Mortgages and Capital Market Instruments

undefined
 
Chapter 7
 
Loans to individuals or businesses to
purchase a home, land or other real property.
Categories of mortgages
Home mortgages
Multifamily dwelling mortgages
Commercial mortgages
Farm mortgages
Capital market instruments
Contract between a financial institution and a
borrower
Contract specifies characteristics of the
mortgage agreement
When a FI receives mortgage application, it
must determine whether the applicant
qualifies for a loan
Backed by a specific property serves as a
collateral
FI will place 
lien
 against property until loan is
fully paid off
Nobody can buy the property and obtain a
clear title
Lien is a public record attached to the title of
the property with public recorder’s office that
gives the FI the right to sell the property if
the borrower defaults or falls into arrears
Mortgage borrower pays a portion of
purchase price of the property on the
day mortgage is closed.
Balance of the purchase price is the
face value of mortgage (Loan
proceeds)
Decreases default risk for the FI
How?
A mortgage borrower who makes a large
down payment invests more personal wealth
into the home
Less likely to default if the property value
falls
Value of the property is more than the
mortgage loan
Size of down payment depends on the
financial position of the borrower
Generally 20% is down payment
Loan to Value ratio may not be more than
80%
Borrowers who pay less than 20% purchase
private mortgage insurance
Purchased by the lender (FI) and paid by the
borrower as part of monthly payment
In the event of default, PMI issuer guarantees
to pay the FI the difference between value of
the property and the balance remaining on
the mortgage.
If the property value increases or mortgage is
paid PMI may be removed by the FI
Originated by FI
Repayment guaranteed (fee 0.5% of loan amount)
by Federal Housing Administration (FHA) or
Veterans Administration (VA)
Loan applicants to meet specific requirements set
by these govt. agencies
Available only to individuals from military
services
Maximum size of the mortgage is limited
depending on location and cost of living
Require either a very low (3%) or zero down
payment
Not federally insured
If down payment less than 20%, privately
insured
Secondary market mortgage buyers will not
buy conventional mortgages if
Loan-to-value ratio more than 80%
Not privately insured
Generally 15 or 30 years
15-year more popular
15-year mortgage offers potential savings in
interest paid
However, monthly payments are higher
Fixed principal and interest payments fully pay
off mortgage by its maturity date.
During the early years of mortgage, most of the
fixed monthly payment represents interest on the
outstanding principal and a small amount
represents payoff of the outstanding principal
As mortgage reaches maturity, most of the
payment represents payoff of the outstanding
principal and a small amount represents interest
Reduces default risk
Shows how the monthly mortgage payments
are split into principal and interest
Interest payment for 3 to 5 years
Full payment of mortgage principal at the end
of the period
Default risk is high
Most important characteristics
Mortgage borrowers choose how much to
borrow and from whom based on interest
rates
FIs base their quoted mortgage rates on
several factors
1. Market rates at which FIs borrow (rate on
certificate of deposit or Federal funds rate)
2. Rate on specific mortgage loan depends on
whether it is a fixed or variable rate of
interest or loan specifies discount points
Locks in interest rate, regardless of market
rate changes
Interest rate tied to some market rate
Required monthly payments can change over
the life of mortgage
Payment made when mortgage loan is issued
One discount point paid up front is equal to
1% of the principal
FI reduces interest rate in exchange of
discount point
Borrower weighs reduced interest payment
over the life of loan versus upfront payment
Decision depends on the period of time the
borrower expects to hold the mortgage
Borrower takes a new mortgage and uses the
proceeds to pay off the current mortgage
Done when interest rate falls
Decision involves balancing the savings of a
lower monthly payment against the costs
(fees) of refinancing
Thumb rule interest rate should fall by 2
percentage points of more
undefined
 
When prevailing rates fall, rate on an existing
mortgage lowers automatically
Unlike variable rate mortgages, in this
mortgage type interest rate only falls and
does not increase
This is to keep off from refinancing when
interest rates fall
Small payments early in the life of mortgage
Payments increase over first 5 to 10 years
Final payments level off at the end of the
mortgage
Used by borrowers who expect their income
to rise
Or quickly refinance
Default risk high
Initial payments same as conventional
Increase over a portion or entire life of the
mortgage
Increase in monthly payments reduces the
principal quickly and reduces the actual life of
mortgage
In contrast to Graduated payment mortgages,
which do not  affect the time until the
mortgage is paid off, in GEM incremental
increase in monthly payments reduces the
actual life of the mortgage
28
Dr. Lakshmi Kalyanaraman
Already a security in first mortgage
Loan is secured again
Should a default occur, the second mortgage
holder is paid only after the first mortgage is
paid off
Interest rates on second mortgages are
generally higher than the first mortgages
Second mortgage only from home equity built
Home equity loan – line of credit secured with
a second mortgage by customers
Home equity = current market value of the
home-outstanding mortgage balance
Mortgage interest at a rate less than the
current market rate in exchange for share in
property value appreciation
If property sold for more than the original
purchase price, 
FI shares the gain
31
Dr. Lakshmi Kalyanaraman
Similar to Share appreciation mortgage
Instead of FI, 
an outside investor share 
the
appreciation
The investor either provides a portion of the
down payment on the property or
Provides monthly payments
32
Dr. Lakshmi Kalyanaraman
Borrower receives regular monthly payments
from a FI
When RAM matures or borrower dies,
property is sold and debt retired
33
Dr. Lakshmi Kalyanaraman
 
After FIs originate mortgages, they
sell or securitize them in secondary
mortgage market.
Reduces liquidity risk, interest rate
risk and credit risk of their portfolios
34
Dr. Lakshmi Kalyanaraman
 
Liquidity Risk:
Depository institutions obtain majority
of their funds from short-term
deposits.
Mortgage maturities are of 15 or 30
years
35
Dr. Lakshmi Kalyanaraman
 
Interest Rate Risk:
Holding long-term fixed rate mortgages
subject them to interest rate risk, if interest
rates are expected to rise
36
Dr. Lakshmi Kalyanaraman
Credit Risk
: (Default Risk)
Since mortgage maturities are of 15 or 30
years, FIs face the risk that promised cash
flows from loans may not be paid in full
FIs prefer servicing mortgages rather than
long-term financing
Long-term financing mortgages are in
Balance sheet
Loan originator acts as Servicer
Servicer – collect payments from mortgage
borrowers and pass the required interest and
principal payments through to the secondary
market investor
Dr. Lakshmi Kalyanaraman
38
Servicer keeps formal records of mortgage
transaction
For the service, FI collects a monthly fee
Fee ranges from ¼ to ½ percent of the
mortgage balance
Dr. Lakshmi Kalyanaraman
39
FIs remove mortgages by
1. pooling all recently originated mortgages
together and sell them in the secondary
mortgage market
2. issuing mortgage backed securities i.e.
securitization of mortgages
Dr. Lakshmi Kalyanaraman
40
The U.S. government established the 
Federal
National Mortgage Association (FNMA or Fannie
Mae)
 
in the 1930s to buy mortgages from thrifts so
they could make more mortgage loans
FHA and VA insured loans make securitization
easier
Government National Mortgage Association (GNMA
or “Ginnie Mae”)
 and 
Federal Home Loan Mortgage
Corp. (FHLMC or “Freddie Mac”)
 
created in the
1960s
encouraged continued expansion of the housing market
provided direct and indirect guarantees that allow for the
creation of mortgage-backed securities
Dr. Lakshmi Kalyanaraman
41
FI originates a mortgage and sells to an
outside buyer
With recourse – loan buyer sells back the loan
back to the originator if it goes bad
contingent credit risk liability for the
originator
Without recourse – buyer bears credit risk
Dr. Lakshmi Kalyanaraman
42
FI sells loans to manage their credit risk better
Removes assets (and credit risk) from the balance
sheet
Allows FI to achieve better asset diversification
Allows FI to better manage interest rate risk and
liquidity risk
Generates fee income
Reduces the cost of reserve requirement
Reduces the cost of holding capital requirements
against mortgages
Domestic banks
Foreign banks
Insurance companies
Pension funds
Closed-end bank loan mutual funds
Nonfinancial corporations
Dr. Lakshmi Kalyanaraman
44
Money center banks
Small regional or community banks
Foreign banks
Investment banks
Dr. Lakshmi Kalyanaraman
45
1. Pass-through security
2. Collateralized Mortgage Obligations (CMO)
3. Mortgage Backed Bonds
Dr. Lakshmi Kalyanaraman
46
Pass through securities and Collateralized
Mortgage Obligations (CMO) are securitized
mortgages.
Securitization of mortgages involves 
pooling of a
group of mortgages
 with similar characteristics
Removal
 of these mortgages 
from Balance sheet
Subsequent sale 
of interests in the mortgage
pool to secondary market investors
Securitization results in the creation of mortgage
backed securities, 
traded in the secondary
markets
FIs asset portfolios more liquid
Reduces interest rate risk and credit risk
Source of fee income
Reduces the effect of regulatory constraints
such as capital requirement
48
Dr. Lakshmi Kalyanaraman
FIs pool mortgages and offer interest in the
pool in the form of pass-through certificates
Each pass through security represents
fractional ownership in mortgage pool
Dr. Lakshmi Kalyanaraman
49
1% share of a pass-through mortgage
security issue is entitled to a 1% share of the
principal and interest payments made over
the life of the mortgages underlying the pool
of securities
Pass through promised payments of principal
and interest on pools of mortgages to
secondary market investors
No guaranteed annual coupon
Dr. Lakshmi Kalyanaraman
50
Originating FI or third party servicer takes a
fee
Dr. Lakshmi Kalyanaraman
51
Three agencies are directly involved in the
creation of pass-through securities
Ginnie Mae
Fannie Mae
Freddie Mac
Private mortgage pass-through issuers
create pass-through from nonconforming
mortgages (mortgages that exceed the size
limit set by government agencies)
Dr. Lakshmi Kalyanaraman
52
Multiclass pass-through with multiple bond holder
classes or 
tranches
Pass through a pro-rata of mortgage pool but CMO
multi-class pass-through with a number of
different bond holder classes or tranches
Pass-through no guaranteed coupon, but CMO,
each class has a different guaranteed coupon
Mortgage prepayments retire only one tranche at a
time, so all other trances are sequentially
prepayment protected
Dr. Lakshmi Kalyanaraman
53
MBBs allow FIs to raise long-term low-cost funds
without removing mortgages from their balance
sheets
Group of mortgage is pledged as collateral
against MBB
MBB issues have excess collateral
Pass-through and CMO are securitization, while
MBB is collateralization
Pass-through and CMO remove mortgage from
Balance sheet, MBB does not
a group of mortgage assets is pledged as
collateral against a MBB issue, but there is no
direct link between the cash flows of the
mortgages and the cash flows on the MBB
Dr. Lakshmi Kalyanaraman
54
Slide Note
Embed
Share

Mortgages play a crucial role in lending for real estate properties, classified into categories such as home, commercial, and farm mortgages. They can be backed by specific property, offering security to lenders in case of defaults. On the other hand, capital market instruments involve contracts between financial institutions and borrowers, specifying mortgage agreement details and assessing loan eligibility. Understanding these concepts is essential for navigating the world of borrowing and investments in real estate and financial markets.


Uploaded on Oct 08, 2024 | 0 Views


Download Presentation

Please find below an Image/Link to download the presentation.

The content on the website is provided AS IS for your information and personal use only. It may not be sold, licensed, or shared on other websites without obtaining consent from the author. Download presentation by click this link. If you encounter any issues during the download, it is possible that the publisher has removed the file from their server.

E N D

Presentation Transcript


  1. Chapter 7

  2. Loans to individuals or businesses to purchase a home, land or other real property. Categories of mortgages Home mortgages Multifamily dwelling mortgages Commercial mortgages Farm mortgages

  3. Mortgages Backed by specific piece of real property. If borrower defaults, FI can take ownership of property Mortgages Stocks and bonds Give a general claim on borrowers assets Only mortgage bonds are backed by a specific piece of property that allows the lender to take ownership in the event of a default. Stocks and bonds

  4. Mortgages Primary mortgages have no set size or denomination. Size of each mortgage depends on the borrower s needs and ability to repay Mortgages Stocks and bonds Bonds denomination $1,000 or multiple of $1,000 per bonds Shares of stock $1 per share Stocks and bonds

  5. Mortgages Primary mortgages generally involve only a single investor Mortgages Stocks and bonds Bonds and stock issues by many investors Stocks and bonds

  6. Mortgages Comparatively little information exists on mortgage borrowers, since borrowers are individuals Mortgages Stocks and bonds Bonds and stocks are issued by publicly traded corporations, hence subject to extensive rules and regulations Hence information is available Stocks and bonds

  7. Capital market instruments Contract between a financial institution and a borrower Contract specifies characteristics of the mortgage agreement When a FI receives mortgage application, it must determine whether the applicant qualifies for a loan

  8. Backed by a specific property serves as a collateral FI will place lien fully paid off Nobody can buy the property and obtain a clear title Lien is a public record attached to the title of the property with public recorder s office that gives the FI the right to sell the property if the borrower defaults or falls into arrears lien against property until loan is

  9. Mortgage borrower pays a portion of purchase price of the property on the day mortgage is closed. Balance of the purchase price is the face value of mortgage (Loan proceeds) Decreases default risk for the FI How?

  10. A mortgage borrower who makes a large down payment invests more personal wealth into the home Less likely to default if the property value falls Value of the property is more than the mortgage loan

  11. Size of down payment depends on the financial position of the borrower Generally 20% is down payment Loan to Value ratio may not be more than 80% Borrowers who pay less than 20% purchase private mortgage insurance

  12. Purchased by the lender (FI) and paid by the borrower as part of monthly payment In the event of default, PMI issuer guarantees to pay the FI the difference between value of the property and the balance remaining on the mortgage. If the property value increases or mortgage is paid PMI may be removed by the FI

  13. Originated by FI Repayment guaranteed (fee 0.5% of loan amount) by Federal Housing Administration (FHA) or Veterans Administration (VA) Loan applicants to meet specific requirements set by these govt. agencies Available only to individuals from military services Maximum size of the mortgage is limited depending on location and cost of living Require either a very low (3%) or zero down payment

  14. Not federally insured If down payment less than 20%, privately insured Secondary market mortgage buyers will not buy conventional mortgages if Loan-to-value ratio more than 80% Not privately insured

  15. Generally 15 or 30 years 15-year more popular 15-year mortgage offers potential savings in interest paid However, monthly payments are higher

  16. Fixed principal and interest payments fully pay off mortgage by its maturity date. During the early years of mortgage, most of the fixed monthly payment represents interest on the outstanding principal and a small amount represents payoff of the outstanding principal As mortgage reaches maturity, most of the payment represents payoff of the outstanding principal and a small amount represents interest Reduces default risk

  17. Shows how the monthly mortgage payments are split into principal and interest

  18. Interest payment for 3 to 5 years Full payment of mortgage principal at the end of the period Default risk is high

  19. Most important characteristics Mortgage borrowers choose how much to borrow and from whom based on interest rates

  20. FIs base their quoted mortgage rates on several factors 1. Market rates at which FIs borrow (rate on certificate of deposit or Federal funds rate) 2. Rate on specific mortgage loan depends on whether it is a fixed or variable rate of interest or loan specifies discount points

  21. Locks in interest rate, regardless of market rate changes

  22. Interest rate tied to some market rate Required monthly payments can change over the life of mortgage

  23. Payment made when mortgage loan is issued One discount point paid up front is equal to 1% of the principal FI reduces interest rate in exchange of discount point Borrower weighs reduced interest payment over the life of loan versus upfront payment Decision depends on the period of time the borrower expects to hold the mortgage

  24. Borrower takes a new mortgage and uses the proceeds to pay off the current mortgage Done when interest rate falls Decision involves balancing the savings of a lower monthly payment against the costs (fees) of refinancing Thumb rule interest rate should fall by 2 percentage points of more

  25. When prevailing rates fall, rate on an existing mortgage lowers automatically Unlike variable rate mortgages, in this mortgage type interest rate only falls and does not increase This is to keep off from refinancing when interest rates fall

  26. Small payments early in the life of mortgage Payments increase over first 5 to 10 years Final payments level off at the end of the mortgage Used by borrowers who expect their income to rise Or quickly refinance Default risk high

  27. Initial payments same as conventional Increase over a portion or entire life of the mortgage Increase in monthly payments reduces the principal quickly and reduces the actual life of mortgage In contrast to Graduated payment mortgages, which do not mortgage is paid off, in GEM incremental increase in monthly payments reduces the actual life of the mortgage affect the time until the Dr. Lakshmi Kalyanaraman 28

  28. Already a security in first mortgage Loan is secured again Should a default occur, the second mortgage holder is paid only after the first mortgage is paid off Interest rates on second mortgages are generally higher than the first mortgages

  29. Second mortgage only from home equity built Home equity loan line of credit secured with a second mortgage by customers Home equity = current market value of the home-outstanding mortgage balance

  30. Mortgage interest at a rate less than the current market rate in exchange for share in property value appreciation If property sold for more than the original purchase price, FI shares the gain FI shares the gain Dr. Lakshmi Kalyanaraman 31

  31. Similar to Share appreciation mortgage Instead of FI, an outside investor share appreciation The investor either provides a portion of the down payment on the property or Provides monthly payments an outside investor share the Dr. Lakshmi Kalyanaraman 32

  32. Borrower receives regular monthly payments from a FI When RAM matures or borrower dies, property is sold and debt retired Dr. Lakshmi Kalyanaraman 33

  33. After FIs originate mortgages, they sell or securitize them in secondary mortgage market. Reduces liquidity risk, interest rate risk and credit risk of their portfolios Dr. Lakshmi Kalyanaraman 34

  34. Liquidity Risk: Depository institutions obtain majority of their funds from short-term deposits. Mortgage maturities are of 15 or 30 years Liquidity Risk: Dr. Lakshmi Kalyanaraman 35

  35. Interest Rate Risk: Holding long-term fixed rate mortgages subject them to interest rate risk, if interest rates are expected to rise Interest Rate Risk: Dr. Lakshmi Kalyanaraman 36

  36. Credit Risk Since mortgage maturities are of 15 or 30 years, FIs face the risk that promised cash flows from loans may not be paid in full Credit Risk: (Default Risk)

  37. FIs prefer servicing mortgages rather than long-term financing Long-term financing mortgages are in Balance sheet Loan originator acts as Servicer Servicer collect payments from mortgage borrowers and pass the required interest and principal payments through to the secondary market investor Dr. Lakshmi Kalyanaraman 38

  38. Servicer keeps formal records of mortgage transaction For the service, FI collects a monthly fee Fee ranges from to percent of the mortgage balance Dr. Lakshmi Kalyanaraman 39

  39. FIs remove mortgages by 1. pooling all recently originated mortgages together and sell them in the secondary mortgage market 2. issuing mortgage backed securities i.e. securitization of mortgages Dr. Lakshmi Kalyanaraman 40

  40. The U.S. government established the Federal National Mortgage Association (FNMA or Fannie Mae) they could make more mortgage loans FHA and VA insured loans make securitization easier Government National Mortgage Association (GNMA or Corp. (FHLMC or Freddie Mac ) 1960s encouraged continued expansion of the housing market provided direct and indirect guarantees that allow for the creation of mortgage-backed securities Federal National Mortgage Association (FNMA or Fannie Mae) in the 1930s to buy mortgages from thrifts so Government National Mortgage Association (GNMA or Ginnie Corp. (FHLMC or Freddie Mac ) created in the Ginnie Mae ) Mae ) and Federal Home Loan Mortgage Federal Home Loan Mortgage Dr. Lakshmi Kalyanaraman 41

  41. FI originates a mortgage and sells to an outside buyer With recourse loan buyer sells back the loan back to the originator if it goes bad contingent credit risk liability for the originator Without recourse buyer bears credit risk Dr. Lakshmi Kalyanaraman 42

  42. FI sells loans to manage their credit risk better Removes assets (and credit risk) from the balance sheet Allows FI to achieve better asset diversification Allows FI to better manage interest rate risk and liquidity risk Generates fee income Reduces the cost of reserve requirement Reduces the cost of holding capital requirements against mortgages

  43. Domestic banks Foreign banks Insurance companies Pension funds Closed-end bank loan mutual funds Nonfinancial corporations Dr. Lakshmi Kalyanaraman 44

  44. Money center banks Small regional or community banks Foreign banks Investment banks Dr. Lakshmi Kalyanaraman 45

  45. 1. Pass-through security 2. Collateralized Mortgage Obligations (CMO) 3. Mortgage Backed Bonds Dr. Lakshmi Kalyanaraman 46

  46. Pass through securities and Collateralized Mortgage Obligations (CMO) are securitized mortgages. Securitization of mortgages involves pooling of a group of mortgages Removal Subsequent sale pool to secondary market investors Securitization results in the creation of mortgage backed securities, traded in the secondary markets pooling of a group of mortgages with similar characteristics Removal of these mortgages from Balance sheet Subsequent sale of interests in the mortgage from Balance sheet traded in the secondary markets

  47. FIs asset portfolios more liquid Reduces interest rate risk and credit risk Source of fee income Reduces the effect of regulatory constraints such as capital requirement Dr. Lakshmi Kalyanaraman 48

  48. FIs pool mortgages and offer interest in the pool in the form of pass-through certificates Each pass through security represents fractional ownership in mortgage pool Dr. Lakshmi Kalyanaraman 49

  49. 1% share of a pass-through mortgage security issue is entitled to a 1% share of the principal and interest payments made over the life of the mortgages underlying the pool of securities Pass through promised payments of principal and interest on pools of mortgages to secondary market investors No guaranteed annual coupon Dr. Lakshmi Kalyanaraman 50

More Related Content

giItT1WQy@!-/#giItT1WQy@!-/#giItT1WQy@!-/#giItT1WQy@!-/#giItT1WQy@!-/#giItT1WQy@!-/#