CHAPTER 11
Sources of Funds for Residential Mortgages
Test Problems
1. Mortgage banking companies:
2. In the last 20 years, the mortgage banking industry has experienced:
3. Currently, which type of financial institution in the primary mortgage market
provides the most funds for the residential (owner-occupied) housing market?
4. For conforming conventional home loans the standard payment ratios for
underwriting are:
5. The numerator of the standard housing expense (front-end) ratio in home loan
underwriting includes:
6. The most profitable activity of residential mortgage bankers is typically
7. Potential justifiable subprime borrowers include persons who:
8. The normal securitization channel for jumbo conventional loans is:
9. The reduced importance of certain institutions in the primary mortgage market
has been largely offset by an expanded role for others. Which has diminished and
which has expanded?
10. Warehousing in home mortgage lending refers to
Study Questions
1. What is the primary purpose of the risk-based capital requirements that Congress
enacted as part of the Financial Institutions Reform, Recovery, and Enforcement
Act (FIRREA)?
Solution: The goal of the Financial Institutions Reform, Recovery, and
Enforcement Act is to charge banks and thrifts for risky lending practices and to
2. Explain what “pipeline risk” is in mortgage banking and why it is such a
dominating risk to mortgage banking.
Solution: Pipeline risk is a combined risk that the mortgage banker faces between
making a loan commitment and selling the loan after origination. If interest rates
fall the (optional) commitment to a borrower typically is declined and the
mortgage banker loses the loan. If rates rise the borrower typically will use the
3. Describe the basic activities of Fannie Mae in the secondary mortgage market.
How are these activities financed?
Solution: Fannie Mae purchases both conventional and government-underwritten
residential mortgages from mortgage companies, commercial banks, savings and
loan associations, and other approved lenders. Part of these acquired mortgages
The agency only needs to fund securitized loans until they are sold as securities.
For loans held in portfolio its obtains funds for the acquisition of mortgages by
4. Explain the importance of Fannie Mae and Freddie Mac to the housing finance
system in the United States.
Solution: Fannie Mae and Freddie Mac have had a vast array of effects on the
housing finance system of the U.S. Their first impact was to bring much-needed
liquidity to housing finance. Probably their second effect was to standardize the
documents and procedures in home mortgage lending. A third effect has been to
5. What went wrong with mortgage brokerage? Is it being fixed?
Solution: There were at least three fundamental problems with residential
mortgage brokerage as practiced in the years up to 2009. First, brokers were
compensated at the beginning of a transaction and had no continuing
responsibility or liability. Thus they could not be held financially accountable for
6. Describe the mechanics of warehouse financing in mortgage banking..
Solution: A warehouse loan is a credit line provided by large banks to mortgage
bankers to fund loans. The originated mortgage serves as security to the lender
and the lender is repaid when the loan is closed and sold in the secondary
7. Explain how affordable housing loans differ from standard home loans.
Solution: Affordable housing loans include a low down payment requirement and
allow for extensive flexibility in one of the “three Cs” of underwriting, while
8. List three “clienteles” for subprime home mortgage loans.
Solution: Three clienteles for subprime loans are borrowers with inadequate
9. You have just signed a contract to purchase your dream house. The price is
$120,000 and you have applied for a $100,000, 30-year, 5.5 percent loan. Annual
property taxes are expected to be $2,000. Hazard insurance will cost $400 per
year. Your car payment is $400, with 36 months left. Your monthly gross income
is $5,000. Calculate:
a. The monthly payment of principal and interest (PI).
b. One-twelfth of annual property tax payments and hazard insurance
payments.
c. Monthly PITI (principal, interest, taxes, and insurance).
d. The housing expense (front-end) ratio.
e. The total obligations (back-end) ratio.
Solution:
a. $567.79
b. 200
10. Contrast automated underwriting with the traditional “Three Cs” approach
Solution: In automated underwriting, the three Cs are used as factors with other
criteria in a statistical evaluation that is designed to distinguish risky from safe