2.  Learning Objectives 
Identify how the residential mortgage market supplies credit for individuals and families to build and buy homes
Understand the problems faced by lenders in designing new home loan contracts that will protect them against inflation, economic recession, and other risks
Consider how federal government agencies and government-sponsored mortgage firms support the development of the market for mortgage loans

3. Introduction
Among the fastest growing of all financial markets today is the residential mortgage market, where individuals and families fund their purchases of homes.
Originally a simple market that was primarily local and regional in character, the residential mortgage market has become an international capital market where home-mortgage-related instruments are traded around the globe

4. Recent Trends in New Home Prices and the Terms of Mortgage Loans
Housing market is counter-cyclical:
Refinance homes
Use proceeds to increase spending
Lessen downturn severity
Conventional home mortgage loan:
Not guaranteed by the government:
Lender bears default risk
Often have private insurance
Secured loan
Also mortgages through government agencies

5. Recent Trends in New Home Prices and the Terms of Mortgage Loans
Relatively low home-mortgage loan rates:
Average rate is about 6% on conventional mortgages
About 2/3 of households own their own dwelling
Record-high home prices prior to the credit crisis of :
Average home price had more than doubled in the past two decades
Average maturity of a conventional home mortgage is now close to 29 years

6. Recent Trends in New Home Prices and the Terms of Mortgage Loans

7. Structure of the Mortgage Market
Residential mortgage:
Loans secured by single-family homes
Also includes other dwelling units
Nonresidential mortgage:
Loans secured by business and farm properties
Less than one-fifth of mortgages outstanding
Total value outstanding is approached $15 trillion

8. Structure of the Mortgage Market

9. Structure of the Mortgage Market

10. Mortgage Lending Institutions
Most mortgages generate multiple potential cash-flow streams:
Origination & commitment fees (when a mortgage loan is first applied for)
Periodic loan repayments & loan interest
Compensation for prepayment & default risks
Service fees associated with collecting & recording amounts owed
Net returns & fees from the securitization of a pool of mortgage loans

11. Mortgage Lending Institutions

12. Mortgage Lending Institutions
A mortgage loan may be:
Held in the originating lender’s portfolio:
Earns the promised payments
Sold to an investor:
At a discounted value
The originating lender may retain servicing rights
Packaged with other, similar mortgage loans:
Into a pool
The lender receives residual interest income (and servicing fees)

13. The Roles Played by Leading Financial Institutions
Savings and loan associations (S&Ls):
Predominantly local lenders
Often service the mortgage loans they made
Commercial banks rank first as lenders:
For purchases of homes, condominiums, and apartments
For commercial mortgages
Savings banks invest in:
Government-guaranteed loans
Conventional mortgage loans

14. The Roles Played by Leading Financial Institutions
Life insurance companies make substantial investments:
Commercial as well as residential mortgage properties
Both nationally and internationally
Moving more toward commercial and apartment mortgages with “equity kickers”
Mortgage banking houses:
Act as a channel for builders or contractors
Meet their working capital needs

15. Government Activity in the Mortgage Market
Major milestones include:
1932: Federal Home Loan Bank System:
Supervised thrifts
Extended loans to thrift institutions that were threatened with collapse by bank runs
Spurred more affordable mortgage loan rates
1934: National Housing Act, Federal Housing Administration (FHA):
The FHA was authorized to guarantee repayment of home loans up to some amount
Helped develop standardized mortgage loans

16. Government Activity in the Mortgage Market
1938: Federal National Mortgage Association (Fannie Mae):
Chartered for buying and selling FHA-guaranteed loans
Encouraged private lenders to make FHA loans
1944: Servicemen’s Readjustment Act, Veterans Administration (VA):
Designed to aid military personnel returning to civilian life
Offered to insure mortgages to lower rates
22-16

17. Government Activity in the Mortgage Market
1968: Government National Mortgage Association (Ginnie Mae):
Pass-through mortgages
Popular with investors
Safe, marketable securities with good returns
1970: Federal Home Loan Mortgage Corporation (Freddie Mac):
Mortgage participation certificates (PCs)
Guaranteed mortgage certificates (GMCs)
Collateralized mortgage obligations (CMOs)
And others including REMICs

18. Government Activity in the Mortgage Market
Development of various types of securitized mortgages:
Made mortgage securities more competitive with government and corporate securities
Allowed many mortgage lenders to expand into the national and international capital markets
New financial instruments have also increased the sensitivity of mortgage interest rates to national and international market conditions

19. Innovations in Mortgage Instruments
Fixed-rate mortgages have fluctuating value:
Fluctuates as interest rates change
Also bias toward refinancing rates when interest rates drop
Made banks very interest rate sensitive:
Many of their liabilities are interest-rate sensitive
Higher interest rates tend to increase liability payments while income is fairly fixed

20. Innovations in Mortgage Instruments
This problem with fixed-rate mortgages (FRMs) led to new developments:
Variable-rate mortgages (VRMs):
Permit the lender to vary the rate on a mortgage loan as market conditions change
Typically linked to a reference rate that is out of the direct control of the lender
Adjustable mortgage instruments (AMIs):
Maturity date may be altered
The interest rate and monthly payments may be altered as well

21. Innovations in Mortgage Instruments
Interest-only mortgages:
Offer borrowers the option of only paying the interest on their home mortgages
Doing so does not reduce the principle of the loan
Reverse-annuity mortgages (RAMs) have been developed to help older families:
Income to those who have paid off their mortgage
Paid a monthly annuity as a portion of the property value
Secured by an increasing mortgage

22. Innovations in Mortgage Instruments
Option adjustable-rate mortgages:
Designed to bring otherwise unaffordable home purchases within reach of more borrowers
Choose among different mortgage payment plans each month
There is a principal cap
Even with all the new mortgage instruments, fixed-rate mortgages (FRMs) continue to hold a major share of the residential loan market:
Primarily because consumers prefer transparency in financing

23. Pricing and Other Issues in Home Mortgage Lending
10-year U.S. Treasury bond rate is a key reference:
Used by many mortgage lenders
Determines the appropriate loan rate on new home loans
A comparison of recent 10-year T-bond yields to home mortgage contract rates:
Mortgage rates move closely with T-bond rates
Maintain a yield spread of about 1.5 to 2 percentage points between them

24. Pricing and Other Issues in Home Mortgage Lending

25. Mortgage Lock-Ins, Loan Modifications, and Foreclosures
Protect borrowers from an increase in loan rates during the house-buying process
Usually 30 to 60 days
Many lock-ins allow a ‘float down” option:
Costs extra
If rates fall before closing, the contractual mortgage rate will fall as well
Sometime the lender will “give a little” even without a float down
Bank does not want to lose customer

26. Mortgage Lock-Ins, Loan Modifications, and Foreclosures
Lender takes possession of home and sells it to recoup mortgage
Have increased greatly in number in the U.S. since the start of the credit crisis
Loan modification agreements:
Alternative to foreclosure
Aid troubled borrowers in avoiding foreclosure
Add missed payments to principal
Often stretch out payments

27. Refinancing Home Mortgages
Many homeowners choose to refinance:
Market interest rates fall
House values increase
The ability of a homeowner to refinance depends upon two factors:
A strong credit history
A significant amount of accumulated equity built up in the home to be refinanced
Refinancing also works to transfer the burden of the mortgage to a latter date

28. Predatory Lending
Some lenders appear to attempt to mislead and take advantage of borrowers:
High-cost loans (subprime loans)
Often their home are pledged as collateral
The exploited borrowers are typically poorly informed and less educated
The current debate on such predatory loans centers on two issues:
Distinguishing predatory from legitimate lending practices
Protecting the most vulnerable consumers

29. Markets on the Net
Federal National Mortgage Association at
Get Smart at
Government National Mortgage Association at
The Guardian at
Houses4sale-Online.com at
HSH Associates Financial Publishers at

30. Markets on the Net InvestorWords.com at www.investorwords.com
Lending Tree at
Mortgage Bankers Association at
Mortgage Professor’s Web Site at
MortgagesInCanada.com at
Federal Citizen Information Center at
CME Group at

31. Markets on the Net U.S. Census Bureau at www.census.gov
U.S. Department of Housing and Urban Development at
U.S. Department of Veterans Affairs at
Access Mortgage Research & Consulting at
Federal Deposit Insurance Corporation News at
Federal Home Loan Mortgage Corporation at

32. Chapter Review Introduction to the residential mortgage market
Recent trends in new home prices and the terms of mortgage loans
The structure of the mortgage market
Volume of mortgage loans
Residential versus nonresidential mortgage loans
Mortgage lending institutions

33. Chapter Review
The roles played by leading financial institutions in the mortgage market
Savings and loan associations
Commercial banks
Life insurance companies
Savings banks
Mortgage bankers

34. Chapter Review Government activity in the mortgage market
The impact of the Great Depression on government involvement in the mortgage market
Launching the Federal Home Loan Bank system
Setting up the Federal Housing and Veterans Administrations (FHA and VA)
The creation of Fannie Mae (FNMA)
The creation of Ginnie Mae (GNMA)
The Federal Home Loan Mortgage Corporation (FHLMC)

35. Chapter Review Innovations in mortgage instruments
Fixed-rate home mortgages
Variable-rate and adjustable mortgage instruments
Convertible mortgages
Interest-only mortgages
Reverse-annuity mortgages

36. Chapter Review Pricing and other issues in home mortgage lending
Pricing home mortgages and the treasury security market
Mortgage lock-ins, loan modifications, and foreclosures
Refinancing home mortgages
Predatory lending