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Mortgage Loans

Mortgage Loans

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Mortgage Loans

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Presentation Transcript

  1. Mortgage Loans Fixed Income Securities

  2. Outline • What is a mortgage? • Major Originators • Alternative Mortgage Instruments • Prepayments and their impacts on cash flows • Risks of investing in mortgages • Factors that affect default on mortgage loans

  3. What is a Mortgage? • A loan that is secured by the collateral of specified real estate property, which obliges the borrower to make a predetermined series of payments. • In the event of default by the borrower, the lender can sell off the property

  4. General Features of a Mortgage Loan • Loan is based on the credit of the borrower and the collateral for the mortgage—Conventional Mortgage • Mortgage Insurance • Usually, amount of loan less than the market value of the property • Classified as one to four family homes (residential property) and income property (office space and apartment buildings) • Loan originators include: thrifts, mortgage companies, and commercial banks for income property

  5. Loan originators for income property include commercial banks, thrifts, and insurance companies • Usually, mortgage companies sell most of their mortgages in the secondary market • Two primary factors that determine whether loan should be extended or not: • The payment to income ratio • The loan to total value ratio

  6. Alternative Mortgage Instruments • Standard Fixed-rate mortgage • A borrower would take out a mortgage loan for a principal amount P and repay in equal monthly installments of M • Adjustable Rate Mortgage • A loan in which the contract rate is reset periodically in accordance with some pre-chosen reference rate, typically one based on short-term interest rate. • Graduated Payment Mortgage • Growing Equity Mortgage

  7. Fixed-Rate Mortgage and Interest Rate Risk • A rising term-structure can create a gap in the balance sheet of the lending institution

  8. ARM and Default Risk • If reference rate rises too much, risk of default rises

  9. Risks in Mortgage Loan Market • Default Risk • Loan to value ratio • Second mortgages behind first mortgage • Seasoning Effect • Liquidity Risk • Interest Rate Risk • Prepayment Risk