Chapter Seven Mortgage Markets McGraw-Hill/Irwin 7-1 2007, The

Chapter Seven Mortgage Markets McGraw-Hill/Irwin 7-1 2007, The McGraw-Hill Companies, All Rights

Mortgages and Mortgage-Backed Securities Mortgages Mortgages are are loans loans to to individuals individuals or or businesses businesses to to purchase purchase aa home, home, land, land, or or other other real real property property Many Many mortgages mortgages are are securitized securitized –– mortgages mortgages are are packaged packagedand and sold sold as as assets assets backing backing aa publicly publicly traded traded or or privately privately held held debt debt instrument instrument Four Four basic basic categories categories of of mortgages mortgages issued issued McGraw-Hill/Irwin 7-2 2007, The McGraw-Hill Companies, All Rights

Mortgage Loans Outstanding, 2004 ( Bn) 582 582 141 141 1,635 1,635 7,771 7,771 family family McGraw-Hill/Irwin commercial commercial 7-3 multifamily multifamily farm farm 2007, The McGraw-Hill Companies, All Rights

Mortgage Characteristics Lien Lien Down Down payment payment Private Private mortgage mortgage insurance insurance Federally Federally insured insured mortgages mortgages Conventional Conventional mortgages mortgages Amortized Amortized Balloon Balloon payment payment mortgages mortgages (continued) McGraw-Hill/Irwin 7-4 2007, The McGraw-Hill Companies, All Rights

Fixed-rate Fixed-rate mortgage mortgage Adjustable-rate Adjustable-rate mortgage mortgage Discount Discount points points Amortization Amortization schedule schedule McGraw-Hill/Irwin 7-5 2007, The McGraw-Hill Companies, All Rights

Calculation of Monthly Mortgage Payments PV PV PMT(PVIFA PMT(PVIFA r,tr,t)) Where: Where: PV PV Principal Principalamount amountborrowed borrowedthrough throughthe themortgage mortgage PMT PMT Monthly Monthlymortgage mortgagepayment payment PVIFA PVIFA Present Presentvalue valueinterest interestfactor factorof ofan anannuity annuity rr interest interestrate, rate,i,i,divided dividedby by12 12(months/year) (months/year) tt number numberof ofmonths months(payments) (payments)over overlife lifeof ofthe themortgage mortgage McGraw-Hill/Irwin 7-6 2007, The McGraw-Hill Companies, All Rights

Comparison of Monthly Mortgage Payments 150,000 150,000home homewith with30-year 30-yearmortgage mortgageatat8%, 8%,00points, points,20% 20%down down 120,000 ) 120,000 PMT(PVIFA PMT(PVIFA8%/12, 8%/12,30 30 12 12 ) PMT PMT 120,000/136.2835 120,000/136.2835 880.52 880.52 150,000 150,000home homewith with15-year 15-yearmortgage mortgageatat8%, 8%,00points, points,20% 20%down down 120,000 ) 120,000 PMT(PVIFA PMT(PVIFA8%/12, 8%/12,15 15 12 12 ) PMT PMT 120,000/104.6406 120,000/104.6406 1146.78 1146.78 McGraw-Hill/Irwin 7-7 2007, The McGraw-Hill Companies, All Rights

Other Types of Mortgages Automatic Automatic rate-reduction rate-reduction mortgages mortgages Graduated-payment Graduated-payment mortgages mortgages Growing-equity Growing-equity mortgages mortgages Second Second mortgages mortgages Home Home equity equity loan loan Shared-appreciation Shared-appreciation mortgage mortgage (SAM) (SAM) Equity-participation Equity-participation mortgage mortgage Reverse-annuity Reverse-annuity mortgage mortgage McGraw-Hill/Irwin 7-8 2007, The McGraw-Hill Companies, All Rights

Secondary Mortgage Market Advantages Advantages for for FI FI to to securitize securitize –– reduces reducesliquidity liquidityrisk, risk,interest interestrate raterisk, risk,and andcredit creditrisk riskof of FIs FIsportfolio portfolio –– FI FIretains retainsincome incomefrom fromorigination originationfees feesand andservice servicefees fees FI’s FI’s remove remove mortgages mortgages from from their their balance balance sheet sheet through through one one of of two two mechanisms mechanisms –– pool poolrecently recentlyoriginated originatedmortgages mortgagestogether togetherand andsell sell them themin inthe thesecondary secondarymarket market –– issue issuemortgage-backed mortgage-backedsecurities securitiesthat thatare arebacked backedby by their theirnewly newlyoriginated originatedmortgages mortgages McGraw-Hill/Irwin 7-9 2007, The McGraw-Hill Companies, All Rights

History of Secondary Mortgage Markets Federal Federal National National Mortgage Mortgage Association Association (FNMA (FNMA or or “Fannie “Fannie Mae”) Mae”) created created during during the the Great Great Depression Depression FHA FHA and and VA VA insured insured loans loans also also created created during during this this time time Government Government National National Mortgage Mortgage Association Association (GNMA (GNMA or or “Ginnie “Ginnie Mae”) Mae”) and and Federal Federal Home Home Loan Loan Mortgage MortgageCorp. Corp. (FHLMC (FHLMC or or “Freddie “Freddie Mac”) Mac”) created created during during 1960’s 1960’s Wide Wide variety variety of of mortgage-backed mortgage-backed securities securities have have been been developed developed and and in in 1999, 1999, approximately approximately 50% 50% of of mortgages mortgages are are securitized securitized McGraw-Hill/Irwin 7-10 2007, The McGraw-Hill Companies, All Rights

Mortgage Sales Mortgage Mortgage sale sale Allow Allow FIs FIs to to manage manage credit credit risk risk and and achieve achieve better better asset asset diversification, diversification, improves improves their their liquidity liquidity risk risk FIs FIs are are encouraged encouraged to to sell sell loans loans for for economic economic and and regulatory regulatory reasons reasons Major Major buyers buyers of of mortgage mortgage loans loans Major Major sellers sellers of of mortgage mortgageloans loans are are money money center center banks, banks, smaller smaller banks, banks, foreign foreign banks, banks, investment investment banks banks McGraw-Hill/Irwin 7-11 2007, The McGraw-Hill Companies, All Rights

Securitization of Mortgages Pass-through Pass-through mortgage mortgage securities securities Issued Issued in in standard standard denominations, denominations, usually usually 25,000 25,000 with with increments increments of of 5,000 5,000 beyond beyond the the minimum minimum Three Three government government owned owned or or sponsored sponsored agencies agencies involved involved -- Ginnie Ginnie Mae Mae (GNMA), (GNMA), Fannie Fannie Mae Mae (FNMA, (FNMA, and and Freddie Freddie Mac Mac (FHLMC) (FHLMC) McGraw-Hill/Irwin 7-12 2007, The McGraw-Hill Companies, All Rights

Government-Related Mortgage-Backed Pass-Through Securities Outstanding ( Bn) 2000 2000 1500 1500 1000 1000 500 500 00 GNMA GNMA McGraw-Hill/Irwin 1995 1995 FNMA FNMA 1998 1998 2000 2000 FHLMC FHLMC 7-13 2004 2004 Private PrivateMortgages Mortgages 2007, The McGraw-Hill Companies, All Rights

Collateralized Mortgage Obligations CMO CMO -- aa mortgage-backed mortgage-backed bond bond issued issued in in multiple multiple classes classes or or tranches tranches –– tranches tranches -- aa bond bond holder holder class class associated associated with with aa CMO CMO Created Created by by packaging packaging and and securitizing securitizing whole whole mortgage mortgage loans loans or or resecuritizing resecuritizing pass-through pass-through securities securities Attractive Attractive to to secondary secondary mortgage mortgage market market investors investors because because they they can can choose choose aa particular particular CMO CMO class class that that fits fits their their maturity maturity needs needs McGraw-Hill/Irwin 7-14 2007, The McGraw-Hill Companies, All Rights

Mortgages Outstanding by Type of Holder(%), 2004 Mortgage MortgagePools Pools 4.39 0.32 0.32 4.39 3.37 3.37 2.62 2.62 52.42 52.42 36.88 36.88 McGraw-Hill/Irwin 7-15 Depository Depository Institutions Institutions Life LifeInsurance Insurance Companies Companies Other OtherFinancial Financial Institutions Institutions Mortgage Mortgage Companies Companies Other Other 2007, The McGraw-Hill Companies, All Rights

One- to Four-Family Mortgage Originations, 2004 17.50 17.50 28.30 28.30 Mortgage Mortgage Companies Companies Commercial CommercialBanks Banks Thrifts Thrifts Other Other 27.50 27.50 26.70 26.70 McGraw-Hill/Irwin 7-16 2007, The McGraw-Hill Companies, All Rights

Issuers of Ginnie Mae Securities, 2004 Mortgage Mortgage Companies Companies Commercial CommercialBanks Banks 31.10 31.10 50.30 50.30 Thrifts Thrifts Other Other 9.50 9.50 9.10 9.10 McGraw-Hill/Irwin 7-17 2007, The McGraw-Hill Companies, All Rights