©2007, The McGraw-Hill Companies, All Rights Reserved 7-1 McGraw-Hill/Irwin Chapter Seven Mortgage Markets

©2007, The McGraw-Hill Companies, All Rights Reserved 7-2 McGraw-Hill/Irwin Mortgages and Mortgage-Backed Securities Mortgages are loans to individuals or businesses to purchase a home, land, or other real property Many mortgages are securitized –mortgages are packaged and sold as assets backing a publicly traded or privately held debt instrument Four basic categories of mortgages issued Mortgages are loans to individuals or businesses to purchase a home, land, or other real property Many mortgages are securitized –mortgages are packaged and sold as assets backing a publicly traded or privately held debt instrument Four basic categories of mortgages issued

©2007, The McGraw-Hill Companies, All Rights Reserved 7-3 McGraw-Hill/Irwin Mortgage Loans Outstanding, 2004 ($Bn)

©2007, The McGraw-Hill Companies, All Rights Reserved 7-4 McGraw-Hill/Irwin Mortgage Characteristics Lien Down payment Private mortgage insurance Federally insured mortgages Conventional mortgages Amortized Balloon payment mortgages Lien Down payment Private mortgage insurance Federally insured mortgages Conventional mortgages Amortized Balloon payment mortgages (continued)

©2007, The McGraw-Hill Companies, All Rights Reserved 7-5 McGraw-Hill/Irwin Fixed-rate mortgage Adjustable-rate mortgage Discount points Amortization schedule Fixed-rate mortgage Adjustable-rate mortgage Discount points Amortization schedule

©2007, The McGraw-Hill Companies, All Rights Reserved 7-6 McGraw-Hill/Irwin Calculation of Monthly Mortgage Payments PV = PMT(PVIFA r,t ) Where: PV = Principal amount borrowed through the mortgage PMT = Monthly mortgage payment PVIFA = Present value interest factor of an annuity r = interest rate, i, divided by 12 (months/year) t = number of months (payments) over life of the mortgage PV = PMT(PVIFA r,t ) Where: PV = Principal amount borrowed through the mortgage PMT = Monthly mortgage payment PVIFA = Present value interest factor of an annuity r = interest rate, i, divided by 12 (months/year) t = number of months (payments) over life of the mortgage

©2007, The McGraw-Hill Companies, All Rights Reserved 7-7 McGraw-Hill/Irwin Comparison of Monthly Mortgage Payments $150,000 home with 30-year mortgage at 8%, 0 points, 20% down $120,000 = PMT(PVIFA 8%/12, 30  12 ) PMT = $120,000/ = $ $150,000 home with 15-year mortgage at 8%, 0 points, 20% down $120,000 = PMT(PVIFA 8%/12, 15  12 ) PMT = $120,000/ = $ $150,000 home with 30-year mortgage at 8%, 0 points, 20% down $120,000 = PMT(PVIFA 8%/12, 30  12 ) PMT = $120,000/ = $ $150,000 home with 15-year mortgage at 8%, 0 points, 20% down $120,000 = PMT(PVIFA 8%/12, 15  12 ) PMT = $120,000/ = $

©2007, The McGraw-Hill Companies, All Rights Reserved 7-8 McGraw-Hill/Irwin Other Types of Mortgages Automatic rate-reduction mortgages Graduated-payment mortgages Growing-equity mortgages Second mortgages Home equity loan Shared-appreciation mortgage (SAM) Equity-participation mortgage Reverse-annuity mortgage Automatic rate-reduction mortgages Graduated-payment mortgages Growing-equity mortgages Second mortgages Home equity loan Shared-appreciation mortgage (SAM) Equity-participation mortgage Reverse-annuity mortgage

©2007, The McGraw-Hill Companies, All Rights Reserved 7-9 McGraw-Hill/Irwin Secondary Mortgage Market Advantages for FI to securitize –reduces liquidity risk, interest rate risk, and credit risk of FIs portfolio –FI retains income from origination fees and service fees FI’s remove mortgages from their balance sheet through one of two mechanisms –pool recently originated mortgages together and sell them in the secondary market –issue mortgage-backed securities that are backed by their newly originated mortgages Advantages for FI to securitize –reduces liquidity risk, interest rate risk, and credit risk of FIs portfolio –FI retains income from origination fees and service fees FI’s remove mortgages from their balance sheet through one of two mechanisms –pool recently originated mortgages together and sell them in the secondary market –issue mortgage-backed securities that are backed by their newly originated mortgages

©2007, The McGraw-Hill Companies, All Rights Reserved 7-10 McGraw-Hill/Irwin History of Secondary Mortgage Markets Federal National Mortgage Association (FNMA or “Fannie Mae”) created during the Great Depression FHA and VA insured loans also created during this time Government National Mortgage Association (GNMA or “Ginnie Mae”) and Federal Home Loan Mortgage Corp. (FHLMC or “Freddie Mac”) created during 1960’s Wide variety of mortgage-backed securities have been developed and in 1999, approximately 50% of mortgages are securitized Federal National Mortgage Association (FNMA or “Fannie Mae”) created during the Great Depression FHA and VA insured loans also created during this time Government National Mortgage Association (GNMA or “Ginnie Mae”) and Federal Home Loan Mortgage Corp. (FHLMC or “Freddie Mac”) created during 1960’s Wide variety of mortgage-backed securities have been developed and in 1999, approximately 50% of mortgages are securitized

©2007, The McGraw-Hill Companies, All Rights Reserved 7-11 McGraw-Hill/Irwin Mortgage Sales Mortgage sale Allow FIs to manage credit risk and achieve better asset diversification, improves their liquidity risk FIs are encouraged to sell loans for economic and regulatory reasons Major buyers of mortgage loans Major sellers of mortgage loans are money center banks, smaller banks, foreign banks, investment banks Mortgage sale Allow FIs to manage credit risk and achieve better asset diversification, improves their liquidity risk FIs are encouraged to sell loans for economic and regulatory reasons Major buyers of mortgage loans Major sellers of mortgage loans are money center banks, smaller banks, foreign banks, investment banks

©2007, The McGraw-Hill Companies, All Rights Reserved 7-12 McGraw-Hill/Irwin Securitization of Mortgages Pass-through mortgage securities Issued in standard denominations, usually $25,000 with increments of $5,000 beyond the minimum Three government owned or sponsored agencies involved - Ginnie Mae (GNMA), Fannie Mae (FNMA, and Freddie Mac (FHLMC) Pass-through mortgage securities Issued in standard denominations, usually $25,000 with increments of $5,000 beyond the minimum Three government owned or sponsored agencies involved - Ginnie Mae (GNMA), Fannie Mae (FNMA, and Freddie Mac (FHLMC)

©2007, The McGraw-Hill Companies, All Rights Reserved 7-13 McGraw-Hill/Irwin Government-Related Mortgage-Backed Pass-Through Securities Outstanding ($Bn)

©2007, The McGraw-Hill Companies, All Rights Reserved 7-14 McGraw-Hill/Irwin Collateralized Mortgage Obligations CMO - a mortgage-backed bond issued in multiple classes or tranches –tranches - a bond holder class associated with a CMO Created by packaging and securitizing whole mortgage loans or resecuritizing pass-through securities Attractive to secondary mortgage market investors because they can choose a particular CMO class that fits their maturity needs CMO - a mortgage-backed bond issued in multiple classes or tranches –tranches - a bond holder class associated with a CMO Created by packaging and securitizing whole mortgage loans or resecuritizing pass-through securities Attractive to secondary mortgage market investors because they can choose a particular CMO class that fits their maturity needs

©2007, The McGraw-Hill Companies, All Rights Reserved 7-15 McGraw-Hill/Irwin Mortgages Outstanding by Type of Holder(%), 2004

©2007, The McGraw-Hill Companies, All Rights Reserved 7-16 McGraw-Hill/Irwin One- to Four-Family Mortgage Originations, 2004

©2007, The McGraw-Hill Companies, All Rights Reserved 7-17 McGraw-Hill/Irwin Issuers of Ginnie Mae Securities, 2004