7-1

Chapter Seven

Mortgage Markets

7-2

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

7-3

Mortgage Loans Outstanding, 2004 ($Bn)

$7,771

$1,635

$582 $141

family commercial multifamily farm

$7,771

$1,635

$582 $141

family commercial multifamily farm

7-4

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)

7-5

• Fixed-rate mortgage

• Adjustable-rate mortgage

• Discount points

• Amortization schedule

• Fixed-rate mortgage

• Adjustable-rate mortgage

• Discount points

• Amortization schedule

7-6

Calculation of Monthly Mortgage Payments

PV = PMT(PVIFA r,t )

Where:

PV = Principal amount borrowed through the mortgage PMT = Monthly mortgage paymentPVIFA = 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 paymentPVIFA = 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

7-7

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 = $120,000/136.2835 = $880.52

$150,000 home with 15-year mortgage at 8%, 0 points, 20% down

$120,000 = PMT(PVIFA 8%/12, 15 12 )

PMT = $120,000/104.6406 = $1146.78

$150,000 home with 30-year mortgage at 8%, 0 points, 20% down $120,000 = PMT(PVIFA 8%/12, 30 12 )

PMT = $120,000/136.2835 = $880.52

$150,000 home with 15-year mortgage at 8%, 0 points, 20% down

$120,000 = PMT(PVIFA 8%/12, 15 12 )

PMT = $120,000/104.6406 = $1146.78

7-8

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

7-9

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

7-10

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

7-11

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

7-12

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)

7-13

Government-Related Mortgage-Backed Pass-Through Securities Outstanding ($Bn)

0

500

1000

1500

2000

1995 1998 2000 2004

GNMA FNMA FHLMC Private Mortgages

0

500

1000

1500

2000

1995 1998 2000 2004

GNMA FNMA FHLMC Private Mortgages

7-14

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

7-15

Mortgages Outstanding by Type of Holder(%), 2004

36.88

0.32 4.393.37

2.62

52.42

Mortgage Pools

DepositoryInstitutions

Life InsuranceCompanies

Other FinancialInstitutions

MortgageCompanies

Other

36.88

0.32 4.393.37

2.62

52.42

Mortgage Pools

DepositoryInstitutions

Life InsuranceCompanies

Other FinancialInstitutions

MortgageCompanies

Other

7-16

One- to Four-Family Mortgage Originations, 2004

26.70

17.50

27.50

28.30 MortgageCompanies

Commercial Banks

Thrifts

Other

26.70

17.50

27.50

28.30 MortgageCompanies

Commercial Banks

Thrifts

Other

7-17

Issuers of Ginnie Mae Securities, 2004

9.10

31.10

9.50

50.30

MortgageCompanies

Commercial Banks

Thrifts

Other

9.10

31.10

9.50

50.30

MortgageCompanies

Commercial Banks

Thrifts

Other