1. Chapter 10 Residential Mortgage Types and Borrower Decisions
Real Estate
FIN 331
Fall 2017

2. Primary and Secondary Mortgage Markets
The primary mortgage market is the loan origination market
Numerous institutions supply capital to borrowers
Mortgage originators can either hold loans in their portfolios or sell them in the secondary mortgage market
The principal buyers in the secondary mortgage market are Fannie Mae and Freddie Mac

3. Prime Conventional Mortgage Loans
Fixed-rate level payment mortgage
Over 85% of loans in 2011 were conventional mortgages
Conventional mortgages typically require 20% down (0.80 loan to value)
Conforming conventional loan: meets requirements for purchase in secondary markets for Fannie Mae or Freddie Mac
Nonconforming Loans
Exceed loan limits (currently $417,000 for most areas of the continental US)
May require private mortgage insurance (PMI
Adjustable Rate Mortgages (ARM): rates reflect changes in lending rates over time

4. FHA Mortgages (Federal Housing Administration)
Primary Objective of 1949 Act: provide good housing
FHA is a loan insurance program
Loans made by private lenders
Mortgage payment includes insurance premiums (included in loan)
FHA insures 100% of loan and makes payments if borrower defaults
If foreclosed, title passes to HUD
Various types of mortgages covered by FHA programs
Veterans Administration has similar program

5. Other Mortgage Types
Purchase money mortgage: Mortgage given by a property buyer simultaneous with receipt of title
Among real estate brokers: refers to a second mortgage loan from a seller to reduce the buyer’s down payment (Amounts to installment payments with interest)
Among government agencies: any loan that finances a purchase
Piggyback loan:
A second mortgage paired with an underlying 1st mortgage
Keeps the 1st below 80 percent LTV, thus avoiding required mortgage insurance

6. Other Mortgage Types Home Equity Loans (HEL)
Some home equity loans are closed-end, fixed-term loans
Mostly open-end or line-of-credit loans (HELOC)
Interest is Tax deductible
Strength of the house as security provides favorable rate and longer term
Usually limited to total mortgage debt (sum of all mortgage loans) of 75% to 80% of value

7. Other Mortgage Types Reverse Mortgage
Many older households are income constrained
Over 80% own their home
Most have little or no mortgage debt
Most do not want to sell
Converts home equity into income
Owners not be forced to move except if owner fails to maintain insurance & taxes
Two major problems:
Owner may outlive cash flows
Loans may exceed value of home (if property values decline over time)

8. Other Mortgage Types Interest-Only: Sub-Prime Loans Alt-A Loans
No amortizing of principal.
Frequently involves a balloon payment
Sub-Prime Loans
Extending credit to high risk borrowers
High default rates due to poor or no creditworthiness background checks
Serious problems occurred for borrower when rates adjusted (always up)
Alt-A Loans
Minimal or no down payments
Very weak credit scores
Bank not required to verify information provided by borrowers
The “NINJA” loans

9. Loan Cost Measures Annual Percentage rate (APR)
APR converts regular interest expense and up-front loan fees into a single equivalent interest expense
APR is far superior to interest rate alone in comparing the cost of loans
APR has a bias for most applications:
APR assumes that up-front fees are spread over the full maturity of the loan
Since most loans are prepaid before maturity, APR will tend to understate the true cost of borrowing when up-front fees are charged
Final APR affected by prepayments

10. Loan Cost Measures Motives for Refinancing
Lowering loan costs (lower APR)
Reduce the term of the loan (30 to 20 or 15 year mortgage)
Lower total amount of interest paid
Net Benefit = Total Savings – Cost of Refinancing
Lower rate results in lower interest deduction – slightly higher tax due
Spread should be ~ 2%: Old – new: Recoup costs over 18 to 24 months

11. Homework Assignment
Key terms: Alt-A Loan, Conforming Conventional Loan, Conventional Mortgage, Fannie Mae, Freddie Mac, FHA, GSE, Home Equity Loan, Jumbo Loans, Primary Mortgage Market, Secondary Mortgage Market, Reverse Mortgage, Subprime Loan
Study questions: 1, 2, 3, 4, 6