Chapter 19 Residential Real Estate Finance

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Chapter 19Residential Real Estate Finance
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Major Topics

• Primary and secondary mortgage markets
• Conventional, FHA and VA mortgages
• The Effect of Points on Mortgage Choice
• Mortgage Underwriting Criteria

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Changes in Financing

• More loan types
• Secondary mortgage market and loan
  securitization
  
• Easier to qualify

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Mortgage Markets

• Primary market loans are created
• Borrowers and lenders
• Secondary market loans are sold/securitized
• FNMA, GNMA, life insurance companies, pension
  funds
  

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Secondary Mortgage Market

• Fannie Mae (1968) Spun from HUD to become a
  primary purchaser of FHA and VA mortgage loans
  
• Ginnie Mae (1968) Empowered to guarantee
  pass-through mortgage-backed securities based
  on FHA and VA loans
  
• Freddie Mac (1970) Formed to purchase and
  securitize conventional home loans from savings
  associations

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Fannie Mae

• Original mission Secondary market for FHA/VA
• Now privately owned but still under U.S. charter
• Public mission for housing
• U.S. Treasury financial credit line available
• Surpasses Freddie Mac in buying conventional
  loans
  
• Has securitized and sold, or owns, about 25 of
  outstanding home loans

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Freddie Mac

• Has congressional charter
• Deals exclusively in conventional loans
• Securitized all loans purchased until recent
  years
  
• Has securitized and sold, or owns, about 18 of
  outstanding home loans

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Importance of Fannie Maeand Freddie Mac

• Have brought about standardization in
• Mortgages and mortgage notes
• Appraisal forms and practices
• Underwriting procedures and standards
• Have increased liquidity of mortgage markets
• No interstate differentials in mortgage interest
  rates
  
• No mortgage lending interruptions when interest
  rates rise
  
• New sources of mortgage funds through security
  investors

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Secondary Mortgage Market

• Other benefits
• 1. R risk shifted (some)
• 2. More funds available for lending
  (liquidity)
  
• 3. Geographic diversification

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Ginnie Mae

• Does not buy mortgages
• Guarantees timely payment of interest and
  principal to holders of GNMA securities.
  
• Guarantees only securities based on FHA/VA loans
• Why necessary if already insured?

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Mortgage-Backed Securities

• Multiple mortgage loans in a single pool or fund
• Security entitles investor to pro rata share of
  all cash flows
  
• Loans in a given pool will be similar
• FHA/VA conventional
• Same vintage (new or recent loans)
• Similar interest rates
• Nearly two-thirds of all new home loans have been
  securitized in recent years

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Pass-through Securities

• Issued by investment bank, originator, or FNMA,
  FHLMC
  
• Security ownership rights to pool of mortgage
• Minimum pool size usually 100M
• CFs from pool (less fees) are passed-through to
  investors

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Pass-through Securities

• Pass-through risk
• 1. No default risk
• 2. R risk
• 3. Prepayment risk

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Conventional Loans

• Conforming conventional home loan Meets the
  requirements for purchase by Freddie Mac or
  Fannie Mae
  
• Standard note
• Standard mortgage
• Standard appraisal
• Size limit Currently 417K
• Interest rate advantage due to liquidity (at
  least .25)
  
• Nonconforming loan Does not meet Fannie
  requirements in some respect
  
• Jumbo Nonconforming in terms of size (currently
  417K)
  
• http//www.bankrate.com/brm/news/mtg/mtg_blurbs/ra
  tes.asp

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Private MortgageInsurance (PMI)

• Protects lender against losses due to default
• Generally required for loans with Loan-to-Value
  ratio 80
  
• Protects lender for losses up to 20 of loan
• Example terms
• 2.5 percent of loan in single up-front premium
• 0.5 percent annual premium (0.041 per month)

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PMI

• Termination may be allowed if LTV ratio falls
  below 80 of current value and borrower is in
  good standing
  
• Must allow termination when loan falls to 80 of
  original value (Homeowners Insurance Act of
  1999)
  
• Obligation to terminate when loan falls to 78 of
  original value

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PMI Example

• House price 100,000
• Loan amount 95,000
• PMI, insuring top 20 First 19,000 in losses
• Borrower pays down loan to 94,000
• Defaults Foreclosure sale at 90,000
• Lenders loss 94,000 90,000 4,000
• With loss less than 19,000, PMI covers it
  completely

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FHA-Insured Mortgages

• FHA is strictly a loan insurance program
• Loans are from private lenders
• Max
• 3 minimum down payment required
• 97.75 maximum
• Insures 100 of loan
• After foreclosure, title is transferred to
  Housing and Urban Development (HUD)
  
• Premiums
• Up-front premium 1.50, which can be included in
  loan
  
• Yearly 0.50

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Underwriting

• Why default?
• Cant afford to pay
• Negative equity
• Traditional underwriting
• Income Ratios
• Housing expense ratio PITI Monthly Income
• Total expense ratio Total payments Monthly
  Income
  
• FNMA required 28, 36 max for fixed rate loans
• Loan-to-Value ratio

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Assessing the probability of default

• 5 major criteria
• Income
• Other Debt Obligations
• Housing Expenses
• Credit Evaluation
• Net Worth
• Creation of single statistical score

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Email from a mortgage lender

• Nah, not really.  We have a Fast and Easy
  (reduced documentation, no income or asset
  verification) that allows 55!  People really max
  it out sometimes.  Minimum requirement is 680
  FICO and 10 down.   That 36 stretches out
  with ARMs and stuff like that, too.  If somebody
  has like 42 with a lot of reserves, that'll go
  through.   Usually 45 is the benchmark, with a
  "speed limit" of 48-49, sometimes 50 depending
  on credit and reserves.  I can get anyone
  approved. Sincerely,Val

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