MORTGAGE MARKETS
Mortgages are securities used to finance real estate purchases;
they are originated by various financial institutions, such as savings
institutions and mortgage companies. A secondary mortgage
market accommodates originators of mortgages that desire to sell
their mortgages prior to maturity. The mortgage markets serve
individuals or firms that need long-term funds to purchase real
estate. They also serve financial institutions that wish to serve as
creditors by lending long-term funds for real estate purchases.
Criteria Used to Measure Creditworthiness
• Level of equity invested by the borrower: The down payment represents the equity invested by the borrower.
The lower the level of equity invested, the higher the probability that the borrower will default.
• Borrower’s income level: Borrowers who have a lower level of income relative to the periodic loan payments are more likely to default on their mortgages.
• Borrower’s credit history: Other conditions being similar,
borrowers with a history of credit problems are more likely
to default on their loans than those without credit problems.
TYPES OF RESIDENTIAL MORTGAGES
• Fixed-rate mortgages: Borrowers with fixed-rate mortgages do not suffer from the effects of rising interest rates, but they also fail to benefit from declining rates.
• Adjustable-Rate Mortgages: An adjustable-rate mortgage (ARM) allows the mortgage interest rate to adjust to market conditions.
• Graduated-Payment Mortgages: allows the borrower to
make small payments initially on the mortgage; the
payments increase on a graduated basis over the first 5 to
10 years and then level off.
• Growing-Equity Mortgages: A growing-equity mortgage is similar to a GPM in that the monthly payments are initially low and increase over time. Unlike the GPM, however, the payments never level off but continue to increase (typically by about 4 percent per year) throughout the life of the loan.
• Second Mortgages: A second mortgage can be used in conjunction with the primary or first mortgage. Some financial institutions may limit the amount of the first mortgage based on the borrower’s income. Other financial institutions may then offer a second mortgage with a maturity shorter than that of the first mortgage.
• A second mortgage or junior-lien is a loan you take out using your house as collateral while you still have another loan secured by your house. ... As a result, second mortgage loans often carry higher interest rates than first mortgage loans. By taking out a second mortgage, you are adding to your overall debt burden.
• Shared-Appreciation Mortgages: A shared-appreciation mortgage allows a home purchaser to obtain a mortgage at a below-market interest rate. In return, the lender providing the attractive loan rate will share in the price appreciation of the home.
• A shared appreciation mortgage, or SAM, is a home loan in which the lender offers a below-market interest rate in exchange for a share of the profit when the house is sold. A SAM usually has a deadline for paying off the principal, for example, 10 years.
• Balloon-Payment Mortgages: A balloon-payment mortgage requires only interest payments for a three-to five-year period. At the end of this period, the borrower must pay the full amount of the
principal (the balloon payment). Because no principal payments are made until maturity, the monthly payments are lower.
VALUATION AND RISK OF MORTGAGES
• The market price (PM) of a mortgage should equal the present value of its future cash flows:
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C= Interest Payment in one installment
•
Prin= Principal payment in one installment
•
K= Required Rate
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