Mortgage banking overview

Saunders Learning Group, LLC, Andover, KSSaunders Learning Group, LLC

Mortgage Banking and Mortgage Backed Securities

Investing Seminar

Financial Services Industry Training

Materials covers chapter 11 of “Figuring Out Wall Street”

Saunders Learning Group, LLC, Andover, KS

Saunders Learning Group provides a variety of training programs, workshops and seminars targeted to the financial services industry.

Programs are available in a wide range of topics, and we are specialists in developing custom programs that are targeted to your needs.

Contact the founder, Floyd Saunders at 316-680-6482 or at [email protected] for more information.

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Training from Saunders Learning Group

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All About Figuring Out Wall Street ...

Everything has changed in the financial services industry and it effects your financial well-being. From bank failures, to record unemployment, home foreclosures and panic around the world, Figuring Out Wall Street, is the concise guide to help everyone from first time investors to veterans of banking understand what to do to persevere and restore our faith in our financial systems.

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This presentation is from Chapter Nine of Figuring Out Wall Street


MORTGAGE BASICS


What is Mortgage An amortized loan whereby a fixed

payment pays both principal and interest each month

A mortgage is a loan to finance the purchase of real estate, usually with: specified payment periods and interest rates which is paid to the bank secured by the property to loan is used to

purchase . The borrower (mortgagor) gives the lender

(mortgagee) a lien on the property as collateral for the loan.

Mortgages involve two main parties: the borrower and the lender. the borrower requires money in order to purchase the property the lender loans them the money at a certain price. the loan is to be paid in instalments in a definite amount of time. If borrower fails to pay back the loan amount, the lender can recover the money by selling his

asset. Thus the property becomes the lender's security on the loan

The actual loan amount is referred to as the principal, and the mortgagor is expected to repay that principal, along with interest, over the repayment period of the mortgage.


What is Mortgage A mortgage can be used for financing many different things, including:

Purchasing or constructing a new house. Purchasing an existing house. Refinancing to consolidate debts. Financing a renovation. Financing the purchase of other investments. Financing the purchase of investment property.

Since a mortgage is a fully secured form of financing, the interest you pay is usually less than with most other types of financing.


A Brief History

Mortgages were used in the 1880s, but massive defaults in the agricultural recession of 1890 made long-term mortgages difficult to attain.

Until post-WWII, most mortgage loans were short-term balloon loans with maturities of five years or less.

Balloon loans, however, caused problems during the depression. Typically, the lender renews the loan. But, with so many Americans out of work, lenders could not continue to extend credit.

As a part of the depression recovery program, the federal government assisted in creating the standard 30-year mortgage we know today.

The U.S. government established the Federal National Mortgage Association (FNMA or Fannie Mae) in the 1930s to buy mortgages from thrifts so they could make more mortgage loans, this created a “secondary market” for mortgages.

FHA and VA insured loans make securitization easier Government National Mortgage Association (GNMA or “Ginnie Mae”) and Federal

Home Loan Mortgage Corp. (FHLMC or “Freddie Mac”) created in the 1960s

encouraged continued expansion of the housing market

provided direct and indirect guarantees that allow for the creation of mortgage-backed securities


What is Mortgage Company

A mortgage company is a company engaged in the business of originating and/or funding mortgages for residential or commercial property.

This is a type of regulated lender that specifically lends money for people to purchase "Real Property" (homes).

A Mortgage bank specializes in originating and/or servicing mortgage loans. A mortgage broker acts as an intermediary whose brokers mortgage loans

on behalf of individuals or businesses. A mortgage bank is a state-licensed banking entity that makes mortgage

loans directly to consumers. The difference between a mortgage banker and a mortgage broker is that the

mortgage banker funds loans with its own capital.


Mortgage Company

Function

Example Activities

Example Companies

Provides consumers with a wide range of mortgage products and services designedto meet the needs of a varied customer base.

Invest in residential, commercial and multifamily loans. Provide services to lenders with regard to assets and credit riskMay be involved in the management of real estate transactions. Some mortgage holding companies also offer mortgage servicing products as well as mortgage

management.Main functions of Mortgage companies/banks are:

Solicitation of new loans Origination of new loans (applications and verification of income, credit, property value,

employment status etc.Loan ServicingAsset ManagementRegulatory ConsultingLoss Mitigation

Citibank, Bank of America, JPMorganChase, Wells Fargo, US Bank Also a variety of regional and local banks.

Credit Unions perform similar functions, provide most of the same products andservices.


Mortgage Banking Functions

Mortgage Banking

Loan Origination Loan Servicing

Application

Processing (or Underwriting)

Payment Processing

Escrow Accounts

Provides consumers with a wide range of mortgage loan products,

Processes payments, adjustments, collects funds to pay property taxes and insurance, arranges for payoff or transfer of loans

Loan Closing Loan payoffs


Mortgage Loan Origination

Function

Example Activities

Example Companies

Provides consumers with a wide range of mortgage products and services designed to meet the needs of a varied customer base.

Most mortgage originations occur in-house or with a mortgage broker.

Mortgage brokers, on the other hand, will help customers find a variety of mortgage loan choices and take applications to start the underwriting process.

Mortgage banks will take an application for a potential customer, review his qualifications--credit, income, assets--and determine the best product offered by that bank only.

Next an in-house underwriter (another bank employee) will corroborate the information on the application with the help of supporting documents (pay stubs, W2s).

Arrange for property appraisals, inspections and title searches to

Pre-approval and approval meetings are often held with both the underwriter and the loan officer as well as the customer.

Mortgage brokers will almost always sell a mortgage in the secondary market after underwriting and origination processing is complete.


Credit Unions perform similar functions, provide most of the same products and services.


Steps in Loan Origination

Stage 6

Closing

Loan documents signed and recorded


Typical Loan Decision Process


Current U.S. Mortgage Requirements Credit Scores — A credit score of 600 or higher for FHA loans, and 620 or higher for conventional

mortgages. Down Payments — A veteran or VA loan does not require a down payment. With an FHA the down

payment could be as low as 3.5%. Conventional mortgages generally require a down payment of at least 5%, and often 20%.

Debt Ratios — Lenders are concerned with your combined debt ratio (a comparison between monthly earnings and debt expenditures). Generally not more of 45% of your income to cover your debts (including the new mortgage payment).

Funds for Closing — Your lender will check your bank account to make sure you have enough money to cover your closing costs. There are the various fees and charges you’ll accrue during the home-buying process. You may need to have these funds on deposit for at least 60 days in advance of loan closing.

Employment — Many lenders want to see at least two years of steady employment, documented with W-2s and paystubs.

Documents — As of 2012, documentation requirements became more stringent These include federal tax returns for the last two years, bank statements, pay stubs, employment letters and a list of any other assets you have. Most lenders today want the tax records to be sent directly from the IRS

Cash Reserves —Some leaders require extra money in the bank at closing, theoretically earmarked for your first few mortgage payments. Other lenders only care that you have enough to cover your down payment and closing costs.


Loan Qualification

Slide 15


Mortgage Interest Rates

More recently, the Federal Reserve has started a program of buying up mortgages and treasuries to pump more money into the markets and keep interest rates low.

Lenders typically match the interest rate on a mortgage to an index like 10 year treasury bonds.


Mortgage-Lending Institutions


Mortgage Loan Servicing

Function

Activities

Example Companies

Provides mortgage bankers with the ability to service mortgage loans, handle escrow accounts, property tax payments and insurance coverage.



Loan Servicing

Most mortgages are immediately sold to another investor by the originator.

This frees cash to originate another loan and generate additional fee income.

Still, someone has to collect the monthly payments and keep records. This is knows as loan servicing, and servicers usually keep a portion of the payments received to cover their costs.

There are three elements in the life of a mortgage loan:

The originator packages the loan for an investor

The investor holds the loan The servicing agent handles the paperwork


Asset Management

The asset management department within a mortgage holding company measures credit risk on residential loans by assessing a variety of factors. This division screens potential borrowers and keeps an eye on acquisitions to limit asset risk.

It also make investments in mortgage loans and securities backed by mortgages.

Employees in the asset management area of a mortgage holding company gather information about a loan, as well as the property, in order to make a complete evaluation of the asset.

They compile borrower information to develop strategies for exit plans for unsuccessful loans.


Regulatory Consulting

Mortgage holding companies provide financial institutions with regulatory consulting services to support company growth and profitability.

This consulting may include creating management services and solutions.

The client company's needs are assessed to provide workable solutions, and the mortgage holding company may provide services such as technology analysis, contract liability and forensic review.

Financial institutions that benefit from these services include banks and hedge funds.

Consulting is sometimes provided through the mortgage holding company's affiliates and subsidiaries.


Loss Mitigation

Mortgage holding companies provide loss mitigation through the use of plans designed to limit a lender's loss.

One function of a loss mitigation division is to analyze a borrower's ability to retain property by creating a portfolio containing borrower information, which helps the bank decide whether the homeowner can continue to pay his mortgage.

If the mortgage holding company's loss mitigation division concludes that the homeowner can continue to make payments, loss mitigation services may also include refinancing, loan modification approval and preparation of appropriate documents.

In the event that the division determines that the borrower is unable to keep the home, loss mitigation can provide short sale approval, streamlined short sales and "cash for keys" services to speed up or avoid the foreclosure process.


TYPES OF MORTGAGE LOANS


Primary Mortgage Market

Four basic types of mortgages are issued by financial institutions home mortgages are used to purchase one- to four-family

dwellings multifamily dwellings mortgages are used to

purchase apartment complexes, townhouses, and condominiums commercial mortgages are used to finance the purchase

of real estate for business purposes farm mortgages are used to finance the purchase of farms


Conventional Mortgage Loans

A type of mortgage in which the underlying terms and conditions meet the funding criteria of Fannie Mae and Freddie Mac.

About 35-50% of mortgages in the United States, depending on market conditions and consumer trends, are conventional mortgages.

In other words, Fannie Mae and Freddie Mac guarantee or purchase 35-50% of all mortgages.

Conventional mortgages may be fixed-rate or adjustable-rate mortgages. Conventional Mortgage Loans are eligible to be resold by the loan originator

in the secondary mortgage markets.


Non-Conforming Loans

Jumbo Loans Jumbo loans are too large to meet the guidelines of a conforming loan. For

example, if you are buying a home and the conforming loan limit is $417,000, but need a single mortgage for $500,000, it would be jumbo loan. As jumbo loans do not meet the standards of a conforming loan, they are more difficult to sell on in the secondary market.

Reasons for Non-Conforming Loan: Loan-to-Value Ratio (LTV). Credit Score and History. Documentation Problems. Total Debt. Recent Bankruptcy. Debt-to-Income Ratio (DTI)

Non-conforming loans are offered to borrowers who do not qualify for conforming loans. Though they are the only borrowing option for some home buyers, they typically have higher interest rates, and may carry additional upfront fees and insurance requirements. Loans can be non-conforming for several different reasons. The best-known type of non-conforming loan is the jumbo loan.


Federal Home Administration

The Federal Housing Administration, or "FHA", provides mortgage insurance on loans made by FHA-approved lenders throughout the United States and its territories.

FHA insures mortgages on single family and multifamily homes including manufactured homes and hospitals. It is the largest insurer of mortgages in the world, insuring over 34 million properties since its inception in 1934.

An FHA refinance mortgage or FHA loan allows for the refinance or purchase of a home with a low down payment. These loans are great for the first-time homebuyer.


Types of Mortgages

The two basic types of Mortgages are : Fixed Rate Mortgage The Adjustable Rate Mortgage (ARM)

While the marketplace offers numerous varieties within these two categories, the first step when shopping for a mortgage is determining which of the two main loan types - the fixed-rate mortgage or the adjustable-rate mortgage - best suits your needs.

Other types of Mortgages are : Interest Only Mortgage Biweekly Mortgage Two step Mortgage Federal Housing Authority (FHA) Mortgage Veterans Affairs Loan


Fixed Rate Mortgage

This is the most common type of residential home loan.

It is repaid through fixed monthly payments of principal and interest over a set term.

The borrowing rate stays the same over the life of the residential mortgage loan.

Merits Repayments stay the same regardless of interest rate increases. Easier to budget because repayments do not change.

Demerits Repayments do not decrease when interest rates decrease. You can’t pay off lump sums or increase your monthly repayments. If you switch mortgage to a different rate, to a different provider or repay it early you may owe a

fixed rate penalty


Fixed Rate Mortgage

Advantages Stability: With your mortgage rates fixed, the

loan period set, you know what your mortgage payment will exactly be for the whole life of the residential loan.

Using a 30 year fixed mortgage of $150,000 as an example, if the borrowing rate is 6.50%, the monthly payment would be $948.10.

If the mortgage interest rate is 8.50%, the mortgage monthly payment would amount to $1,153.37.

The difference in monthly payments is $205.27.

Disadvantages Affordability: If mortgage interest rates are

high, you might have difficulty making the high mortgage payments. The home loan in this situation might not be approved.

High payments in a high mortgage rate environment: Nobody wants to be saddled with high home mortgage payments over the long term.

Slide 15


Adjustable Rate Mortgage

The adjustable rate mortgage or ARM is a combination of a fixed rate mortgage and a floating rate mortgage.

At the beginning of the mortgage term, the mortgage rate is fixed for certain periods.

These periods could be for 3, 5, 7 or 10 years. After this period expires, the mortgage interest rate becomes adjustable.


The Adjustable Rate Mortgage (ARM)

• The market derived interest rate which is used as a base to set future rates of the ARM mortgage loan. Depending on the index chosen, the rate could be adjusted monthly, quarterly, semi-annually or annually. The index could be pegged to the following: Treasury Bill Rates, The Prime Rate, Libor and 6 month CD.

Index:

• This is the spread added to the index to determine the actual rate charged to the mortgage borrower. Example: Index is based on One Year Treasury Bills 3%. The margin is 2%. The mortgage rate the borrower pays is 5%. Rate = Index Rate + Margin.

Margin:

• This is the duration for which the mortgage interest rate is fixed. If the adjustment period is one year, then the interest rate will remain fixed for one year, after which time it will adjust.

Adjustment Period:

• This is the maximum the interest rate can adjust either up or down for each adjustment period. Example: The adjustment cap is 1 point. The index based interest rates since the last adjustment period went up 1.5 points.

Adjustment Cap:

• The maximum mortgage interest rate charged over the duration of the arm mortgage loan. The cap can be as high as 6%. The cap is based on the interest rate from the first year adjustment period. The rate is 5%. The highest the mortgage interest rate can go is 11% (Base Rate + Lifetime Cap).

Lifetime Cap:

There are several components that go into calculating the ARM mortgage.


The Adjustable Rate Mortgage (ARM)

As interest rates remain at record low rates, more people select a fixed-rate loan, as they will be more affordable.An ARM is more attractive when interest rates are rising, you can still qualify for a mortgage, and plan for a rate increase if it happens.


The Adjustable Rate Mortgage (ARM) Merits

Repayments may fall when interest rates fall.

You can increase your repayments. You can pay off lump sums. You can apply for a payment break/

holiday. The margin is less on a tracker rate

or LTV rate when your LTV is lower.

Demerits Repayments may increase when interest rates increase. More difficult to budget for repayments because of uncertainty

with rates.


Adjustable Rate Mortgage

Advantages Teaser Rate: This is the starting interest rate of the arm

adjustable rate mortgage. It is usually referred to as the teaser rate, since it is lower than the fully indexed rate.

Affordability: If current mortgage rates this may be the only option available to you.

Interest rates have peaked: By going with an adjustable rate mortgage arm at the peak of the interest rate cycle, the successive rates will be lower as interest rates go down.

Disadvantages Complicated to understand: Unlike a fixed rate

mortgage that is simple to understand,

Interest rates have bottomed out: By going with an adjustable rate mortgage arm at the bottom of the interest rate cycle, successive borrowing rates will likely go higher as interest rates go down.

Uncertainty: If you plan to be at your property for more than 7 years, you will be dealing with the uncertainty associated with an ARM mortgage.


Interest Only Mortgage An interest only home mortgage features no

payments of principal made at the beginning of the home loan.

The monthly payments consist only of mortgage interest only. Due to the lower monthly mortgage payments, you qualify for a bigger residential loan.

After the interest only payment is over, you will begin making payments on your mortgage principal.

Your monthly mortgage payment will go up considerably. For example, you took out a 15/30 year interest only mortgage. After the 15th year, the principal balance will be amortized over 15 years. With a $175,000 home loan with a mortgage borrowing rate of 6.50%, the

interest only monthly payment is $947.92. When the principal payments kick in after the 15th year, the mortgage monthly

payment jumps to $1,524.44.


Interest Only Mortgage


Interest Only Mortgage

Advantages Lower mortgage payments

The lower monthly mortgage payments let you purchase a home where a fixed mortgage loan would not.

You get to jump on the housing bandwagon Free up cash to invest the money elsewhere

Instead of using the cash to pay down your mortgage principal, you can invest in other vehicles such as stocks and mutual funds to generate a superior return.

Disadvantages Income Risks: There are no assurances that

your income will rise fast enough to cover the higher monthly mortgage payments.

Property Risks: Instead of the property rising fast enough to pay off your interest only home mortgage, it could stay at current levels or even drop. As a result, you might require another loan just settle the interest only mortgage loans.

No guarantee of getting superior returns in other investments: If you used the money to generate returns in investments such as equities and mutual funds, there is no guarantee you’ll make money.

Slide 24


Biweekly Mortgage

In Biweekly Mortgage, mortgage payments are made every two weeks. The amount paid is half of what your monthly mortgage payment would be.

On an annualized basis, there are two extra payments in a year. You will be making 26 biweekly mortgage payments instead of 24 payments.

A biweekly mortgage program has you paying down your principal mortgage earlier.

As a result, you’ll save significant amounts in mortgage interest and pay off your home mortgage years earlier. Example: 30 year fixed mortgage $175,000 Interest Rate: 6.75%

By opting for a biweekly mortgage payment plan for this mortgage, you will be saving $54,257.52 in mortgage interest. Your mortgage will be paid off 5 years 9 months earlier.


Biweekly Mortgage


Two Step Mortgage

A two step mortgage is essentially a 30 year mortgage with special features: Convertible or non-convertible.

These mortgage loans are also known as 5/25s and 7/23s. The 5/25s has a fixed interest rate for the

first five years and then switches to either a 25 year fixed mortgage rate or a 1 year adjustable mortgage rate.

The 7/23 has a fixed interest rate for the first seven years and then converts to a 23 year fixed or a 1 year adjustable.

The starting home loan rate is lower than a 30-year fixed. However, it is higher than a 1-year ARM mortgage.

This type of residential mortgage is less risky than a mortgage ARM initially since the adjustment interval is longer.


Other Types of Mortgages

Automatic rate-reduction mortgages Graduated-payment mortgages (GPMs) Growing-equity mortgages (GEMs) Second mortgages and home equity loans Shared-appreciation mortgages (SAMs) Equity-participation mortgages (EPMs) Reverse-annuity mortgages (RAMs)


MORTGAGE TERMS TO KNOW


Common Mortgage Terms

Annual percentage rate (APR)-The actual cost of borrowing money, expressed in the form of an annual rate to make it easier to compare the cost of borrowing money among several lenders or sellers on credit. The APR includes all the financing costs of a mortgage, including points, origination fees and other finance charges and the mortgage interest.

Point-A fee or charge equal to one percent (1%) of the principal amount of the loan which is collected by the lender at the time the loan is made. It is collected only once. Generally the lower the interest rate, the more points you'll pay.

PITI – Principal, interest, taxes, insurance. The total monthly payment if fully amortized. PITI also used to calculate reserve requirements for asset documentation .

LTV – Loan to Value – Percentage of a homes value owed on a mortgage.

CLTV – Combined Loan to Value – This is the total percentage of a home’s value owed on all mortgages combined


Common Mortgage Terms

DTI – Debt to Income Ratio – Represented as a percentage, this is the ratio between debts and income.

Amortize-Paying off a debt by making regular instalment payments over a set period of time, at the end of which the loan balance is zero.

Deed-A legal document under which ownership of a property is conveyed.

3-Day Right of Rescission – A period of 3 full business after the signing of a mortgage that the borrower has to rescind, or change his mind, and cancel the loan without any negative consequences.


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Summary of Book

Book summary: From bank failures to home foreclosures and panic around the world, Figuring Out Wall Street, is the concise guide to help everyone understand how this latest crisis happened, who was responsible and what to do now to restore our financial systems. Written in an easy to understand manner, even the most complex financial concepts are easy to digest. This book provides help to monitor investments with a review of investment products, financial regulators and economic indicators. Learn how the stock market exchanges work and the world of investment banking, hedge funds, venture capital and private equity. Every chapter includes action plans for investing.

Figuring Out Wall Street Consumer’s Guide To Financial Markets By Floyd Saunders Publisher: Saunders Learning Group

ISBN: 978-0-9824019-0-3

available from Amazon, B&N, and http://www.figuringout wallstreet.comor www.floydsaunders.com

Author Contactemail: [email protected]

Blog: www/money/floydsaunders.com

Twitter @floydsaunders

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mailto:[email protected]


About the Presenter/Author

Floyd Saunders has worked on Wall Street with both Bank of America and JPMorgan, where is was a vice president in global financial systems. He has worked across the industry in retail, commercial, and investment banking.

He has taught courses in Money and Banking and extensively for the American Institute of Banking and various colleges.

As a consultant, he developed and taught a wide range of banking and investing courses.

He authored three programs for the American Bankers Association: Banking on Mutual Funds and Annuities, Introduction to Securities Markets and Investing in Securities.

Economy & Finance

Mortgage banking overview