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Chapter 5: Mortgage loans

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  1. Chapter 5: Mortgage loans Andrew Davidson Anthony B. Sanders Lan-Ling Wolff Anne Ching

  2. What is a Mortgage? • A mortgage is an instrument in which the title to real estate is held as a security against the repayment of a debt. • A lien is a legal claim on the property that allows the lien holder to satisfy the debt through foreclosure and sale of the property, if necessary. Chapter 5

  3. Mortgage deed and promissory note • All mortgages are basically composed of two parts: 1) the mortgage deed or deed of trust, and 2) the promissory note. • The mortgage deed describes the real estate to be used as collateral against the repayment of the note. • A deed of trust is similar to a mortgage deed except that the borrower creates a trust and conveys the title of the property to a trustee who holds it as security for the benefit of the lender. • The promissory note is a personal promise to repay the note, and even in the absence of any real estate security, the borrower would still have an obligation to repay the note. • The note spells out the financial terms of repayment as well as the rights and interest of the lender and borrower. Chapter 5

  4. Title theory and lien theory • There are two general approaches used in most states to establish the legal relationship between a borrower and a lender. • One is called title theory, where title is held by, or rests with, the mortgagee (lender). • The other is called lien theory, where the mortgagor (borrower) retains title and the mortgagee merely has a lien against the property. • Lien theory is more modern in origin and the most common approach in most states, although many states have a hybrid approach encompassing both theories in part. Chapter 5

  5. Size of the mortgage market • The mortgage market in the U.S. is the largest in the world and has exceeded $7.5 trillion as of 2001 in terms of mortgage debt outstanding (see Table 5.1). • Mortgages can be categorized by either the type of underlying property or by the type of institution that holds or owns the mortgage loans. • In terms of property type, Table 5.1 shows that the outstanding mortgage debt is dominated by residential property also commonly referred to in mortgage parlance as 1-4 Family. • Commercial mortgages represent the second largest segment of outstanding mortgage debt with over $1.3 trillion as of 2001. Chapter 5

  6. Size of the mortgage market Chapter 5

  7. Types of mortgages • Fixed-rate mortgages • Maturity (30 year and 15 year) • Type (conforming and non-conforming) • Adjustable-rate mortgages • Key terms: • LTV • Points • Lock • APR Chapter 5

  8. Types of mortgages (example) Chapter 5

  9. Fixed-rate mortgages • A fixed-rate mortgage has a fixed-rate of interest for the term of the loan. • Loan terms can vary from 15 to 30 years, although other terms are available as well. • There are several variations of amortizing mortgages. • Constant payment mortgage(CPM). • Constant interest mortgage (CIM). • Constant amortization mortgage (CAM) Chapter 5

  10. Comparative mortgage designs Chapter 5

  11. The constant payment mortgage Chapter 5

  12. Amortization of mortgages Chapter 5

  13. Adjustable-rate mortgages • ARMs differ from fixed-rate mortgages in that the rate on the mortgage varies every month or year (depending on the terms of the ARM). • There are a number of variations on the adjustable rate mortgages (also known as variable rate mortgages). • Adjustable rate mortgages are not as popular in the current low interest rate environment, but may return to popularity when interest rates begin to increase. Chapter 5

  14. Features of ARMs • ARM Indexation • Adjusting the ARM Payment • Adjustable Rate Mortgage with Capped Payments • Adjustable Rate Mortgage Terms Chapter 5

  15. Other mortgage types • Graduated payment mortgages • Shared appreciation mortgages • Reverse annuity mortgages Chapter 5

  16. Mortgage Default and Legal Issues Concerning Mortgages • What is “Default?” • What is “Foreclosure?” • Why Most Mortgages Don’t Proceed to the Foreclosure Stage Chapter 5

  17. Important Clauses in Uniform Mortgages • Acceleration Clause • Defeasance Clause • Prepayment Clause • Subordination Clause • The Estoppel Clause Chapter 5

  18. Issues in mortgages • Mortgage priority • Due-on-sale clause • Redlining • The FNMA/FHLMC Uniform Loan Contract Chapter 5