10-1Copyright 2000 by Harcourt, Inc.

CHAPTER 10

MORTGAGE MARKETS

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The Unique Nature ofMortgage Markets Mortgage loans are secured by the pledge of real

property as collateral. Mortgage loans are made for varied amounts --

no standard denomination. Issuers of mortgages are usually small family or

business entities.

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The Unique Nature ofMortgage Markets (concluded) Weak Secondary Market

– Little standardization of contracts and terms.– Traditionally issued and held by lender.

Mortgage markets are highly regulated and supported by federal government policies.

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Borrower Signs a Note and Mortgage, and Title Is Conveyed to Borrower The note is the borrowing agreement. Payments amortized over time. Interest is usually computed on the declining

balance. The mortgage is a lien on the property used as

collateral for the loan. If the contract is broken, the lender may use the

property to pay the loan.

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Mortgage Balance and Payments

A. Balance due on 15-year, 9%, $100,000 mortgage with payments of $1,015 per monthmade promptly.Balance after payment number:

1 2 3 4 5 6 In99,735.00 99,468.01 99,199.02 98,928.02 98,654.98 98,379.89 Year 184,377.69 83,995.52 83,610.49 83,222.57 82,831.74 82,437.97 Year 555,553.05 54,954.70 54,351.86 53,744.50 53,132.58 52,516.07 Year 1010,422.85 9,486.03 8,542.17 7,591.24 6,633.17 5,667.92 Year 15

7 8 9 10 11 12 In98,102.74 97,823.51 97,542.18 97,258.75 96,973.19 96,685.49 Year 182,041.26 81,641.57 81,238.88 80,833.17 80,424.42 80,012.60 Year 551,894.94 51,269.16 50,638.67 50,003.46 49,363.49 48,718.72 Year 104,695.43 3,715.65 2,728.51 1,733.98 731.98 -277.53 Year 15

Initial mortgage $100,000 Monthly payments $1,015 Total payments $182,400+Interest rate 9% First payment interest $750 Total interest $82,400+Maturity 15 years First payment principal $265 Total principal $100,000

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Mortgage Balance and Payments (continued)

Principal and interest Payments on a 9%, 15-year, $100,000 mortgage with payments of

$1,015 per month

$0

$200

$400

$600

$800

$1,000

$1,200

0 12 24 36 48 60 72 84 96 108 120 132 144 156 168

Month

Pay

men

t

Interest PaymentPrincipal Payment

10-7Copyright 2000 by Harcourt, Inc.

Mortgage Balance and Payments(continued)A. Balance due on 30-year, 9%, $100,000 mortgage with payments of $805 per monthmade promptly.Balance after payment number:

1 2 3 4 5 6 In99,945.00 99,889.59 99,833.76 98,777.51 99,720.84 99,663.75 Year 196,757.63 96,678.32 96,598.40 96,517.89 96,436.78 96,355.05 Year 590,775.16 90,650.97 90,525.86 90,399.80 90,272.80 90,144.85 Year 1081,408.52 81,214.08 81,018.19 80,820.82 80,621.98 80,421.64 Year 1554,215.43 53,817.04 53,415.67 53,011.29 52,603.87 52,193.40 Year 207,832.77 7,086.51 6,334.66 5,577.17 4,814.00 4,045.11 Year 30

7 8 9 10 11 12 In99,606.23 99,548.28 99,489.89 99,431.06 99,371.79 99,312.08 Year 199,272.71 96,189.76 96,106.18 96,021.98 95,937.14 95,851.67 Year 590,015.93 89,886.05 89,755.20 89,623.36 89,490.54 89,356.71 Year 1080,219.81 80,016.45 79,811.58 79,605.16 79,397.20 79,187.68 Year 1551,779.85 51,363.20 50,943.42 50,520.50 50,094.40 49,665.11 Year 203,270.44 2,489.97 1,703.65 911.42 113.26 -690.89 Year 30

Initial mortgage $100,000 Monthly payments $805 Total payments $289,100+Interest rate 9% First payment interest $750 Total interest $189,100+Maturity 30 years First payment principal $55 Total principal $100,000

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Mortgage Balance and Payments(concluded)

Principal and interest Payments on a 9%, 30-year, $100,000 mortgage with payments of

$805 per month

$0.00

$100.00

$200.00

$300.00

$400.00

$500.00

$600.00

$700.00

$800.00

$900.00

0 36 72 108 144 180 216 252 288 324

Month

Pay

men

t

Interest PaymentPrincipal Payment

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Conventional and Insured Mortgages Conventional mortgages represent

lending/borrowing in the private markets. Insured and/or guaranteed mortgages are

supported by federal and state agencies.– Federal Housing Administration (FHA).– Veterans Administration (VA).– Downpayment and rates may be lower.

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Private Mortgage Insurance

Conventional mortgage borrowers with low downpayments must usually buy private mortgage insurance (PMI).

PMI premiums are added to mortgage payments until the value of the mortgage is less than 75% of the value of the house.

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Private Mortgage Insurance

$112,500mortgage at10% plusinsurancepremium = 10¼to 10½% APRon $112,500balance

Insured Risk $12,500 mortgageinsurance

UninsuredMortgage

Equity

Privately Insuredconventional mortgage

$100,000mortgage at10% APR.

Equity$25,000 downpayment

$12,500 downpayment

UninsuredMortgage

Uninsured conventionalmortgage

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Adjustable Rate Mortgage (ARM)

Fixed-rate mortgages are not acceptable to lenders in high inflation periods.

With adjustable rate contracts, borrowers' costs vary with inflation and interest rate levels.

Caps on ARM interest rates limit interest rate risk to borrowers.– 1 to 2 % cap per year.– 5 % cap over the life of the loan.

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Early Payoff Mortgages

Balloon Payment Mortgages -- Traditional loan where interest is paid until a time when the principal was due.

Rollover Mortgage (ROMs) -- refinanced at new rate every few years.

Renegotiated Rate Mortgages (RRMs) -- Loan terms renegotiated periodically at terms prevailing in the market.

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Methods of Adjustment for ARMs

Rate may vary in a prescribed range (caps) or without limit.

Payments, maturity, or principal may vary. Rates may vary based on a previously determined

interest rate index or the cost of the funds of the lender.

The market prices (difference between fixed and variable rates) the extent of interest rate risk (impact of varying interest rates) assumed by borrower and lender.

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Other Mortgage Instruments Emerging in High Interest (Inflation) Periods

Graduated Payment Mortgage (GPM) -- Payments increase with income expectations.

Growing Equity Mortgage (GEM) -- Increasing payments to pay off loan quickly.

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Other Mortgage Instruments Emerging in High Interest (Inflation) Periods (concluded)

Reverse Annuity Mortgage (RAM) -- Borrower receives monthly loan proceeds. Interest and principal paid at time of sale of home.

Second Mortgage -- extended at time of purchase or later as equity is borrowed from property. Home equity lines of credit became popular after the 1986 federal tax law.

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Rate Difference Needed for Borrowers to Take the Risk of an Adjustable-Rate Mortgage

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Mortgage Interest Rates for FRMs and Capped and Uncapped ARMsJanuary 1985 - January 1991

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Mortgage-Backed Securities -- One way to develop a secondary market for mortgages.

Mortgage pass-through securities pass through payments of principal and interest on pools of mortgages to holder of the securities.

Other Mortgage backed securities use pools of mortgages as collateral for debt securities.

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Types of Pass-Through Securities Ginnie Mae Pass-Throughs - pools of

government insured mortgages. Freddie Mac Participation Certification - pools of

conventional mortgages. Freddie Mac Guaranteed Mortgage Certificates -

promises regular repayment of principal and interest.

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Types of Pass-Through Securities (concluded) Collateralized mortgage obligations (CMOs) --

fixed maturity date and interest payments similar to bonds.

REMICS -- real estate mortgage investment conduit; Investor pays taxes. Type of CMO.

Fannie Mae pass-throughs - pools of conventional or insured mortgages.

Privately issued pass-throughs (PIP).

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Other Mortgage-backed Securities

Unit investment trusts -- Mortgage pools assembled by investment bankers in unit "trusts." Claims on trust is sold to investor.

Mortgage-backed mutual funds -- offer GNMA insurance but at yields higher than treasuries.

FHLMC, FNMA, and private mortgage-backed debt.

State/local government revenues bonds -- type of muni, tax-free bond.

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Advantages of Mortgage-backed Securities over Individual Mortgages Issued in standardized denominations and are

negotiable. Issued or backed by quality borrowers. Usually insured and highly collateralized. Repayment schedules vary, but many are similar

to other bonds.

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Participants in the Mortgage Markets Thrifts -- dominated and increased share of

market until 1970s. Banks -- Increased share of market and

increased powers to make mortgage loans. Insurance Companies and Pension Funds. Pools -- Pass-through certificates have become

an important source of funds. Pools represented the largest component of mortgage investment in 1998.

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Participants in the Mortgage Markets (concluded) Government Holdings -- All Levels of

Government– FNMA, FHLMC, Federal Land Banks, Farmers

Home Administration.– State and local housing authorities issue bonds

and buy subsidized, lower-rate mortgages, often for first-time home-buyers.

10-26Copyright 2000 by Harcourt, Inc.

Other Participants Mortgage Insurers

– Developed in 1930s to enhance acceptability of mortgages and to encourage more risky low equity/loan lending.

– FHA guaranteed payment to lender in case of default.– VA insurance (1944) for mortgage loans to veterans.– Private mortgage insurance covered low down

payment conventional mortgages.– Mortgage insurance has enhanced the development

of secondary markets.

10-27Copyright 2000 by Harcourt, Inc.

Other Participants (concluded)

Mortgage bankers originate mortgages, sell them, and often service the mortgage.