1. Residential Mortgage Loans
Chapter 10

2. 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

3. 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

4. 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

5. 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)

6. 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

7. 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
interest for month 1 is $ and monthly payment is $ $65.41 to reduce principal

8. Amortization Schedule

9. 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

10. 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)

11. 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

12. 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

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

14. 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

15. 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