were used in the 1880s, but massive defaults in the agricultural recession of 1890 made long-term mortgages difficult to attain.

• Until post-WWII, most mortgage loans were short-term balloon loans with maturities of five years or less.

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What Are Mortgages? History
• Balloon loans, however, caused problems during the depression. Typically, the lender renews the loan. But, with so many Americans out of work, lenders could not continue to extend credit. • As a part of the depression recovery program, the federal government assisted in creating the standard 30-year mortgage we know today.
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Characteristics of the Residential Mortgage • Mortgages can be roughly classified along the following three dimensions:
– Mortgage Interest Rates – Loan Terms – Mortgage Loan Amortization

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Characteristics of the Residential Mortgage: Mortgage Interest Rates • The stated rate on a mortgage loan is determined by three rates:
– Market Rates: general rates on Treasury bonds (short-term for arms, intermediateterm for fixed rate) – Term: longer-term mortgages have higher rates – Discount Points: a lower rates negotiated for cash upfront
A variety of fun mortgage calculators http://interest.com/calculators/index.shtml

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Characteristics of the Residential Mortgage: Mortgage Interest Rates • The next slide shows the relationship between mortgage rates and long-term treasury rates. As can be seen, mortgage rates are typically higher than Treasury rates, but the spread (difference) between the two varies considerably.

A variety of fun mortgage calculators http://interest.com/calculators/index.shtml

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Characteristics of the Residential Mortgage: Mortgage Interest Rates
From Text:

Current mortgage interest rates http://www.interest.com/

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10

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0

2 7 Yr CMT 30 Yr Mtg 10 Yr CMT

4

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Apr-71 Apr-73 Apr-75 Apr-77 Apr-79 Apr-81 Apr-83 Apr-85 Apr-87 Apr-89 Apr-91 Apr-93 Apr-95 Apr-97 Apr-99 Apr-01 Apr-03 Apr-05 Apr-07
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Mortgage Rates – More Meaningful Data

Apr-09

Mortgage Spread Vs 7 Yr CMT
30 YR Mtg - 7 Yr CMT Spread 5.00 4.50 4.00 3.50 3.00 2.50 2.00 1.50 1.00 0.50 0.00 30 YR Mtg - 7 Yr CMT Spread

Apr-71

Apr-74

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Apr-95

Apr-98

Apr-01

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Apr-07
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Characteristics of the Residential Mortgage: Loan Amortization Mortgage loans are amortized loans. This means that a fixed, level payment will pay interest due plus a portion of the principal each month. It is designed so that the balance on the mortgage will be zero when the last payment is made. The next table shows a typical amortization table for a 30-year mortgage at 8.5%.
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Characteristics of the Residential Mortgage: Loan Amortization Schedule

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Characteristics of the Residential Mortgage: Mortgage Interest Rates & Points

• A difficult decision when getting a mortgage is whether to pay points (cash) upfront in exchange for a lower interest rate on the mortgage. Suppose you had to choose between a 12% 30year mortgage or an 11.5% mortgage with 2 discount points. Which should you choose? Assume you wished to borrow $100,000.

A variety of fun mortgage calculators http://interest.com/calculators/index.shtml

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Characteristics of the Residential Mortgage: Mortgage Interest Rates & Points

First, examine the 12% mortgage. Using a financial calculator, the required payments is: n = 360, i = 1.0, PV = 100,000, Calculate the PMT. PMT = $1,028.61 You can do this in Excel: =PMT(rate,#periods,LoanAmount) =PMT(.12/12,360,100000)
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Characteristics of the Residential Mortgage: Mortgage Interest Rates & Points

Now, examine the 11.5% mortgage. Using a financial calculator, the required payments is: n = 360, i = 11.5/12, PV = 100,000, Calculate the PMT. PMT = $990.29

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Characteristics of the Residential Mortgage: Mortgage Interest Rates & Points

• So, paying the points will save you $38.32 each month. However, you have to pay $2,000 upfront. • You can see that the decision depends on how long you want to live in the house, keeping the same mortgage.

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Characteristics of the Residential Mortgage: Mortgage Interest Rates & Points

• If you only want to live there 12 months, clearly the $2,000 upfront cost is not worth the monthly savings. • Let’s see how to determine the answer (according to the text).

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Characteristics of the Residential Mortgage: Mortgage Interest Rates & Points

You need to determine when the present value of the savings ($38.32) equals the $2,000 upfront. Using a financial calculator, this is: i = 1, PV = -2,000, PMT = 38.32 Calculate n. n = 74 months, or about 6.2 years.

• THIS IS WRONG – We will calculate the real # in class using Excel
– The real answer is more like 5.6 years
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Characteristics of the Residential Mortgage: Mortgage Interest Rates & Points

So, if you think you will stay in the house and not refinance for at least 6.2 (5.6) years, paying the $2,000 for the lower payment is a sound financial decision.

Otherwise, you should accept the 12% loan.

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Characteristics of the Residential Mortgage: Loan Terms
Mortgage loan contracts contain many legal terms that need to be understood. Most protect the lender from financial loss.
• Collateral: usually the real estate being finance • Down payment: a portion of the purchase price paid by the borrower • Term (maturity) • Rate (and rate adjustments for ARMs)
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Qualifying for a Mortgage
• LTV – loan to value

• PTI – payments to Income or “loan payments coverage”
• Certain aspects of credit history considered • PMI: insurance against default by the borrower for high LTV loans

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Conforming versus Non-Conforming Mortgages

• Conforming mortgages meet agency underwriting standards.
– Maximum PTI – Maximum LTV – Maximum loan amount ($417,000)

• Nonconforming mortgages do not meet agency underwriting standards.
– Can be held as portfolio investment – Can be securitized
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Characteristics of the Residential Mortgage: Loan Terms Lenders will also order a credit report from one of the credit reporting agencies. • The score reported is called the FICO. • The range is 300 to 850, with 660 to 720 being average. • Payment history, debt, and even credit card applications can affect your credit score.
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Types of Mortgage Loans
• Insured (guaranteed) vs. Conventional (Conforming) Mortgages: if the down payment is less than 20%, insurance is usually required

• Fixed-Rate Mortgages: the interest rate is fixed for the life of the mortgage
• Adjustable-Rate Mortgages: the interest rate can fluctuate within certain parameters
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Types of Mortgage Loans
• Other Types
– – – – – – Graduated-Payment Mortgages (GPMs) Growing Equity Mortgages (GEMs) Shared-Appreciation Mortgages (SAMs) Equity Participation Mortgages Second Mortgages Reverse Annuity Mortgages (RAMs)

• The following table lists additional characteristics on all the loans.
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Types of Mortgage Loans

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