REE3043 Test 3 Study Guide Powerpoints Chapter 10 Primary Mortgage Market Where loans are originated placed Retail market or street market Players o Commercial banks o Credit unions thrifts o Mortgage bankers o Mortgage brokers Secondary Mortgage Markets Where existing home loans are resold o Wholesale market among leaders Government sponsored enterprises GSE s o Fannie Mae o Freddie Mac Government National Mortgage Association o Ginnie Mae GNMA Loan Securitization and its role Other loan securitizers Conventional Mortgage Loans Standard home mortgage loan o Oldest and most dominant loan form o Key is that it is not insured by FHA nor guaranteed by Department of Veterans Affairs and meets requirements to be purchased in the secondary market Will typically require the borrower to purchase private mortgage insurance PMI if less than 20 down payment on purchase i e 200 000 home purchase requires 40 000 down with 160 000 mortgage to avoid paying PMI Private Mortgage Insurance PMI o Protects the lender against losses due to default o Generally required for loans over 80 of value o Protects lender for losses up to 20 of loan o Insurer may allow termination of the insurance if loan falls below 80 of current value of the home and borrower is in good standing o o Must allow termination when loan falls to 80 of original value Homeowner s Insurance Act of 1999 o Must terminate when loan falls to 78 of original value o Example House price 100 000 Loan amount 95 000 PMI insuring top 20 First 19 000 in losses Borrower pays until loan balance is 94 000 Defaults Foreclosure sale at 90 000 Lender s loss 94 000 90 000 4 000 With loss less than 19 000 PMI covers it completely FHA Mortgages Federal Housing Administration Established to fulfill the goals of the National Housing Act of 1949 o To encourages homeownership and suitable living environments FHA loans are implemented with two primary features o Implemented as loan insurance program through the private market o Loan qualification requirements relaxed due to insurance provided lowered requirements allows payment to be larger portion of gross income How FHA Insurance Works o Insures 100 of loan o Premiums Up front premium 1 75 which can be included in loan Annual premium based on average balance 0 25 for loans of 15 years or less 0 50 for loans over 15 years but under 95 of value 0 55 for loans over 15 years and 95 of value Veterans Affairs VA Mortgage Loan Limited to qualified veterans of military service Loan can be up to 100 of value Guarantee limits to lender in event of default o Loans under 45 000 50 percent o Loans over 144 000 25 percent o Maximum guarantee One fourth of GSE loan limit Fee is based on loan to value ratio and service o Over 95 LTV 2 15 for active military 2 4 for other o Home 90 95 LTV 1 5 for active duty 1 75 for other o Up to 90 LTV 1 25 for active duty 1 5 for other Mortgage Types by payment Fixed Rate Level Payment Mortgage FRM LPM Fixed Rate Level Payment Mortgage o Noted interchangeably as FRM or LPM Adjustable Rate Mortgage ARM Hybrid Mortgage 5 1 3 1 ARM Subprime and Alt A Loans Home Equity Loans Others o Reverse Annuity Mortgage RAM o Purchase Money Mortgage owner financing o Package Mortgage o Noted interchangeably as FRM or LPM o Typically amortized over 30 year or 15 year period o Example Assume 200 000 loan at 4 5 annual rate paid monthly Determine the monthly payment if amortized over 30 years pmt 1 013 37 Determine the monthly payment if amortized over 15 years pmt 1 529 99 o Payments are typically amortized over 30 years o Interest rate is typically adjusted each year relative to an index e g 1 year T bill o Initial interest rate may include a teaser rate for the first year e g lower than market rate o The index plus the margin determines the market index rate however Annual interest rate changed are typically capped Interest rates over the life of the ARM are typically capped o Example Adjustable Rate Mortgage ARM Determine the contract interest rate applied in years 2 3 and 4 on an ARM with a 1 annual cap and a 5 lifetime cap i e ARM with 1 5 caps given the following index changes Adjustable Rate Mortgage ARM Hybrid ARM Yr 1 contract rate set with teaser rate i e market contract Yr 2 contract rate increase is capped at 1 Yr 3 contract rate must not be higher than market Yr 4 contract rate increase capped at 1 o Interest rate is fixed for some years then becomes adjustable o Payment is always fully amortizing o Fixed rate period ranges from three to ten years o Fixed rate is higher as its term is longer o Successfully blends the need of borrowers for predictable payments with the need of lenders for market level interest rates o Became unfortunately tainted in recent years due to association with sub prime lending Alt A Loans o More standard in type than sub prime o Usually relaxed one standard loan underwriting requirement Low or no cash down payment Weak credit score No documentation of borrower s finances o Majority were no doc or low doc loans Became referred to as liar loans o Not a unique design but a high risk underwriting standards o Wide spread abandonment of prudent underwriting Started at very high loan to value ratio Designed so that refinancing would become a necessary due to severe payment increases o Mostly 2 28 hybrid option ARM or Interest only o Almost all were adjustable rate o Low initial payment sometimes large negative amortization feature Options ARM often subprime or Alt A o Borrower could select among three types of payments Fully amortizing Interest only Minimum o Minimum payment based on a very low rate say 1 5 percent o Minimum payment increases 7 5 percent per year o Interest rate charged was adjustable usually deeply reduced for the first few months o With minimum payment the loan balance grew due to negative amortization Subprime Loans o At the end of five years or when the balance reaches 125 percent of the original loan the payment is recast to fully amortize the loan over its remaining term o Most borrowers unfortunately chose the minimum payment Payment and Balance of Alternate Loans Home Equity Loans o Mostly open end or line of credit loans HELOC o Some home equity loans are fixed term loans o Usually but not always limited to total mortgage debt sum of all mortgage loans of 75 to 80 of home value o Advantages Tax deductible interest Strength of the house as security provides favorable rate and longer term Reverse Mortgage Loan o Disadvantages o Converts home