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Section 1 - Fixed Income > CRE 16 - Mortgage Basics > Flashcards

CRE 16 - Mortgage Basics Flashcards

1
Q

Definition and Types of Residential Mortgages

A

Loans secured by single family homes:

  • Agency Loans: where government insures lender against default or foreclosure
  • Conventional Loans: have no government-provided defaults insurance
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2
Q

Commercial mortgages

A

Loans that are secured by income producing property

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3
Q

Describe differences between residential and commercial mortgages

A
  • Residentail loans
    • Smaller on average
    • Owner-occupied generate no income
    • More regulated
    • Properties relatively homogeneous
    • Fairly standadized industry
  • Commercial loans:
    • Staffed w/ professionals w/ greater financial expertise
    • Properties more unique
    • Mortgages are customized and created/negotiated one deal at a time
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4
Q

Describe the process of Mortgage loan securitization

A
  • Large number of individual mortgages are pooled together and sold into the bond market
  • Cashflows of mortgages are then passed through to investors
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5
Q

Reason why secondary market for Commercial Mortgages was not as developed historically as Residential Mortgages

A

Commercial Propreties

  • Larger
  • More heterogenous
  • Do not benefit from government support (FHA insurance)
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6
Q

Describe two types of commercial mortgages

A
  1. Construction loans: Short-term loans made for financing a construction project
  2. Permanent loans: Long-term loans made for financing a completed income property
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7
Q

Compare and contrast the interest rate and default risk, and issuers of construction and permanent loans

A
  • Construction loans
    • Have high default risk - underlying building does not exist when the loan is made
    • Have low interest rate risk - loan has short duration and often made at floating interest rates
    • Issued by commercial banks and thrift institutions whose liabilities are short
  • Permanent loans
    • They have less default risk, - secured by a fully operational property
    • Have more interest rate risk - loan is long-term
    • Issued by life insurance companies and pension funds whose liabilities have longer-duration
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8
Q

Mortgages two legal documents

A
  1. Promissory note: A written contract where the borrower promises to pay the cash amounts specified in the loan
  2. Mortgage deed: Secures the debt by conveying the ownership of the collateral from the borrower to the lender (allows for foreclosure)
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9
Q

Order of Application of Mortgage Payments to different component of debt

A

Establishes the order in which any payment received from the borrower will be applied to different components of the debt. Standard order is:

  • Expenses
  • Penalties
  • Interest
  • Principal
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10
Q

Good Repair Clause in a mortgage covenant

A

Requires the borrower to maintain the value of the property/collateral
and keep it in reasonably good condition

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11
Q

Acceleration Clause in a mortgage covenant

A

Allows the lender to accelerate the loan and make the entire outstanding principal balance due immediately

  • Commonly used when the borrower fails to make loan payments
  • Allows the lender to obtain the entire remaining loan balance through foreclosure
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12
Q

Due-on-Sale Clause in a mortgage covenant

A

Enables the lender to accelerate a loan whenever the borrower sells the property

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13
Q

Release Clause in mortgage covenant

A

The conditions in which the borrower will be released from the debt when
the loan is paid off

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14
Q

Prepayment Clause in a mortgage covenant

A
  • Gives the borrower the option to pay the loan off prior to maturity
  • Enables the borrower to refinance the mortgage if interest rates have decreased
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15
Q

Subordination clause in a mortgage covenant

A

Provisions for making a loan subordinate to other loans that the
borrower has obtained on the property

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16
Q

Lender’s right to notice in a mortgage covenant

A

A provision in subordinate loan that requires a borrower to notify the lender if a foreclosure action is being brought against the borrower

  • May be in the junior lender’s best interests to help borrower avoid a foreclosure since they could lose more than senior lender
17
Q

Future Advances Clause in a mortgage covenant

A

Provides for some (additional) of the loan principal to be paid from the lender to the borrower at future points in time w/o having to obtain another loan

  • Common in construction loans, when the cash is provided as the project is built
18
Q

Describe what an exculpatory clause is in a mortgage covenant

A

Removes the borrower from responsibility for the debt

  • If the borrower defaults, the lender will only receive the property that secures the loan
  • Loans with this clause are called nonrecourse loans
19
Q

Describe some costs associated with foreclosure

A
  • Legal/administrative expenses such as court costs
  • Deterioration of the property during the foreclosure process
  • Revenue may be lost by the property (i.e. rent paid by tenants), and interest
    payments lost to the lender
  • Both the borrower and lender can suffer negative reputation effects
  • Lenders will usually have to write down the value of the assets on their balance sheets after a foreclosure
20
Q

Describe nonlitigious actions a bank can make in the event of a default

A
  1. Transfer of the loan to a new borrower (e.g., short sale)
  2. A procedure called deed in lieu of foreclosure
    • The borrower gives the property to the lender in return for the lender releasing the borrower from the debt (no legal expenses)
  3. Work with the borrower to restructure the loan
    • ​some combination of rescheduling or foregiving
21
Q

Describe a situation when a borrower can strategically default

A
  • If ”property value - foreclosure costs < remaining loan balance”,
  • the borrower can threaten the lender with default to force a better deal
  • non-recourse loan has additional leverage over the lender because foreclosure is a time-consuming and expensive process
    • Sometimes the lender might consider reputation effects (i.e. being a ”tough guy”) and refuse to negotiate with the borrower
    • Foreclosure could still occur, and the borrower could also suffer from the negative reputation effects of defaulting
22
Q

Describe Non-recourse mortgage loans and their advantages to borrowers

A
  • Loans in which that the borrower has limited liability in the loan
  • Gives borrower two advantages:
    • put option on the value of the underlying property
    • opportunity to default strategically

Section 1 - Fixed Income (18 decks)

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