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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
24 - 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.
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
24 - 3
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
24 - 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.
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
24 - 5
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 ($000) 29.80 59.30 112.40 177.00Loan/price ratio (%) 74.30 73.30 74.50 77.40Maturity (years) 26.30 28.20 27.30 29.20Fees & charges (points) 1.30 % 2.10 % 1.93 % 0.70 %Contract interest rate (%) 8.71 12.25 9.68 7.41FHA mortgage yield (%) 9.22 13.95 10.17 7.45 *
* FHA mortgage yield is for 1999.Data Source: Board of Governors of the Federal Reserve System,
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
24 - 6
The Structure of the Mortgage Market
0
1000
2000
3000
4000
5000
6000
7000
8000
1961 1966 1971 1976 1981 1986 1991 1996 2001
Data Source: Board of Governors of the Federal Reserve System
Outstanding Mortgage Loans in the U.S.$ 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
24 - 7
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
24 - 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
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
24 - 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).
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
24 - 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.
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
24 - 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.
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
24 - 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.
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
24 - 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
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
24 - 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.
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
24 - 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.
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
24 - 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/
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
24 - 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
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
24 - 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
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
24 - 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)
2003 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw Hill / Irwin
24 - 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