FINE 442 - Mortgages (6)

What is a mortgage?

A long-term loan secured by real estate. It's usually an amortized loan, meaning one fixed monthly payment covers both interest and principal.

Who mainly takes mortgages?

Mostly households, but also commercial, multifamily, and farm borrowers.

Which property type makes up the biggest share of US mortgage loans (2024 Q3)?

One- to four-family dwellings - about 69% of total mortgage loans.

Why were early mortgages mostly between individuals?

Because banks originally had restrictions on making long-term loans, so people borrowed directly from other individuals

What happened to mortgages in the 1890s agricultural recession?

There were massive defaults, making long-term mortgages hard to get for a long time.

What kind of mortgage was common before WWII and why was it a problem?

Short-term balloon loans (≈5 years): principal had to be repaid or renewed. During the Great Depression, many borrowers couldn't renew, causing big problems

How did the US government change mortgages after the Depression?

As part of recovery programs, it helped create the standard 30-year fully amortizing mortgage we know today.

What is the biggest recent development in mortgages?

Creation of a secondary market and the originate-to-distribute model (lenders sell loans instead of keeping them).

Along which three dimensions can you roughly classify residential mortgages?

1. Mortgage interest rates

2. Loan terms

3. Loan amortization

What three components determine the stated mortgage rate in the US?

1. Market rates (long-term Treasury yields)

2. Term (longer term → higher rate)

3. Discount points (pay cash up front to lower the rate)

What is a discount point?

An up-front fee equal to 1% of the loan amount that typically reduces the mortgage rate by about 0.25 percentage points.

Example: On a $100,000 mortgage, what does "2 points" mean?

ou pay $2,000 up front and usually get about a 0.50% lower interest rate.

When is paying mortgage points financially worth it?

When the present value of lower monthly payments is greater than the up-front cost of the points (i.e., you stay in the loan long enough). In the example, the break-even is about 6.2 years.

What is collateral in a mortgage?

The property itself that secures the loan; the lender can foreclose and sell it if the borrower defaults.

What is a down payment?

The portion of the purchase price paid in cash by the borrower; reduces the loan size and lender's risk.

What is Private Mortgage Insurance (PMI) and when is it usually required?

Insurance that covers the difference between the collateral value and the loan if the borrower defaults. It is usually required for conventional mortgages with LTV > 80% (down payment < 20%).

What are borrower qualifications?

Checks of credit history, employment, income, ratios like loan-to-income and loan-to-value to decide if the borrower can repay.

What is a FICO score and what range is "average"?

A credit score from about 300 to 850; typical average range is 660-720. Higher = lower credit risk.

What does it mean that a mortgage is amortized?

You make a fixed level monthly payment; each payment covers interest plus some principal, so the loan balance is zero at the final payment.

In a typical 30-year fixed mortgage, how do interest and principal portions evolve over time?

At the start, most of the payment is interest; over time the interest portion falls and principal portion rises until the loan is fully paid.

Difference between insured and conventional mortgages

Insured: guaranteed by FHA/VA or similar, often with low or zero down payment.
Conventional: not government-guaranteed, usually requires private mortgage insurance and 5-20% down payment.

What is a fixed-rate mortgage (FRM)?

A mortgage where the interest rate is fixed for the entire life of the loan.

What is an adjustable-rate mortgage (ARM)?

A mortgage where the interest rate changes periodically, tied to some reference rate, often with caps/ceilings on how much it can move.

What is a graduated-payment mortgage (GPM)?

A mortgage with initially low payments that increase each year; still amortizes in 30 years.

What is a growing-equity mortgage (GEM)?

Payments increase each year so the loan is paid off faster than 30 years.

What is a second mortgage?

A second lien on the same property, often used for home-equity lines of credit or renovations. It is riskier for the lender because it is paid after the first mortgage

Historically, who mainly originated and held US mortgages?

Thrift institutions (savings & loans). Today, mortgages are held by a mix of banks, federal agencies, mortgage pools/trusts, insurers, etc.

What are the three distinct roles around a modern mortgage?

Originator - makes and packages the loan
Investor - ultimately holds the loan or MBS
Servicer - handles payments and paperwork for a fee

Why did the US government create Fannie Mae after WWII?

To buy mortgages from thrifts, giving them cash to make more loans, financed by Fannie Mae issuing bonds. This helped standardize contracts and expand housing.

Why is securitizing mortgages (pooling them into securities) useful?

It overcomes problems of heterogeneous default risk, prepayment/servicing costs, non-standardization, and small loan sizes; pooling allows diversification and makes mortgages easier to sell to investors.

What is a Mortgage-Backed Security (MBS)?

A security backed by a pool of mortgages. Investors buy a claim on the cash flows (interest + principal) from hundreds of mortgages.

What is a mortgage pass-through?

The simplest MBS: borrowers' payments "pass through" a trustee and are then paid out to investors, who still face prepayment risk.

Who is Ginnie Mae (GNMA) and what does it guarantee?

A government-owned corporation (since 1968) that aggregates FHA/VA-insured mortgages, creates pass-through MBS, and guarantees on-time payment of principal and interest to investors.

Who is Freddie Mac (FHLMC) and what are its securities called?

A government-sponsored enterprise (created 1970) that buys mortgages, pools them, and issues MBS called participation certificates; pools often contain non-insured mortgages. 07_mortgages

What is a CMO (Collateralized Mortgage Obligation)?

A structured MBS where cash flows are split into tranches with different priorities and exposure to prepayment risk; some tranches are safer, others riskier.

What characterizes private pass-throughs?

Issued by private institutions (e.g., banks) that can include jumbo, Alt-A, and other non-traditional mortgages in their pools (not government-guaranteed)

What is a subprime mortgage?

A mortgage to a borrower with poor credit or weak collateral, typically with FICO around 624 vs about 742 for prime borrowers.

How did the share of subprime loans change between 2000 and 2006?

It went from about 2% of mortgages in 2000 to around 17% by 2006.

Name two factors that drove the boom in subprime lending.

New mortgage products (2/28 ARMs, No-Doc loans, NINJA loans) made expensive homes look affordable.
CDOs created strong demand for subprime loans to package into securities

In Canada, how are most mortgages financed?

Mostly through bank deposits, but securitization grew via CMHC programs like NHA MBS and Canada Mortgage Bonds (CMBs)

What are NHA MBS and who guarantees them?

Mortgage-backed securities backed by insured Canadian mortgages; CMHC guarantees timely principal and interest in exchange for a fee.

What are Canada Mortgage Bonds (CMBs)?

Bonds backed by pools of NHA MBS, effectively fully government-backed, highly liquid, and very safe.