HOFIS 24 - Mortgages & the Mortgage Market Flashcards

1
Q

Mortgage definition

A

Loan secured by the underlying real estate

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2
Q

Lien status

A
  • Dictates the loan’s seniority in liquidation
  • First-lien status: grant the lender first call on proceeds of liquidation of property
  • Second-lien status: used for purposes such as home improvements or other large purchases
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3
Q

Balloon Mortgages

A

Require the borrower to repay all unamortized principal at a specified date (e.g., 5 or 7 years)

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4
Q

Adjustable-rate Mortgages (ARMs)

A

Have an interest rate that varies during the term

  • Set based on underlying index plus spread a (margin)
  • Rates usually reset annually
    • Teaser (artificially low) rate in the first year
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5
Q

Interest-only (IO) ARM Mortgages

A
  • Have lower monthly payments initially since no principal is included; at the end of the IO period, the loan is recast
  • Recast a loan means the payments are recalculated so that the new payments (principal and interest) will pay off the loan over the remaining perdiod
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6
Q

Payment-Option and Negative-Amortization Mortgages

A

Allow for payments less than the monthly interest accrual

  • Less common and illegal in some states
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7
Q

Role and Sources of Mortgage Credit Support

A
  • Enhance mortgage loans liquidity
  • Come from the goverment, GSEs, or private entities
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8
Q

Jumbo Loans

A
  • Loans larger than the conforming limits
  • Securitized by private-label transactions (private sector - not agencies or GSEs)
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9
Q

Morgage Loan Conforming vs Nonconforming Balances

A
  • Conforming balances are loans within limits set by statue for GSEs
    • Freddie Mac and Fannie Mae
  • Ginnie Mae limits are lower and differentiated b/w high and low costs states
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10
Q

Alternative- A (Alt-A) Mortgages

A

Fall b/w prime and subprime mortgages

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11
Q

Direct vs. Third-Party Originations in the Mortgage Industry

A
  • Direct lender - underwrite and provide loans direclty to borrowers
  • Brokers - represents clients and works with various lenders
  • Wholesale channels - lender operations that work with brokers
  • Retail channels - ones that work directly with borrowers
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12
Q

Depository vs. Nondepository in the Mortgage Industry

A
  • Depository institutions - (e.g., banks) can use deposits to fund loan activities
  • Nondepository lender - (e.g., mortgage bankers) sell most of their loan production to investors
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13
Q

Originators vs. Servicers in the Mortgage Industry

A
  • Originators - underwrite and fund loans
  • Servicers - collect monthly payments, handle property taxes, and deal with delinquencies
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14
Q

Fully Amortized Mortgage Monthly Payment Formula

A
  • B is the original loan balance;
  • i is the monthly interest rate;
  • n is the loan term in months
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15
Q

Committed vs Uncommitted Mortgage Loans

A
  • Uncommitted loans - borrower has not yet locked in an interest rate
  • Committed loans - borrower has locked in the interest rate
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16
Q

Components of Mortgage Underwriting Process

A
  • Evaluating of borrower’s creditworthiness
  • Ensuring the integrity of the property value
17
Q

Indications of Loan-to-Value (LTV) Ratios

A
  • Indicator of the borrower’s leverage
    • Indicates how much can be recovered in a default situation
    • Impacts expected payment performance of the borrower
  • Combined LTV (CLTV) takes into account any second liens (better indicator)
18
Q

Debt-to-Income Ratios

A
  • Front Ratio: (should be below 28%)
    • Total monthly mortgage payments divided by borrower’s gross monthly income
  • Back Ratio: (should be less than 36%)
    • Includes other debt payments such as auto loans in front ratio numerator
19
Q

Stated Income (Mortagage Loan Documentation)

A
  • Mortgage loans that require no documentation
    • Called NINA (no income/no asset)
20
Q

Influencers of Mortgage Rates

A

MBS market (GSEs and agencies) has a lot of influence on mortgage rates

21
Q

Creation of MBS

A
  • MBS providers aggregate loans with similar characteristics into pools
    • Called “pass-throughs” since principal and interest are passed to investors
  • MBS provider sells shares to the pool of investors
22
Q

MBS Weighted Average Coupon (WAC)

A

Average loan rate in the MBS pool

23
Q

Components of Spread b/w MBS investor’s coupon and WAC

A
  1. Servicing fee paid to servicer of the loan
  2. Guaranty fees paid to agencies that insure the loans
  3. Excess servicing fee - additional spread that reduces investor’s spread to a desired level
24
Q

Mortgage Discount Points

A

Upfront fee that lenders charge borrower at closing

  • the higher discount points, the lower the loan rate
25
Q

Mortgage Risk-based Pricing

A
  • Riskier borrowers require higher guaranty costs (a.k.a credit enhancements)
  • To offset, lenders charge more discount points (add-ons) which increases the borrowers closing costs
26
Q

Non-Agency (private) MBS Credit Enhancement

A

Accomplished through subordination

  • Junior (subordinate) bonds will suffer losses before senior bonds
  • Junior bonds trade at larger discounts to senior bonds (riskier for investors)
27
Q

Mortgage Prepayment Risk

A
  • Similar to call risk
  • Borrowers tend to refinance as market rates fall
  • Investors lose a high-yielding asset and have to reinvest principal in lower-yielding assets
28
Q

Events that Cause Mortgage Prepayments

A
  • Refinancing
  • Partial principal prepayements
  • Sale of property
  • Default of borrower
  • Destruction of property (e.g., fire)
29
Q

MBS Convexity

A

MBS have negative convexity and tend to under-perform non-callable bonds

  • if rates fall, prepayments increase -> MBS duration fall (mutes increase in prices)
  • if rates rise, prepayments slow -> MBS duration lenghten (mutes decrease in price)
30
Q

Measures of Mortgage Prepayment Speeds - SMM

A
  1. Single Monthly Mortality (SMM)
    • (scheduled balance - actual balance) / scheduled balance
31
Q

Measures of Mortgage Prepayment Speeds - CPR

A
  • Conditional Prepayment Rate (CPR) = annualized SMM
    • CPR = 1 - (1-SMM)^12
32
Q

Measures of Mortgage Prepayment Speed - PSA Model

A
  • Reflects that CPRs are not constant over the life of the loan
    • assumes CPR increases by .2% per month until it hits 6.0% in month 30
    • can express in multiples (e.g., 200% PSA doubles the speed at each time step)
33
Q

Aspects of MBS credit risk modeling that are different from bonds

A
  • Quantifying and stratifying characteristics of 1000s of underlying loans
  • Translating characteristics into best-, worst-, and likely-case scenarios
  • Calculating returns based on above scenarios
34
Q

Characteristics used to evaluate mortgage credit risk before and after mortgage is originated

A
  • Before mortgage is originated:
    • Credit scores
    • LTVs
  • After mortgage pool is created:
    • Number of days delinquent
    • Default (90+ days delinquent)
    • Agency insured vs. non-agency
    • Default loss severity
35
Q

Morgage Default Severity Factors

A

Severity is higher when:

  • High LTV
  • Appraisal values exceed market values
  • Property values decline after origination
  • Foreclosure process is expensive
36
Q

Mortgage Agency Pool vs Private-Label Defaults Recoveries

A
  • Agency pool defaults – covered by the agency, so effectively just another prepayment to the investor
  • Private-label (non-agency) defaults – recoveries depend on the foreclosure process
    • Reported separately and measured by condition default rates (CDRs)
37
Q

Explain the impacts of prepayment risk on cash flow patterns of
mortgages

A

Changes in prepayment rates lead to negative convexity of price performance.
Prepayment risk leads to extension, causing the price of mortgage or MBS to
decline more than comparable fixed-maturity instruments at the prevailing level
of yields increases.

when market yields increase, prepayments tend to slow, causing the average life and duration of mortgages or MBS to increase;

while when market yields decline and bond prices increase, prepayment increase, mortgage shorten in average life and duration.

As a result, the price performance tends to lag that of bonds without prepayment exposure when interests decline.