© 2011 Cengage Learning created by Dr. Richard S. Savich. California Real Estate Finance Bond, McKenzie, Fesler & Boone Ninth Edition Chapter 7 Points, Discounts, and the Secondary Mortgage Market

© 2011 Cengage Learning created by Dr. Richard S. Savich. Objectives After completing this chapter, you should be able to: Explain the difference between the terms points and discounts. Define the term premium, and contrast this to discount. Differentiate between secondary financing and secondary mortgage market. Describe the purpose of Fannie Mae and Freddie Mac. Explain how a Ginnie Mae mortgage-backed security works. Discuss the role of investment bankers in mortgage-backed securities and the secondary market.

© 2011 Cengage Learning created by Dr. Richard S. Savich. Outline Secondary Mortgage Market Points and Discounts

© 2011 Cengage Learning created by Dr. Richard S. Savich. Secondary Mortgage Market Buying and selling of existing loans Not seconds or thirds Mortgage bankers are intermediaries between primary and secondary markets Market shifts money between surplus areas and shortage areas Participation - Banks sometimes sell percentages of portfolios of loans Another bank buys 90% First bank continues to service loan Pays 90% of payments to other bank Use mortgage-backed securities Government National Mortgage Association (GNMA) Ginnie Mae Government agency Federal Home Loan Mortgage Corporation (FHLMA) Freddie Mac Quasi-government agency Federal National Mortgage Association (FNMA) Fannie Mae Former government agency, now private corporation Federal Agricultural Mortgage Corporation (FAMC) Farmer Mac Student Loan Marketing Association (SLMA) Sallie Mae Traded on Wall Street

© 2011 Cengage Learning created by Dr. Richard S. Savich.

Points and Discounts Point is 1% of the loan (not the sales price) Discount is amount lender deducts from the loan when proceeds are funded Premium - $100K loan sold for $102K AKA “service release premium” or “rebate pricing” Very rare Good Faith Estimate required beginning January 1, 2010

© 2011 Cengage Learning created by Dr. Richard S. Savich. Yield Yield = Effective Interest Rate = Annual Percentage Rate (APR) (Interest + Discount) / (Loan – Points*) * Also known as money disbursed

© 2011 Cengage Learning created by Dr. Richard S. Savich. Price and Yield Realtors to lenders Points and loan fees Lender to lender Price and discount Three point discount = price of 97% See Tables 7.1 and 7.2 for examples

© 2011 Cengage Learning created by Dr. Richard S. Savich. Where are Discounts Used? Junior mortgages (See Chapter 14) Seconds Thirds Sold at deep discounts See Table 7.3 for examples See Chapter 13 for calculator solutions

© 2011 Cengage Learning created by Dr. Richard S. Savich. Mortgage-Backed Securities Created to make investing in mortgages as simple as buying stocks or bonds As mortgages grew Fueled by sub-prime markets MBS changed to “mortgage swaps” Sold worldwide Supposedly Wall Street firms insured them When market collapsed Wall Street did not have reserves to cover losses Led to lack of liquidity Government bailout

© 2011 Cengage Learning created by Dr. Richard S. Savich. Ginnie Mae Government Agency Does not purchase mortgages Guarantees principal and interest Known as pass-through securities Only FHA and DVA loans in any combo See for more infowww.gnma.com

© 2011 Cengage Learning created by Dr. Richard S. Savich. Freddie Mac Handles conventional loans Subsidiary of the Office of Thrift Supervision Buys mortgages and sells them in the secondary market Securities are called Participating Certificates or Guaranteed Mortgage Certificates Guarantees full payment of principal and interest See for more infowww.fhlmc.com

© 2011 Cengage Learning created by Dr. Richard S. Savich. Fannie Mae Private Corporation Buys mortgages Places them in a pool Sells securities Guarantees principal and interest See for more infowww.fmna.com

© 2011 Cengage Learning created by Dr. Richard S. Savich.

Collateralized Mortgage Obligations (CMO) Issued by Fannie Mae Limit prepayment risk to investors Divided into three classes Investors can invest in any of three classes If borrower prepays loan Proceeds go into class one, until paid in full Then proceeds go into class two, etc.

© 2011 Cengage Learning created by Dr. Richard S. Savich. Nonconforming Loans Freddie Mac and Fannie Mae had $417,000 maximums for 2009 High Balance loans up to $729,750 were available in some areas Any amount above these limits are “Jumbo” loans But High Balance loan limits expire at end of 2010

© 2011 Cengage Learning created by Dr. Richard S. Savich. Investment Bankers Morgan Stanley merged with Goldman Sachs Lehman Brothers – Gone! Merrill Lynch merged with Bank of America They all created “swaps” that sold subprime loans that were thought to be backed But no reserves to cover them Government bailout

© 2011 Cengage Learning created by Dr. Richard S. Savich. Mortgage Revenue Bonds State of California Tax exempt Backed by mortgages

© 2011 Cengage Learning created by Dr. Richard S. Savich. Questions and Comments?