Chapter 19 Residential Real Estate Finance

1. Chapter 19Residential Real Estate Finance

2. Major Topics • Primary and secondary mortgage markets • Conventional, FHA and VA mortgages • The Effect of Points on Mortgage Choice • Mortgage Underwriting Criteria

3. Changes in Financing • More loan types • Secondary mortgage market and loan securitization • Easier to qualify

4. Mortgage Markets • Primary market = loans are created • Borrowers and lenders • Secondary market = loans are sold/securitized • FNMA, GNMA, life insurance companies, pension funds

5. Secondary Mortgage Market • Fannie Mae (1968): Spun from HUD to become a primary purchaser of FHA and VA mortgage loans • Ginnie Mae (1968): Empowered to guarantee “pass-through” mortgage-backed securities based on FHA and VA loans • Freddie Mac (1970): Formed to purchase and securitize conventional home loans from savings associations

6. Fannie Mae • Original mission: Secondary market for FHA/VA • Now privately owned but still under U.S. charter • Public mission for housing • U.S. Treasury financial credit line available • Surpasses Freddie Mac in buying conventional loans • Has securitized and sold, or owns, about 25% of outstanding home loans

7. Freddie Mac • Has congressional charter • Deals exclusively in conventional loans • Securitized all loans purchased until recent years • Has securitized and sold, or owns, about 18% of outstanding home loans

8. Importance of Fannie Maeand Freddie Mac • Have brought about standardization in: • Mortgages and mortgage notes • Appraisal forms and practices • Underwriting procedures and standards • Have increased liquidity of mortgage markets • No interstate differentials in mortgage interest rates • No mortgage lending interruptions when interest rates rise • New sources of mortgage funds through security investors

9. Secondary Mortgage Market Other benefits: 1. R risk shifted (some) 2. More funds available for lending (liquidity) 3. Geographic diversification

10. Ginnie Mae • Does not buy mortgages • Guarantees timely payment of interest and principal to holders of GNMA securities. • Guarantees only securities based on FHA/VA loans • Why necessary if already insured?

11. Mortgage-Backed Securities • Multiple mortgage loans in a single pool or fund • Security entitles investor to pro rata share of all cash flows • Loans in a given pool will be similar: • FHA/VA; conventional • Same vintage (new or recent loans) • Similar interest rates • Nearly two-thirds of all new home loans have been securitized in recent years

12. Pass-through Securities • Issued by investment bank, originator, or FNMA, FHLMC • Security = ownership rights to pool of mortgage • Minimum pool size usually $100M • CF’s from pool (less fees) are passed-through to investors

13. Pass-through Securities Pass-through risk: 1. No default risk 2. R risk 3. Prepayment risk

15. Conventional Loans • Conforming conventional home loan: Meets the requirements for purchase by Freddie Mac or Fannie Mae: • Standard note • Standard mortgage • Standard appraisal • Size limit: Currently $417K • Interest rate advantage due to liquidity (at least .25%) • Nonconforming loan: Does not meet Fannie requirements in some respect • Jumbo: Nonconforming in terms of size (currently $417K) • http://www.bankrate.com/brm/news/mtg/mtg_blurbs/rates.asp

16. Private MortgageInsurance (PMI) • Protects lender against losses due to default • Generally required for loans with Loan-to-Value ratio > 80% • Protects lender for losses up to 20% of loan • Example terms: • 2.5 percent of loan in single up-front premium • 0.5 percent annual premium (0.041 per month)

17. PMI • Termination may be allowed if LTV ratio falls below 80% of current value and borrower is in good standing • Must allow termination when loan falls to 80% of original value (Homeowner’s Insurance Act of 1999) • Obligation to terminate when loan falls to 78% of original value

18. PMI: Example • House price: $100,000 • Loan amount: $95,000 • PMI, insuring “top 20%”: First $19,000 in losses • Borrower pays down loan to $94,000 • Defaults: Foreclosure sale at $90,000 • Lender’s loss: $94,000 – $90,000 = $4,000 • With loss less than $19,000, PMI covers it completely

19. FHA-Insured Mortgages • FHA is strictly a loan insurance program • Loans are from private lenders • Max < $200K • 3% minimum “down payment” required • 97.75% maximum • Insures 100% of loan • After foreclosure, title is transferred to Housing and Urban Development (HUD) • Premiums: • Up-front premium: 1.50%, which can be included in loan • Yearly: 0.50%

20. Underwriting • Why default? • Can’t afford to pay • Negative equity • Traditional underwriting • Income Ratios • Housing expense ratio = PITI ÷ Monthly Income • Total expense ratio = Total payments ÷ Monthly Income • FNMA required 28%, 36% max for fixed rate loans • Loan-to-Value ratio

21. Assessing the probability of default • 5 major criteria: • Income • Other Debt Obligations • Housing Expenses • Credit Evaluation • Net Worth • Creation of single statistical score

22. Email from a mortgage lender Nah, not really.  We have a Fast and Easy (reduced documentation, no income or asset verification) that allows 55%!  People really max it out sometimes.  Minimum requirement is 680 FICO and 10% down.   That 36% stretches out with ARMs and stuff like that, too.  If somebody has like 42% with a lot of reserves, that'll go through.   Usually 45% is the benchmark, with a "speed limit" of 48%-49%, sometimes 50% depending on credit and reserves.  I can get anyone approved. Sincerely,Val

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