Chapter 14
The Mortgage Markets
What A Mortgages?
Characteristics of the Residential Mortgage
Mortgage Interest Rates
Case: The Discount Point Decision
Loan Terms
Mortgage Loan Amortization
Types of Mortgage Loans
Insured and Conventional Mortgages
Fixed- and Adjustable-Rate Mortgages
Other Types of Mortgages
Mortgage-Lending Institutions
Loan Servicing
E-Finance Box: Borrowers Shop the Web for Mortgages
Secondary Mortgage Market
Securitization of Mortgages
What Is a Mortgage-Backed Security?
Types of Pass-Through Securities
Subprime Mortgages and CDOs
The Real Estate Bubble
◼ Overview and Teaching Tips
This chapter deals with a subject that will affect all of us eventually, mortgages. A mortgage is a long-term
loan secured by real estate. Individuals are usually the primary borrowers who use mortgages to finance
their homes or small businesses. The characteristics of residential mortgages are covered in depth so
students will get a full understanding of the topic at hand. A detailed section covers interest rates on
mortgages and how they are determined for different types of rates, terms, and discount points. There is an
excellent application in this section to review discount points with the students. One requirement for most
mortgages is collateral, which is usually a piece of real property pledged to the lender for security on the
loan. In addition, the borrower is required to make a down payment that is determined by the type of
mortgage loan. Computing the payment of mortgage loans is explained in the next section along with an
application.
76 Mishkin/Eakins • Financial Markets and Institutions, Eighth Edition
Mortgage loans are available in several different types, including insured and conventional mortgages,
fixed- and adjustable-rate mortgages, growing equity mortgages, and second mortgages. Since many
institutions do not want to back mortgage loans, the creation of the mortgage-backed security was
established. The government created two more institutions to offer new securities backed by both insured
and uninsured mortgages. Mortgage pass-throughs are the most common type of these mortgages. GNMA
pass-through securities, FHLMC pass-throughs, and private pass-through securities are three types of
mortgage pass-through securities that exist. Over the years, mortgage-backed securities have created
several benefits for borrowers and lenders. The securitization of mortgages has also created problems. By
putting the investor one more layer removed from the borrower, abuses have occurred in the industry
where loans have been made to borrowers, who can’t afford the payments. This practice led to mortgage
industry problems beginning in 2006. The category of loans are referred to as sub prime loans. The role of
subprime mortgages and CDOs is very relevant to the current economic and real estate climate.
◼ Answers to End-of-Chapter Questions
1. Securities in the mortgage markets are collateralized by real estate.
2. Balloon loans require that a large final payment be made to pay off the remaining principal balance.
4. Discounts points paid when a loan is initiated result in a reduced interest rate. If the borrower plans to
5. A lien is a publicly recorded claim on a piece of real property that has been pledged as collateral.
Mortgage lenders file liens to secure loans.
6. The down payment means that if the borrower chooses not make payments on the loan, the borrower
8. Most mortgage loans are sold to government agencies. These agencies establish criteria for which
loans they will accept. If the loans do not meet these criteria, the initiating bank cannot sell them.
9. The Veterans Administration and the Federal Housing Administration guarantee lenders against
10. The loan is an adjustable-rate mortgage on which the interest rate is set at 2 percentage points above
11. The goal of the graduated-payment loan is to let the borrower qualify by reducing the first few years’
80 Mishkin/Eakins • Financial Markets and Institutions, Eighth Edition
Copyright © 2015 Pearson Education, Inc.
The required payment for the 2nd year is computed as:
N = 348; I = 4.5/12; PV = $243,855.29; FV = 0
Compute PMT; PMT = $1,255.84
The maximum required payment for the 4th year is computed as:
N = 324; I = 8.5/12; PV = $236,551.31; FV = 0
Compute PMT; PMT = $1,865.02
The maximum possible payment would occur in the 5th year if the 10.5% rate is required.
The payment would be:
N = 312; I = 10.5/12; PV = $234,187.24; FV = 0
Compute PMT; PMT = $2,193.93
9. Consider a 30-year, fixed-rate mortgage for $500,000 at a nominal rate of 6%. What is the difference
in required payments between a monthly payment and a bi-monthly payment (payments made twice
a month)?
Solution: The required payment for monthly payments is computed as:
10. Consider the following options available to a mortgage borrower:
Loan
Amount
Interest Rate
Type of
Mortgage
Discount Point
Option 1
$100,000
6.75%
30-yr fixed
none
Option 2
$150,000
6.25%
30-yr fixed
1
Option 3
$125,000
6.0%
30-yr fixed
2
What is the effective annual rate for each option?
Solution: Option 1: (1 + 0.0675/12)12 − 1 = 0.069628