Money and Capital Markets

2424C h a p t e r

Eighth Edition

Financial Institutions and Instruments in a Global Marketplace

Peter S. Rose

McGraw Hill / Irwin Slides by Yee-Tien (Ted) Fu

The Residential Mortgage MarketThe Residential Mortgage Market

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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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.

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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Learning Objectives

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

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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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.

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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Recent Trends in New Home Prices and the Terms of Mortgage Loans

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 $234.50Amount of loan ($000) 29.80 59.30 112.40 177.00Loan/price ratio (%) 74.30 73.30 74.50 77.40Maturity (years) 26.30 28.20 27.30 29.20Fees & charges (points) 1.30 % 2.10 % 1.93 % 0.70 %Contract interest rate (%) 8.71 12.25 9.68 7.41FHA 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,

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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The Structure of the Mortgage Market

0

1000

2000

3000

4000

5000

6000

7000

8000

1961 1966 1971 1976 1981 1986 1991 1996 2001

Data Source: Board of Governors of the Federal Reserve System

Outstanding Mortgage Loans in the U.S.$ billions

Total Mortgage DebtResidential Properties(1-4 family & multifamily)Nonresidential Properties(commercial & farm)

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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The Structure of the Mortgage MarketF

low

of

Sav

ings

Government loans to mortgage

lendersCommercial banks

& bank holding co.

Savings & loan associations

Savings banksCredit unions

Real estate investment trusts

Insurance co.Pension plansMutual funds

Individual domestic investorsForeign investors

Conventional home mortgage loansMortgage banks

Government guaranteed home

loansCommercial

mortgage loansFarm & ranch mortgage loans

Private mortgage

pools (securitized

loans)Federal & federally

sponsored mortgage agencies

Builders & developers of residential & commercial properties

Home buyers, business firms, & other recipients of mortgage credit

Mortgage Lending Institutions

Source: Board of Governors of the Federal Reserve System

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2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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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

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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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).

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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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.

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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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.

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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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.

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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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

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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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).)

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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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.

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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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.

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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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/

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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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

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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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

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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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)

2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin

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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