Residential Mortgage Loans

A set of vocabulary flashcards covering key terms related to the residential mortgage market, underwriting standards, loan types, and investment risks based on Chapter 10 of Bond Markets, Analysis, and Strategies.

Primary Mortgage Market

The environment where mortgage loans are created or originated by entities such as mortgage bankers, mortgage brokers, banks, savings and loan institutions (thrifts), and credit unions.

Secondary Mortgage Market

The market where existing home loans are resold to various financial institutions.

Fannie Mae

Also known as the Federal National Mortgage Association, it is a government-sponsored enterprise ($GSE$) that acts as a loan securitizer.

Freddie Mac

Also known as the Federal Home Loan Mortgage Corporation, it is a government-sponsored enterprise ($GSE$) that acts as a loan securitizer.

Payment-to-Income Ratio ($PTI$)

Also called the debt-to-income ratio ($DTI$), this is the ratio of monthly debt payments to monthly income used to measure an applicant's ability to make monthly payments.

Front Ratio

A ratio computed by dividing total mortgage monthly payments (interest, principal, property taxes, and homeowner insurance) by the applicant’s pre-tax monthly income.

Back Ratio

A ratio computed similarly to the front ratio but includes other debt payments, such as auto loans and credit card payments, in the total debt calculation.

Loan-to-Value Ratio ($LTV$)

The ratio of the amount of the loan to the market or appraised value of the property; it is the single most important determinant of default likelihood.

Lien Status

The seniority of a mortgage loan in the event of forced liquidation; a first lien has first call on proceeds, while a second or junior lien is paid only after the first lien holder.

Prime Loan

A loan where the borrower has high credit quality, typically characterized by FICO scores of $660$ or higher, front and back $PTI$ ratios of no more than $28\%$ and $36\%$, and $LTV$s less than $90\%$.

Subprime Loan

A loan originated for a borrower of lower credit quality or a loan that is not a first lien on the property.

Fixed-rate Mortgage ($FRM$)

A mortgage where the interest rate is set at the closing of the loan and remains unchanged over the life of the loan.

Adjustable-rate Mortgage ($ARM$)

A mortgage where the interest rate changes over the life of the loan based on an index (reference rate) and a spread (margin).

Periodic Rate Cap

A limit on the amount that the interest rate of an $ARM$ may increase or decrease at a specific reset date.

Lifetime Rate Cap

An upper limit on the mortgage rate that can be charged over the entire life of an adjustable-rate mortgage loan.

Hybrid ARM

A mortgage that blends features by keeping the interest rate fixed for an initial term (typically $2$ to $10$ years) before it becomes adjustable.

Loan Amortization

The process of paying off a loan over time through regular, scheduled payments.

Fully Amortizing Loan

A loan where monthly mortgage payments are sufficient to completely repay the loan amount by the time the last payment is made.

Balloon Payment

A large final payment required at the end of a partially amortizing loan term when the amortization schedule is longer than the loan term.

Government Loans

Mortgage loans backed by agencies of the federal government, such as the Federal Housing Administration ($FHA$) and the Veterans Administration ($VA$).

Conventional Loans

Loans that have no explicit guarantee from the federal government and are obtained through conventional financing.

Conforming Loans

Conventional loans that meet the specific underwriting standards of Fannie Mae and Freddie Mac.

Jumbo Loans

Loans that exceed the conforming limits specified for Freddie Mac and Fannie Mae for a given property type.

Credit Risk

The risk that the homeowner or borrower will default on the mortgage payments.

Liquidity Risk

The risk arising from the fact that mortgage loans are large and indivisible, leading to large bid-ask spreads compared to other debt instruments.

Price Risk

The risk that the price of a mortgage loan will decrease as market interest rates rise.

Prepayment Risk

The risk associated with a mortgage's cash flow uncertainty due to borrowers paying off loans when prevailing mortgage rates fall below the loan's note rate.