UNIT 4
The Mortgage Markets
LEARNING OBJECTIVES
After studying this unit, you should be able to:
define the organization of the mortgage markets;
outline the basic components and structure of the mortgage markets;
enumerate the main participants of the mortgage markets;
define terminology related to the mortgage markets;
Starting-up
state the role of the mortgage markets in the financial system.
Exercise 1.Comment on the following quotations. Which of them do you agree with? Which do you disagree with? Why?
“There is no class of people in the world, who have such good memories as creditors.” P.T. Barnum
2. “A banker is a fellow who lends you his umbrella when the sun is shining, but wants it back the minute it begins to rain." Mark Twain
Reading
The Aspects of the Mortgage Markets Industry
The mortgage markets form a subcategory of the capital markets because mortgages involve long-term funds. But the usual borrowers in the capital markets are government entities and businesses, whereas the usual borrowers in the mortgage markets are individuals. Also mortgage loans are made for varying amounts and maturities, depending on the borrowers' needs, features that cause problems for developing a secondary market.
A mortgage is a long-term loan secured by real estate. A developer may obtain a mortgage loan to finance the construction of an office building, or a family may obtain a mortgage loan to finance the purchase of a home. The loan is amortized: the borrower pays it off over time in some combination of principal and interest payments that result in full payment of the debt by maturity.
The mortgage markets can be divided into primary and secondary mortgage markets.
The primary mortgage market is the market where borrowers and mortgage originators come together to negotiate terms and effectuate mortgage transaction. Mortgage brokers, mortgage bankers, credit unions and banks are all part of the primary mortgage market.
The secondary mortgage market is the market where mortgage loans and servicing rights are bought and sold between mortgage originators, mortgage aggregators and investors. The secondary mortgage market is extremely large and liquid.
A large percentage of newly originated mortgages are sold by their originators into the secondary market, where they are packaged into mortgage-backed securities and sold to investors such as pension funds, insurance companies and hedge funds. The secondary mortgage market helps to make credit equally available to all borrowers across geographical locations.
The mortgage market has become very competitive in recent years. Thirty years ago, savings and loan institutions and the mortgage departments of large banks originated most mortgage loans. Currently, there are many loan production offices that compete in real estate financing. Some of these offices are subsidiaries of banks, and others are independently owned. As a result of the competition for mortgage loans, borrowers can choose from a variety of terms and options such as mortgage interest rates, loan terms (influenced by collateral, down payments, private mortgage insurance, borrower qualification) and mortgage loan amortization.
* The mortgage interest rate is the percent charged, or paid, for the use of money. It is charged when the money is being borrowed, and paid when it is being loaned. The interest rate that the lender charges is a percent of the total amount loaned. Similarly, the interest rate that an institution, such as a bank, pays to hold your money is a percent of the total amount deposited. Thus the mortgage interest rate borrowers pay is probably the most important factor in their decision of how much and from whom to borrow.
* A loan term is a periodover which a loan agreement is in force, and before or at the end of which the loan should either be repaid or renegotiated for another term. A loan term must not be confused with loan terms. Loan terms are conditions and requirements included in a loan agreement that specify the loan amount, term, interest rate, and other enforceable conditions agreed to by the borrower and the lender.
Mortgage loan contracts contain many legal and financial terms, most of which protect the lender from financial loss. Options that influence a loan term are the following:
Collateral is one of the characteristics common to mortgage loans. It is the requirement that collateral, usually the real estate being financed, be pledged as security. The lending institution will place a lien against the property, and this remains in effect until the loan is paid off. A lien is a public record that attaches to the title of the property, advising that the property is security for a loan, and it gives the lender the right to sell the property if the underlying loan defaults.
No one can buy the property and obtain clear title to it without paying off this lien. For example, if you purchased a piece of property with a loan secured by a lien, the lender would file notice of this lien at the public recorder’s office. The lien gives notice to the world that if there is a default on the loan, the lender has the right to seize the property. If you try to sell the property without paying off the loan, the lien would remain attached to the title or deed to the property. Since the lender can take the property away from whoever owns it, no one would buy it unless you paid off the loan. The existence of liens against real estate explains why a title search is an important part of any mortgage loan transaction. During the title search, a lawyer or title company searches the public record for any liens. Title insurance is then sold that guarantees the buyer that the property is free of encumbrance, any questions about the state of the title to the property, including the existence of liens.
A down payment on the property is also required by the lender from the borrower to obtain a mortgage loan, it means that the borrower is to pay a portion of the purchase price. The balance of the purchase price is paid by the loan proceeds. Down payments (like liens) are intended to make the borrower less likely to default on the loan. A borrower who does not make a down payment could walk away from the house and the loan and lose nothing. Furthermore, if real estate prices drop even a small amount, the balance due on the loan will exceed the value of the collateral. The down payment reduces moral hazard for the borrower. The amount of the down payment depends on the type of mortgage loan.
Purchasing private mortgage insurance (PMI) is another way that lenders protect themselves against default of borrowers. PMI is an insurance policy that guarantees to make up any discrepancy between the value of the property and the loan amount, should a default occur.
Borrower qualification is a preliminary assessment by a lender of the amount it will lend to a potential homebuyer. Before granting a mortgage loan, the lender will determine whether the borrower qualifies for it. Qualifying a borrower is rather complex and constantly changing procedure. Factors that influence it are loan payment, taxes, insurance other debt obligations and gross monthly income.
Mortgage loan amortization is the schedule for how each monthly mortgage payment is allocated to interest on the loan and principal payment. Mortgage loan borrowers agree to pay a monthly amount of principal and interest that will fully amortize the loan by its maturity. “Fully amortize” means that the payments will pay off the outstanding indebtedness by the time the loan matures. During the early years of the loan, the lender applies most of the payment to the interest on the loan and a small amount to the outstanding principal balance. Many borrowers are surprised to find that after years of making payments, their loan balance has not dropped appreciably.