Professional Documents
Culture Documents
Mortgages &
Mortgage-Backed Securities
Mortgage Markets
These are markets where funds are
borrowed to finance the acquisition
of houses.
A mortgage is a pledge of property to
secure payment of a debt.
Such loans are made by banks and
financial institutions, and are
collateralized by the property so
acquired.
Mortgages
The borrower is the mortgagor.
The lender is the mortgagee.
In 1990 the mortgage finance
market in the U.S. was larger than
the markets for U.S government
securities and U.S. corporate bonds
combined.
Mortgage Originators
The entity that initiates the
mortgage loan is called the
Originator.
Originators include:
Commercial Banks
Life Insurance Companies
Pension Funds
Savings & Loan Institutions or Thrifts
Sources of Income For The
Originator
They charge an origination fee.
This is expressed in terms of points.
A point is 1% of the borrowed funds.
For instance a fee of 2 points on a loan of
$100,000 is $2,000.
The originators can subsequently sell
the loans in the secondary market.
If interest rates have declined they
will make a capital gain.
Income For The Originator
If the originator chooses to hold the
loan as an asset, he will earn interest
income.
Credit Evaluation
Before extending a loan the originator
will make a credit check.
There are two main factors to be
evaluated.
The Payment to Income Ratio (PTI)
It is the ratio of the monthly installment due
from the mortgage to the applicant’s monthly
income.
The lower the PTI the better the chances of
getting the loan.
Credit Evaluation
Loan to Value Ratio (LTV)
It is the ratio of the loan amount to the
market value of the property.
The lower the ratio, the more is the
protection for the lender.
Mortgage Servicing
Once a loan is made, it has to be
serviced.
Servicing can be done by the
lender himself, or can be
contracted out to an external
agency.
Servicing
Servicing involves the following activities.
Collection of monthly payments.
Sending payment notices to the mortgagors.
Sending reminders for overdue payments.
Maintaining records of outstanding principal.
Initiating foreclosure proceedings if required.
Sources of Income For The
Servicer
He gets a servicing fee.
The fee is a fixed percentage of the
outstanding mortgage balance.
As each installment is made, the
outstanding balance will decline.
Hence so will the servicing fee.
Servicing Income
Servicers also earn a float on the
monthly mortgage payment.
This is because there is a delay
between the time they receive the
payment and the time they pass it on
to the lender.
They also earn a late fee if
payments are overdue.
Mortgage Insurance
Lenders require mortgage insurance as a
safeguard against default.
The cost is borne by the borrowers in the form
of a higher rate of interest.
Many mortgagors acquire Credit Life
Insurance from life insurance companies.
Such insurance provides for a continuation of
monthly payments even if the mortgagor were
to die.
Thus dependents will not lose possession of
the property.
Features of a Traditional
Mortgage
A traditional mortgage is known as
a Level Payment Mortgage.
Borrowers make fixed monthly
payments consisting partly of
principal repayment and partly of
interest on the outstanding balance.
Loans which are paid off in such a
fashion are called Amortized Loans.
Features of Amortized
Loans
Mortgages are usually for 20 years (240 months)
or for 30 years (360 months).
The interest component is equal to one twelfth the
annual rate of interest multiplied by the amount
outstanding at the beginning of the previous month.
With the payment of each installment, the interest
component will keep declining and the principal
component will keep increasing.
Amortization
It refers to the process of repaying a loan
by means of equal installments at periodic
intervals.
The installment payments form an annuity
whose present value is equal to the
original loan amount.
A Amortization Schedule is a table that
shows the division of each payment into
principal and interest, and the
outstanding loan balance after each
payment.
Calculating The
Installment
Consider a loan to be of $L to be
repaid by way of N installments of
$A each.
Let the periodic interest rate be `r’.
L = A xAPVIFA(r,N)1=
x[1 − ]
r (1 +r ) N
Example
A person has taken a loan of
$10,000.
It has to be paid back in 5 equal
annual installments.
Interest rate is 10% per annum.
L = A x PVIFA(10,5) = A x 3.7908
A = 2,637.97
Amortization Schedule
Year Payment Interest Principal Outstandin
Repayment g Principal
0 10,000
1 2637.97 1000 1637.97 8362.03