The Residential Mortgage Market

1. 24 The Residential Mortgage Market C h a p t e r Money and Capital Markets Financial Institutions and Instruments in a Global Marketplace Eighth Edition Peter S. Rose McGraw Hill / Irwin Slides by Yee-Tien (Ted) Fu

2.  Learning Objectives  • To understand how the residential mortgage market supplies credit to build and buy homes. • To learn about the problems faced by families and individuals in finding credit to finance the purchase of their homes. • To see the problems faced by lenders in designing new home loan contracts that will protect them against inflation and other risks.

3.  Learning Objectives  • To look at how federal government agencies and government-sponsored mortgage firms support the development of the market for mortgage loans.

4. Introduction • Among the fastest growing of all financial markets today is the residential mortgage market, where individuals and families fund their purchases of homes. • Originally a simple market that was primarily local and regional in character, the residential mortgage market has become an international capital market where home-mortgage-related instruments are traded around the globe.

5. Average Terms Quoted on Conventional Home Mortgage Loans (U.S. Primary Market) 1974 1980 1990 2000 Purchase price ($000) $40.10 $83.50 $153.20 $234.50 Amount of loan ($000) 29.80 59.30 112.40 177.00 Loan/price ratio (%) 74.30 73.30 74.50 77.40 Maturity (years) 26.30 28.20 27.30 29.20 Fees & charges (points) 1.30 % 2.10 % 1.93 % 0.70 % Contract interest rate (%) 8.71 12.25 9.68 7.41 FHA mortgage yield (%) 9.22 13.95 10.17 7.45 * * FHA mortgage yield is for 1999. Data Source: Board of Governors of the Federal Reserve System, Recent Trends in New Home Prices and the Terms of Mortgage Loans

6. Outstanding Mortgage Loans in the U.S. $ billions Total Mortgage Debt Residential Properties (1-4 family & multifamily) Nonresidential Properties (commercial & farm) Data Source: Board of Governors of the Federal Reserve System The Structure of the Mortgage Market

7. Government loans to mortgage lenders Commercial banks & bank holding co. Savings & loan associations Savings banks Credit unions Real estate investment trusts Insurance co. Pension plans Mutual funds Individual domestic investors Foreign investors Builders & developers of residential & commercial properties Conventional home mortgage loans Mortgage banks Government guaranteed home loans Commercial mortgage loans Farm & ranch mortgage loans Private mortgage pools (securitized loans) Federal & federally sponsored mortgage agencies Home buyers, business firms, & other recipients of mortgage credit The Structure of the Mortgage Market Flow of Savings

8. 24 - 8 Mortgage Lending Institutions Source: Board of Governors of the Federal Reserve System

9. Mortgage Lending Institutions • Most mortgages generate multiple potential cash-flow streams: • origination & commitment fees (when a mortgage loan is first applied for) • periodic loan repayments & loan interest • compensation for prepayment & default risks • service fees associated with collecting & recording amounts owed • net returns & fees from the securitization of a pool of mortgage loans

10. Mortgage Lending Institutions • A mortgage loan may be • held in the originating lender’s portfolio for the promised interest and principal payments, • sold to an investor at a discounted value (although the originating lender may retain servicing rights and charge the loan purchaser loan servicing fees), or • packaged with other similar mortgage loans into a pool and securitized (the lender receives residual interest income and servicing fees).

11. The Roles Played by Financial InstitutionsIn the Mortgage Market • Savings and loan associations (S&Ls) are predominantly local lenders. They often service the mortgage loans they made. • Commercial banks rank first as lenders for the purchase of homes, condominiums, and apartments, and in the commercial mortgage sector. • Savings banks invest in both government-guaranteed and conventional mortgage loans.

12. The Roles Played by Financial InstitutionsIn the Mortgage Market • Life insurance companies make substantial investments in commercial as well as residential mortgage properties, both nationally and internationally. • Mortgage banking houses act as a channel through which builders or contractors in need of long-term funds can find permanent mortgage financing.

13. Government Activity • The Great Depression generated massive, unprecedented unemployment, such that there were thousands of foreclosures, property values fell, and many mortgage lenders faced liquidity crises. • So, the U.S. federal government had to move in to tackle the mortgage market’s problems, through government guarantees and the development of a secondary market.

14. Government Activity • The major milestones include: • 1932: Federal Home Loan Bank System • 1934: National Housing Act, Federal Housing Administration • 1938: Federal National Mortgage Association (Fannie Mae) • 1944: Servicemen’s Readjustment Act, Veterans Administration

15. Government Activity • 1968: Government National Mortgage Association (Ginnie Mae) (Its pass-throughs are popular with investors as safe, readily marketable securities with attractive rates of return.) • 1970: Federal Home Loan Mortgage Corporation (Freddie Mac) (Its mortgage-backed securities include mortgage participation certificates (PCs), guaranteed mortgage certificates (GMCs), collateralized mortgage obligations (CMOs), and real estate mortgage investment conduits (REMICs).)

16. Innovations in Mortgage Instruments • The problems created by fixed-rate mortgages (FRMs) led to the development of variable-rate mortgages (VRMs) and adjustable mortgage instruments (AMIs). • Volatile interest rates also led to the development of convertible mortgage instruments (CMIs) and balloon loans. • Reverse-annuity mortgages (RAMs) have also been developed to help older families.

17. Innovations in Mortgage Instruments • Mortgage lock-ins protect borrowers from an increase in loan rates during the house-buying process, while loan modification agreements aid troubled borrowers in avoiding disclosure. • In recent years, as market interest rates fell, many homeowners have chosen to refinance their home mortgages. Some have also opted to take home equity loans.

18. Money and Capital Markets in Cyberspace • More information about the residential mortgage market can be found at: • http://www.cityresearch.com/ • http://www.hsh.com/ • http://www.wholesaleaccess.com/ • http://mortgagesincanada.com/ • http://www.hud.gov/

19. Chapter Review • Introduction • Recent Trends in New Home Prices and the Terms of Mortgage Loans • The Structure of the Mortgage Market • Volume of Mortgage Loans • Residential versus Nonresidential Mortgage Loans • Mortgage Lending Institutions

20. Chapter Review • The Roles Played by Financial Institutions in the Mortgage Market • Savings and Loan Associations • Commercial Banks • Life Insurance Companies • Savings Banks • Mortgage Bankers

21. Chapter Review • Government Activity • The Impact of the Great Depression on Government Involvement in the Mortgage Market • The Creation of Fannie Mae (FNMA) • The Creation of Ginnie Mae (GNMA) • The Federal Home Loan Mortgage Corporation (FHLMC)

22. Chapter Review • Innovations in Mortgage Instruments • Variable-Rate and Adjustable Mortgage Instruments • Convertible Mortgages • Reverse-Annuity Mortgages • Mortgage Lock-ins • Refinancing Home Mortgages and Home Equity Loans