Chapter 19 residential real estate finance
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Chapter 19 Residential Real Estate Finance. Major Topics. Primary and secondary mortgage markets Conventional, FHA and VA mortgages The Effect of Points on Mortgage Choice Mortgage Underwriting Criteria. Changes in Financing. More loan types

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Chapter 19 residential real estate finance
Chapter 19Residential Real Estate Finance

Major topics
Major Topics

  • Primary and secondary mortgage markets

  • Conventional, FHA and VA mortgages

  • The Effect of Points on Mortgage Choice

  • Mortgage Underwriting Criteria

Changes in financing
Changes in Financing

  • More loan types

  • Secondary mortgage market and loan securitization

  • Easier to qualify

Mortgage markets
Mortgage Markets

  • Primary market = loans are created

    • Borrowers and lenders

  • Secondary market = loans are sold/securitized

    • FNMA, GNMA, life insurance companies, pension funds

Secondary mortgage market
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

Fannie mae
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

Freddie mac
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

Importance of fannie mae and freddie mac
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

Secondary mortgage market1
Secondary Mortgage Market

Other benefits:

1. R risk shifted (some)

2. More funds available for lending (liquidity)

3. Geographic diversification

Ginnie mae
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?

Mortgage backed securities
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

Pass through securities
Pass-through Securities

  • Issued by investment bank, originator, or FNMA, FHLMC

  • Security = ownership rights to pool of mortgage

  • Minimum pool size usually $100M

  • CF’s from pool (less fees) are passed-through to investors

Pass through securities1
Pass-through Securities

Pass-through risk:

1. No default risk

2. R risk

3. Prepayment risk

Conventional loans
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)


Private mortgage insurance pmi
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)


  • 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 (Homeowner’s Insurance Act of 1999)

  • Obligation to terminate when loan falls to 78% of original value

Pmi example
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

  • Lender’s loss: $94,000 – $90,000 = $4,000

  • With loss less than $19,000, PMI covers it completely

Fha insured mortgages
FHA-Insured Mortgages

  • FHA is strictly a loan insurance program

  • Loans are from private lenders

    • Max < $200K

  • 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%


  • Why default?

    • Can’t 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

Assessing the probability of default
Assessing the probability of default

  • 5 major criteria:

    • Income

    • Other Debt Obligations

    • Housing Expenses

    • Credit Evaluation

    • Net Worth

  • Creation of single statistical score

Email from a mortgage lender
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