MORTGAGE

MARKETS
MORTGAGES AND
MORTGAGE-BACKED
SECURITIES
MORTGAGES AND
MORTGAGE-BACKED
SECURITIES
▪ Mortgages are loans to individuals or businesses to purchase a home, land, and other real
property.
▪ Many mortgages, particularly residential mortgages, are subsequently securitized by the
mortgage holder– they are packaged and sold as assets backing a publicly traded or privately
held debt instrument.
▪ Securitization allows financial institutions’ asset portfolios to become more liquid, reduces
interest rate risk and credit risk, provides financial institutions with a source of fee income, and
helps reduce the effects of regulatory constraints such as capital requirements, reserve
requirements, and deposit insurance premiums on FI profits.
MORTGAGES AND
MORTGAGE-BACKED
SECURITIES
We examine mortgage markets separately from bond and stock markets for several reasons:
1. Mortgages are backed by a specific piece of real property. If the borrower defaults on a
mortgage, the financial institution can take ownership of the property. All other corporate
bonds/stock give the holder a general claim to a borrower’s assets.
2. There is no set size or denomination for primary mortgages. Rather, the size of each
mortgage depends on the borrower’s needs and ability to repay. Bonds generally have a
denomination of $1,000 (or P50,000) or a multiple of $1,000 (or P50,000) per bond and
shares of stock are generally have a denominations of P1 per share.
MORTGAGES AND
MORTGAGE-BACKED
SECURITIES
3. Primary mortgages generally involve a single investor (e.g. bank or mortgage company).
Bonds, on the other hand, generally held by many investors.
4. Because primary mortgage borrowers are often individuals, information on these borrowers
is less extensive and unaudited. Bonds and stocks are issued by publicly traded corporations
that are subject to extensive rules and regulations regarding information availability and
reliability.
PRIMARY MORTGAGE
MARKET
PRIMARY MORTGAGE
MARKET
Four basic categories of mortgages issued by financial institutions:
1. Home mortgages – used to purchase one-to-four family dwellings.
2. Multifamily dwelling mortgages – used to finance the purchase of apartment complexes,
town houses, and condominiums.
3. Commercial mortgages – used to finance the purchase of real estate for business purposes.
4. Farm mortgages – used to finance the purchase of farms.
5. Chattel mortgages – used to finance the purchase of movable personal property.
MORTGAGE
CHARACTERISTICS
▪ All mortgage loans are backed by a specific piece of property that serves as collateral to the mortgage
loan. As part of the mortgage agreement, the financial institution will place a lien against property that
remains in place until the loan is fully paid off.
▪ Lien – A public record attached to the title of the property that gives that financial institution the right
to sell the property if the mortgage borrower defaults.
▪ As part of any mortgage agreement, a financial institution requires the mortgage borrower to pay a
portion of the purchase price of the property (down payment) at the day the mortgage is issued.
▪ A down payment decreases the probability that the borrower will default on the mortgage.
▪ A mortgage borrower who makes a large down payment invests more personal wealth into the home
and, therefore, is less likely to walk away from the house should property values fall, leaving the
mortgage unpaid.
MORTGAGE
CHARACTERISTICS
▪ Private mortgage insurance (PMI) – Insurance contract purchased by a mortgage borrower
guaranteeing to pay the financial institution the difference between the value of the property
and the balance remaining on the mortgage.
▪ Mortgages may come from government (e.g. National Home Mortgage Finance Corporation)
or private financial institutions.
▪ A mortgage generally has an original maturity of either 15 or 30 years.
MORTGAGE
CHARACTERISTICS
▪ Mortgage contracts specify whether a fixed or variable rate of interest will be paid by the
buyer.
▪ A fixed-rate mortgage locks in the borrower’s interest rate and thus required monthly
payments over the life of the mortgage, regardless of how market rates change.
▪ The interest rate on an adjustable-rate mortgage (ARM) is tied to some market interest rate
or interest rate index. Thus, the required monthly payments can change over the life of the
mortgage.
▪ ARMs generally limit the change in the interest rate allowed each year and during the life of
the mortgage (called caps). For example, an ARM might adjust the interest rate based on the
average T-Bill rate plus 1.5%, with caps of 1.5% per year and 4% over the life of the mortgage.
MORTGAGE
CHARACTERISTICS
▪ Discount points are fees or payments made when a mortgage loan is issued.
▪ For example, if the borrower pays 2 points up front on a P100,000 mortgage, he/she must pay
P2,000 (P100,000 x 2%) at the closing of the mortgage. While the mortgage principal is
P100,000, the borrower effectively has received P98,000.
▪ In exchange for points paid up front, the principal institution reduces the interest rate used to
determine the monthly payments on mortgage.
MORTGAGE
CHARACTERISTICS
▪ In addition to interest, mortgage contracts generally require the borrower to pay an assortment
of fees to cover the mortgage issuer’s costs of processing the mortgage. These include such
items as:
▪ Application fee – covers the issuer’s initial costs of processing the mortgage application and obtaining
a credit report.
▪ Title search – confirms the borrower’s legal ownership of the mortgaged property and ensures there
are no outstanding claims against the property.
▪ Title insurance – protects the lender against an error in the title search.
▪ Appraisal fee – covers the cost of an independent appraisal of the value of the mortgaged property.
▪ Loan origination fee – covers the remaining costs to the mortgage issuer for processing the mortgage
application and completing the loan.
▪ Closing agent and review fees – covers the costs of the closing agent who actually closes the
mortgage.
MORTGAGE
CHARACTERISTICS
▪ Mortgage refinancing occurs when a mortgage borrower takes out a new mortgage and uses the
proceeds obtained to pay off the current mortgage.
▪ Mortgage refinancing involves many of the same details and steps involved in applying for a
new mortgage and can involve many of the same fees and expenses.
▪ Mortgage are most often refinanced when a current mortgage has an interest rate has an
interest rate that is higher than the current interest rate.
MORTGAGE AMORTIZATION
▪ The fixed monthly payment made by a mortgage borrower generally consists partly of
repayment of the principal borrowed and partly of the interest on the outstanding (remaining)
balance of the mortgage.
▪ Amortization schedule – Schedule showing how the monthly mortgage payments are split
between principal and interest.
MORTGAGE AMORTIZATION
Calculation of Monthly Mortgage Payments
You plan to purchase a house for P150,000 using a 30-year mortgage obtained from your local
bank. The mortgage rate offered to you is 8% with zero points. In order to forgo the purchase of
private mortgage insurance, you will make a down payment of 20% of the purchase price at
closing and borrow P120,000 through the mortgage.
1. Compute for the monthly payments on mortgage.
2. Compare it if the agreement is only for 15 years.
MORTGAGE AMORTIZATION
Analyzing the Choice between Points and Monthly Payments of Interest
You plan to purchase a house for P150,000 using a 30-year mortgage obtained from your local
bank. You will make a down payment of 20% of the purchase price, in this case, equal to
P30,000. Thus, the mortgage loan amount will be P120,000. Your bank offers you the following
two options for payment:
▪ Option 1: Mortgage rate of 8% and zero points
▪ Option 2: Mortgage rate of 7.75% and 2 points.

Which one is better?

OTHER MORTGAGES
▪ Jumbo mortgages – Mortgages that exceed the conventional mortgage conforming limits.
▪ Subprime mortgages – Mortgages to borrowers who have weakened credit histories.
▪ Alt-A mortgages – Short for Alternative A-paper; mortgages that are considered more risky
than a prime mortgage and less risk than a subprime mortgage.
▪ Option ARMs – Adjustable rate mortgages that offer the borrower several monthly payment
options.
▪ Second mortgages – Loans secured by a piece of real estate already used to secure a first
mortgage.
▪ Home equity loan – Loans that let customers borrow on a line of credit secured with a second
mortgage on their homes.
OTHER MORTGAGES
▪ Reverse-annuity mortgage (RAM) – A mortgage for which a mortgage borrower receives
regular monthly payments from a financial institution rather than making them. When the
RAM matures (or the borrower dies) the borrower (or the estate of the borrower) sells the
property to retire the debt.
SECONDARY MORTGAGE
MARKET
MORTGAGE SALES
▪ Financial institutions have sold mortgages and commercial real estate loans among themselves.
▪ A large part of correspondent banking involves small banks making loans that are too big for
them to hold on their balance sheets—either for lending concentration risk or capital adequacy
reasons—and selling parts of these loans to large banks with whom they have had a long-term
deposit and lending correspondent relationship. In turn, large banks often sell parts of their
loans, called participations, to smaller banks.
▪ A mortgage sale occurs when a financial institution originates a mortgage and sells it with or
without recourse to an outside buyer.
▪ Recourse – The ability of a loan buyer to sell the loan back to the originator should it go bad.
MORTGAGE SALES
▪ If the mortgage is sold without recourse, the financial institution not only removes it from its
balance sheet but also has no explicit liability if the mortgage eventually goes bad.
▪ If the mortgage is sold with recourse, under certain conditions, the buyer can return the
mortgage to the selling financial institution; therefore, the financial institution retains a
contingent credit risk liability.
MORTGAGE-BACKED
SECURITIES
▪ Pass-Through Securities – Mortgage-backed securities that “pass through” promised
payments of principal and interest on pools of mortgages created by financial institutions to
secondary market participants holding interests in the pools.
▪ Mortgage-backed bonds – Bonds collateralized by a pool of assets.