Chapter 9: Mortgage Markets

What is a mortgage and what does it specify? (2)

1. A form of debt where the loan is secured by real estate property.

2. The mortgage interest rate, the maturity, and the collateral (the real estate that secures the loan).

When you obtain a mortgage, who owns the house? (2)

1. YOU do and you are pledging the house as collateral.

2. If you fail to make required payments, the lender can foreclose.

The Bank Side (3)

1. Mortgage originators charge origination fees when providing a mortgage.

2. They obtain funding from deposits and by selling some mortgages originated to institutional investors in the secondary market.

3. Banks continue to service originated mortgages, even if they sell them.

What do lenders consider when deciding to originate a mortgage? (3)

1. The downpayment.

2. The borrowers income.

3. The borrowers credit history.

Prime Mortgage

The borrow meets the traditional lending standards (is in good standing with what the lenders consider).

Subprime Mortgage

The borrower does not qualify for a prime loan because they have either low income, high existing debt, or a small downpayment.

Insured Mortgage (FHA?)

A mortgage covered by insurance or FHA/VA, protecting the lender in case the borrower is unable to make the mortgage payment due to default or foreclosure.

Conventional Mortgage

A home loan made through a private lender and tends to have higher interest rates than FHA loans.

Fixed-Rate Mortgages (3)

1. Locks in an interest rate over the life of the mortgage.

2. Financial institutions suffer from interest rate risk because short term deposits fund long term assets.

3. Borrowers don’t suffer from rising rates, but don’t benefit from falling ones unless they refinance.

Adjustable Rate Mortgages (ARMs) (3)

1. Allows the mortgages interest rate to adjust with market rates.

2. Changing rates shift the risk from the lender to the borrower.

3. Is amortized over the life of the loan, usually 30 years.

Home Equity Lines of Credit (HELOC) (3)

1. Loans tied to available equity in a home.

2. For instance, if my home is worth 300,00 but I still owe 100,000, I have 200,000 in home equity.

3. Are usually above FRM because they are second in terms of getting their claim satisfied in the event of default.

Graduated Payment Mortgages

Allow the borrower to make small initial payments, but payments gradually increase over the first 5 to 10 years, then level off.

Growing Equity Mortgages

Payments keep growing and never level off.

Shared Appreciation Mortgages

Purchasers get a below market interest rate and lender gets a share in the price appreciation of the home.

Baloon Payment Mortgages

A payment of the full remaining balance is required at some point.

Securitization (2)

1. The pooling and repackaging of loans into securities.

2. Securities are then sold to investors, who become the owners of the loans.

Fannie Mae

Channels funds from institutional investors to financial institutions that desire to sell their mortgages.

Freddie Mac

Sells participation certificates and uses the proceeds to finance the origination of conventional mortgages from financial institutions.

Ginne Mae

Guarantees timely payment of principal and interest to investors who purchase securities backed by FHA and VA mortgages.

Credit Default Swap (CDS)

A financial swap agreement that the seller of the CDS will compensate the buyer in the event of a debt default.

What risks do banks face with mortgages? (3)

1. Credit Risk.

2. Interest Rate Risk.

3. Prepayment Risk.