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Residential Mortgage Characteristics
Calculate the monthly payment for a $330,000 home. The new owner has made a $70,000 down payment and plans to finance over 30 years at the current fixed rate of 7%. $330,000 – $70,000 = $260,000 PV (original investment of the financial institution) 30 x 12 = 360 N; 7/12 = I; Calculate PMT
interest rates rise in the market, lender’s cost of funds increases x No matching increase in fixed-rate mortgage return
q Borrowers
lock in their cost and have to refinance to benefit from lower market rates
Residential Mortgage Characteristics
s
Fixed monthly payment includes
q Interest
owed first q Balance to principal
Interest on the declining principal balance s Calculating monthly payment
CHAPTER
Mortgage Markets
Chapter Objectives
Describe characteristics of residential mortgages s Describe the common types of creative mortgage financing s Explain the role of the federal government in supporting the development of the secondary mortgage market s Relate the development and use of mortgagebacked securities
q Monthly
payments consist of interest and principal q During loan’s early years, most of the payment reflects interest
Creative Mortgage Financing
s
Graduated-payment mortgage (GPM)
Residential Mortgage Characteristics
Fixed-Rate vs. Adjustable Mortgages
s
Adjustable-rate mortgages
q
Rates and the size of payments can change
x x
Maximum allowable fluctuation over year and life of loan Upper and lower boundaries for rate changes
Mortgage Maturities
s
Trend shows increased popularity of 15-year loans
q Lender
has lower interest rate risk if the term or maturity of the loan is lower q Borrower saves on interest expense over loan’s life but monthly payments higher
s
q Origination,
servicing and funding are separate business activities and may be “unbundled” q Secondary market exists for loans
s
Securitization
q Pool
and repackage loans for resale q Allows resale of loans not easily sold on an individual basis
Commercial banks
q q
s
Savings institutions
q q
s
Life insurance companies
q q
Institutional Use of Mortgage Markets
s
Mortgage companies
q Originate
and quickly sell loans q Do not maintain large portfolios
Institutional Use of Mortgage Markets, December, 2002
s s
Federally related mortgage pools
q
37% of all mortgages, mostly residential Dominate commercial mortgage market Hold 23.3% of all mortgages Primarily residential mortgages Hold 10% of all mortgages Commercial mortgages Hold 3% of all mortgages
Government agencies including Fannie Mae and Freddie Mac s Brokerage firms s Investment banks s Finance companies
s
Valuation of Mortgages
s
Market price of mortgages is present value of cash flows
q
s
Shared-appreciation mortgage
q Below
market rate but lender shares in home’s price appreciation
Activities in the Mortgage Markets
How the secondary market facilitates mortgage activities s Selling loans
s
Residential Mortgage Characteristics
Insured vs. Conventional Mortgages
q Federal
and private insurance guarantees repayment in the event of borrower default q Limits on amounts, borrower requirements q Borrower pays insurance premiums q Federal insurers include Federal Housing Administration and Veterans Administration
q q
Lenders stabilize profits as yields move with cost of funds Uncertainty for borrowers whose mortgage payments can change over time
Residential Mortgage Characteristics
Creative Mortgage Financing
s
Second mortgage used in conjunction with first or primary mortgage
Shorter maturity typically for 2nd mortgage q 1st mortgage paid first if default occurs so 2nd mortgage has a higher rate q If used by sellers, makes a home with an assumable loan more affordable
PM =
Where:
n
∑
t =1
C + PRIN t (1 + k )
q Small
initial payments q Payments increase over time then level off q Assumes income of borrower grows
s
Growing-equity mortgage
q Like
GPM low initial payments q Unlike GPM, payments never level off
Activities in the Mortgage Markets
s
Unbundling of mortgage activities provides for specialization in:
q Loan
origination q Loan servicing q Loan funding q Any combination of the above
Residential Mortgage Characteristics
Fixed Rate vs. AdjustablLeabharlann Baidu Mortgages
s
Fixed rate loans have a constant, unchanging rate
q Interest
x If
rate risk can hurt lender rate of return
s
q Principal
borrowed = PV q Number of months to maturity = years × 12 = N q Rate/12 = I q Calculate PMT
Residential Mortgage Characteristics
Calculate the monthly payment for a $330,000 home. The new owner has made a $70,000 down payment and plans to finance over 30 years at the current fixed rate of 7%.
Residential Mortgage Characteristics
Mortgage Maturities
s
Balloon payments
q Principal
not paid until maturity q Forces refinancing at maturity
s
Amortizing mortgages
Residential Mortgage Characteristics
Calculate the monthly payment for a $330,000 new home. The new owner has made a $70,000 down payment and plans to finance for 30 years at the current fixed rate of 7%. $330,000 – $70,000 = $260,000 PV (original investment of the financial institution) 30 × 12 = 360 N; 7/12 = I; Calculate PMT PMT = $1,729.79
