Mortgages

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Chapter 13

• Mortgages

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Mortgages

• Standard Fixed Rate
• Variable Rate
• Refinancing and Prepayments
• Marketable Mortgages

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Fixed Rate Mortgage
P Principal M Periodic payment Y Interest
rate
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Example
P 100, y 10, n 20
Total Payments (20)(11.75) 235. Interest
235 100 135 Total Principal.
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Repayment Time P Interest
of P 0 100 1 98.25 10 1.75
11.75 10.00 2 96.33 9.83 1.92 11.75
9.83 3 9.63
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Amount of Repayment of Principal Called
Amortization
AMj Amortization of principal in period j
If n 20, P 100, y 10, j 10
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Remaining Principal at time j Pj
Pj MPVAn-j P10 11.75PVA20-10,10
11.756.1446 72.20.
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Variable Rate Mortgage, Floating Rate, Adjustable
Rate
Current rate Index Premium. Annual cap on
change Lifetime cap minimum Teaser
rate Borrower bears risk of changing interest
rates
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• Due on sale clause
• Assumable

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Prepayment Option
Borrower has right to repay early. Reasons A. M
oving B. Lower interest rates C. Improved
financial condition of borrower
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Refinancing Because of Lower Interest Rates
Costs include points, loan initiation fees, legal
costs, surveying, etc.
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Refinancing Example 10 Years Remaining
P 100, n 20, yOld 10, yNew 7, j 10,
costs 6.
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Prepayment Pattern
Prepaid
Lower Rates
Moving Other
Change in Interest Rates
0
Lower Rates
Higher Rates
Public Securities AssociationPSA Constant
Prepayment RateCPR
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Methods of Mortgage Financing
Traditional Mortgages
Marketable Mortgages
Types
Borrowers
Borrowers
SL Bank Mortgage Company
Mortgage originator
Banks, SLs
FHA VA Private Insurance
Mortgageguarantees
Organizers Guaranteers FNMA GNMA FHLMC FNMA Privat
e FHLMC
Depositors
Mortgagepools
Bonds Pass-throughs CMOs
Claims sold toinvestors
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Advantages of Marketable Mortgages

• Government guarantees and insurance
• Fewer failures of SLs
• Uniform interest rates
• Lower interest rates?

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Derivative Mortgage Products
Pass-through
Pool of Mortgages
All investors have a proportional share in
prepayments.
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Partitioning of Prepayments
Class 1
Class 3
Class 2
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Sequential Pay
Prepayments go to Class 1 until paid off. Then
prepayments go to Class 2, then to Class 3. Suits
some buyers better. Some get higher prepayment
risk and some get lower prepayment risk. Size of
each class is small, resulting in reduced
liquidity.
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Planned Amortization Class (PAC)
Early classes have precisely defined cash
flows. Residual class cash flows vary widely in
timing.
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Division of Principal and Interest Classes
Principal Only (PO) Interest Only (IO)