Chapter 12
The Mortgage Markets
◼ Multiple Choice Questions
1. Which of the following are important ways in which mortgage markets differ from the stock and
bond markets?
(a) The usual borrowers in the capital markets are government entities and businesses, whereas the
usual borrowers in the mortgage markets are individuals.
(b) Most mortgages are secured by real estate, whereas the majority of capital market borrowing is
unsecured.
(c) Because mortgages are made for different amounts and different maturities, developing a
secondary market has been more difficult.
(d) All of the above are important differences.
(e) Only (a) and (b) of the above are important differences.
2. Which of the following are important ways in which mortgage markets differ from stock and bond
markets?
(a) The usual borrowers in capital markets are government entities, whereas the usual borrowers in
mortgage markets are small businesses.
(b) The usual borrowers in capital markets are government entities and large businesses, whereas
the usual borrowers in mortgage markets are small businesses.
(c) The usual borrowers in capital markets are government entities and large businesses, whereas
the usual borrowers in mortgage markets are small businesses and individuals.
(d) The usual borrowers in capital markets are businesses and government entities, whereas the
usual borrowers in mortgage markets are individuals.
3. Which of the following are true of mortgages?
(a) A mortgage is a long-term loan secured by real estate.
(b) A borrower pays off a mortgage in a combination of principal and interest payments that result
in full payment of the debt by maturity.
(c) Over 80 percent of mortgage loans finance residential home purchases.
(d) All of the above are true of mortgages.
(e) Only (a) and (b) of the above are true of mortgages.
Chapter 12 The Mortgage Markets 145
4. Which of the following are true of mortgages?
(a) A mortgage is a long-term loan secured by real estate.
(b) Borrowers pay off mortgages over time in some combination of principal and interest payments
that result in full payment of the debt by maturity.
(c) Less than 65 percent of mortgage loans finance residential home purchases.
(d) All of the above are true of mortgages.
(e) Only (a) and (b) of the above are true of mortgages.
5. Which of the following are true of mortgages?
(a) Prior to the 1920s, U.S. banking legislation discouraged mortgage lending by banks.
(b) In the 1920s, most mortgages were balloon loans, which required the borrower to pay the entire
loan amount after three to five years.
(c) Because mortgages are long-term loans secured by real estate, mortgage lenders tended to fail
when land prices declined, as was often the case during economic recessions.
(d) All of the above are true.
(e) Only (a) and (b) of the above are true.
6. Which of the following is true of mortgage interest rates?
(a) Interest rates on mortgage loans are determined by three factors: current long-term market rates,
the term of the mortgage, and the number of discount points paid.
(b) Mortgage interest rates tend to track along with Treasury bond rates.
(c) The interest rate on 15-year mortgages is lower than the rate on 30-year mortgages, all else
the same.
(d) All of the above are true.
(e) Only (a) and (b) of the above are true.
7. Which of the following are true of mortgages?
(a) More than 80 percent of mortgage loans finance residential home purchases.
(b) The National Banking Act of 1863 rewarded banks that increased mortgage lending.
(c) Most mortgages during the 1920s and 1930s were balloon loans.
(d) All of the above are true.
(e) Only (a) and (c) of the above are true.
8. Which of the following is true of mortgage interest rates?
(a) Longer-term mortgages have lower interest rates than shorter-term mortgages.
(b) Mortgage rates are lower than Treasury bond rates, because of the tax-deductibility of mortgage
interest rates.
(c) In exchange for points, lenders reduce interest rates on mortgage loans.
(d) All of the above are true.
(e) Only (a) and (b) of the above are true.
146 Mishkin/Eakins • Financial Markets and Institutions, Fifth Edition
9. Typically, discount points should not be paid if the borrower will pay off the loan in _________
years or less.
(a) 5
(b) 10
(c) 15
(d) 20
10. Which of the following is true of mortgage interest rates?
(a) Longer-term mortgages have higher interest rates than shorter-term mortgages.
(b) In exchange for points, lenders reduce interest rates on mortgage loans.
(c) Mortgage rates are lower than Treasury bond rates because of the tax deductibility of mortgage
interest payments.
(d) All of the above are true.
(e) Only (a) and (b) of the above are true.
11. Which of the following reduces moral hazard for the mortgage borrower?
(a) Collateral
(b) Down payments
(c) Private mortgage insurance
(d) Borrower qualifications
12. Which of the following protects the mortgage lender’s right to sell property if the underlying loan
defaults?
(a) A lien
(b) A down payment
(c) Private mortgage insurance
(d) Borrower qualification
(e) Amortization
13. Which of the following is true of mortgage interest rates?
(a) Mortgage rates are closely tied to Treasury bond rates, but mortgage rates tend to stay below
Treasury rates because mortgages are secured with collateral.
(b) Longer-term mortgages have higher interest rates than shorter-term mortgages.
(c) Interest rates are higher on mortgage loans on which lenders charge points.
(d) All of the above are true.
(e) Only (a) and (b) of the above are true.
Chapter 12 The Mortgage Markets 147
14. During the early years of an amortizing mortgage loan, the lender applies
(a) most of the monthly payment to the outstanding principal balance.
(b) all of the monthly payment to the outstanding principal balance.
(c) most of the monthly payment to interest on the loan.
(d) all of the monthly payment to interest on the loan.
(e) the monthly payment equally to interest on the loan and the outstanding principal balance.
15. During the last years of an amortizing mortgage loan, the lender applies
(a) most of the monthly payment to the outstanding principal balance.
(b) all of the monthly payment to the outstanding principal balance.
(c) most of the monthly payment to interest on the loan.
(d) all of the monthly payment to interest on the loan.
(e) the monthly payment equally to interest on the loan and the outstanding principal balance.
16. During the last years of a balloon mortgage loan, the lender applies
(a) most of the monthly payment to the outstanding principal balance.
(b) all of the monthly payment to the outstanding principal balance.
(c) most of the monthly payment to interest on the loan.
(d) all of the monthly payment to interest on the loan.
(e) the monthly payment equally to interest on the loan and the outstanding principal balance.
17. During the early years of a balloon mortgage loan, the lender applies
(a) most of the monthly payment to the outstanding principal balance.
(b) all of the monthly payment to the outstanding principal balance.
(c) most of the monthly payment to interest on the loan.
(d) all of the monthly payment to interest on the loan.
(e) the monthly payment equally to interest on the loan and the outstanding principal balance.
18. A borrower who qualifies for an FHA or VA loan enjoys the advantage that
(a) the mortgage payment is much lower.
(b) only a very low or zero down payment is required.
(c) the cost of private mortgage insurance is lower.
(d) the government holds the lien on the property.
19. (I) Conventional mortgages are originated by private lending institutions, and FHA or VA loans are
originated by the government. (II) Conventional mortgages are insured by private companies, and
FHA or VA loans are insured by the government.
(a) (I) is true, (II) is false.
(b) (I) is false, (II) is true.
(c) Both are true.
(d) Both are false.
148 Mishkin/Eakins • Financial Markets and Institutions, Fifth Edition
20. Borrowers tend to prefer _________ to _________, whereas lenders prefer _________
(a) fixed-rate loans; ARMs; fixed-rate loans.
(b) ARMs; fixed-rate loans; fixed-rate loans.
(c) fixed-rate loans; ARMs; ARMs.
(d) ARMs; fixed-rate loans; ARMs.
21. (I) ARMs offer lower initial rates and the rate may fall during the life of the loan. (II) Conventional
mortgages do not allow a borrower to take advantage of falling interest rates.
(a) (I) is true, (II) is false.
(b) (I) is false, (II) is true.
(c) Both are true.
(d) Both are false.
22. Growing-equity mortgages (GEMs)
(a) help the borrower pay off the loan in a shorter time.
(b) have such low payments in the first few years that the principal balance increases.
(c) offer borrowers payments that are initially lower than the payments on a conventional mortgage.
(d) do all of the above.
(e) do only (a) and (b) of the above.
23. A borrower with a 30-year loan can create a GEM by
(a) simply increasing the monthly payments beyond what is required and designating that the
excess be applied entirely to the principal.
(b) converting his ARM into a conventional mortgage.
(c) converting his conventional mortgage into an ARM.
(d) converting his conventional mortgage into a GPM.
24. Which of the following are useful for home buyers who expect their income to rise in the future?
(a) GPMs
(b) RAMs
(c) GEMs
(d) (a) and (b)
(e) (a) and (c)
25. Which of the following are useful for home buyers who expect their income to fall in the future?
(a) GPMs
(b) RAMs
(c) GEMs
(d) (a) and (b)
(e) (a) and (c)
Chapter 12 The Mortgage Markets 149
26. Retired people can live on the equity they have in their homes by using a
(a) GEM.
(b) GPM.
(c) SAM.
(d) RAM.
27. Second mortgages serve the following purposes:
(a) they give borrowers a way to use the equity they have in their homes as security for another
loan.
(b) they allow borrowers to get a tax deduction on loans secured by their primary residence or
vacation home.
(c) they allow borrowers to convert their conventional mortgages into GEMs.
(d) all of the above.
(e) only (a) and (b) of the above.
28. Which of the following is a disadvantage of a second mortgage compared to credit card debt?
(a) The loans are secured by the borrower’s home.
(b) The borrower gives up the tax deduction on the primary mortgage.
(c) The borrower must pay points to get a second mortgage loan.
(d) The borrower will find it more difficult to qualify for a second mortgage loan.
29. The share of the mortgage market held by savings and loans is approximately
(a) 50 percent.
(b) 40 percent.
(c) 20 percent.
(d) 10 percent.
30. The share of the mortgage market held by commercial banks is approximately
(a) 50 percent.
(b) 25 percent.
(c) 15 percent.
(d) 5 percent.
31. Which of the following has not been a reason for the development and growth of on-line mortgage
lending?
(a) Mortgage lending is an information-based service and no products have to be inventoried or
shipped.
(b) The product (a mortgage loan) is homogeneous.
(c) It has led to simplification of loan alternatives and made comparison shopping easier.
(d) On-line lenders have lower overhead and can offer loans at lower costs.
150 Mishkin/Eakins • Financial Markets and Institutions, Fifth Edition
32. A loan-servicing agent will
(a) package the loan for an investor.
(b) hold the loan in their investment portfolio.
(c) collect payments from the borrower.
(d) (a) and (c).
(e) (b) and (c).
33. Distinct elements of a mortgage loan include
(a) origination.
(b) investment.
(c) servicing.
(d) all of the above.
(e) only (b) and (c).
34. The Federal National Mortgage Association (Fannie Mae)
(a) was set up to buy mortgages from thrifts so that these institutions could make more loans.
(b) funds purchases of mortgages by selling bonds to the public.
(c) provides insurance for certain mortgage contracts.
(d) all of the above.
(e) only (a) and (b) of the above.
35. The Federal Housing Administration (FHA)
(a) was set up to buy mortgages from thrifts so that these institutions could make more loans.
(b) funds purchases of mortgages by selling bonds to the public.
(c) provides insurance for certain mortgage contracts.
(d) all of the above.
(e) only (a) and (b) of the above.
36. _________ issues participation certificates, and _________ provides federal insurance for
participation certificates.
(a) Freddie Mac; Freddie Mac
(b) Freddie Mac; Ginnie Mae
(c) Ginnie Mae; Freddie Mac
(d) Ginnie Mae; Ginnie Mae
(e) Freddie Mac; no one
Chapter 12 The Mortgage Markets 151
37. REMICs are most like
(a) Freddie Mae pass-through securities.
(b) Ginnie Mae pass-through securities.
(c) participation certificates.
(d) collateralized mortgage obligations.
38. Ginnie Mae
(a) insures qualifying mortgages.
(b) insures pass-through certificates.
(c) insures collateralized mortgage obligations.
(d) (a) and (b).
(e) (b) and (c).
39. All of the following add to concerns about the safety and soundness of Fannie Mae and Freddie Mac
except their
(a) large publicly issued debt relative to that of the federal government.
(b) political influence.
(c) high capital-asset ratio that gives rise to conflicts of interest.
(d) multiple goals of profit maximization and working to further the public interest.
40. Mortgage-backed securities
(a) have been growing in popularity in recent years as institutional investors look for attractive
investment opportunities.
(b) are securities collateralized by a pool of mortgages.
(c) are securities collateralized by both insured and uninsured mortgages.
(d) all of the above.
(e) only (a) and (b) of the above.
41. The most common type of mortgage-backed security is
(a) the mortgage pass-through, a security that has the borrower’s mortgage payments pass through
the trustee before being disbursed to the investors.
(b) collateralized mortgage obligations, a security which reduces prepayment risk.
(c) the participation certificate, a security which passes the borrower’s mortgage payments equally
among all the owners of the certificates.
(d) the securitized mortgage, a security which increases the liquidity of otherwise illiquid
mortgages.
152 Mishkin/Eakins • Financial Markets and Institutions, Fifth Edition
◼ True/False
1. Down payments are designed to reduce the likelihood of default on mortgage loans.
2. Discount points (or simply points) are interest payments made at the beginning of a loan.
3. A point on a mortgage loan refers to one monthly payment of principal and interest.
4. Closing for a mortgage loan refers to the moment the loan is paid off.
5. Private mortgage insurance is a policy that guarantees to make up any discrepancy between the
value of the property and the loan amount, should a default occur.
6. During the early years of the loan, the lender applies most of the payment to the principal on
the loan.
7. One important advantage to a borrower who qualifies for an FHA or VA loan is the very low interest
rate on the mortgage.
8. Adjustable-rate mortgages generally have lower initial interest rates than do fixed-rate mortgages.
9. Mortgage interest rates loosely track interest rates on three-month Treasury bills.
10. An advantage of a graduated-payment mortgage is that borrowers will qualify for a larger loan than
if they requested a conventional mortgage.
11. Nearly half the funds for mortgage lending come from mortgage pools and trusts.
12. Many institutions that make mortgage loans do not want to hold large portfolios of long-term
securities, because it would subject them to unacceptably high interest-rate risk.
13. A problem that initially hindered the marketability of mortgages in a secondary market was that they
were not standardized.
Chapter 12 The Mortgage Markets 153
14. Mortgage-backed securities have declined in popularity in recent years as institutional investors
have sought higher returns in other markets.
15. Mortgage-backed securities are marketable securities collateralized by a pool of mortgages.
16. Fannie Mae and Freddie Mac together either own or insure the risk on nearly one-fourth of
America’s residential mortgages.
154 Mishkin/Eakins • Financial Markets and Institutions, Fifth Edition
◼ Essay
1. How has the modern mortgage market changed over recent years?
2. Explain the features of mortgage loans that are designed to reduce the likelihood of default.
3. What are points? What is their purpose?
4. How does an amortizing mortgage loan differ from a balloon mortgage loan?
5. Evaluate the advantages and disadvantages, from both the lender’s and the borrower’s perspectives,
of fixed-rate and adjustable-rate mortgages.
6. Why has the on-line lending market developed in recent years and what are the advantages and
disadvantages of this development?
7. Why may Fannie Mae and Freddie Mac pose a threat to the health of the financial system?
8. What are mortgage-backed securities, why were they developed, what types of mortgage-backed
securities are there, and how do they work?