MORTGAGE MARKETS
LEARNING OBJECTIVES
A. Describe what Mortgage Markets are
B. Determine the various types of Mortgage Loans
C. Apply computations on Amortization of Mortgage Loans
D. Describe the different Mortgage Lending Institutions
DEFINITION OF MORTGAGES
MORTGAGES
a type of loan used to purchase or maintain a home, land, or other types of real estate.
The borrower agrees to pay the lender over time, typically in a series of regular
payments that are divided into principal and interest. (Investopedia)
are long term loan secured by real estate
How Mortgages Work
Individuals and businesses use mortgages to buy real estate without paying the entire
purchase price up front. The borrower repays the loan plus interest over a specified number of
years until they own the property free and clear. Most traditional mortgages are fully-
amortizing. This means that the regular payment amount will stay the same, but different
proportions of principal vs. interest will be paid over the life of the loan with each payment.
Typical mortgage terms are for 30 or 15 years.
Mortgages are also known as liens against property or claims on property. If the
borrower stops paying the mortgage, the lender can foreclose on the property.
For example, a residential homebuyer pledges their house to their lender, which then has
a claim on the property. This ensures the lender’s interest in the property should the
buyer default on their financial obligation. In the case of a foreclosure, the lender may evict the
residents, sell the property, and use the money from the sale to pay off the mortgage debt.
The Mortgage Process
Would-be borrowers begin the process by applying to one or more mortgage lenders.
The lender will ask for evidence that the borrower is capable of repaying the loan. This may
include bank and investment statements, recent tax returns, and proof of current employment.
The lender will generally run a credit check as well.
If the application is approved, the lender will offer the borrower a loan of up to a certain
amount and at a particular interest rate. Homebuyers can apply for a mortgage after they have
chosen a property to buy or while they are still shopping for one, a process known as pre-
approval. Being pre-approved for a mortgage can give buyers an edge in a tight housing market
because sellers will know that they have the money to back up their offer.
Once a buyer and seller agree on the terms of their deal, they or their representatives will
meet at what’s called a closing. This is when the borrower makes their down payment to the
lender. The seller will transfer ownership of the property to the buyer and receive the agreed-
upon sum of money, and the buyer will sign any remaining mortgage documents. The lender
may charge fees for originating the loan (sometimes in the form of points) at the closing.
CHARACTERISTICS OF THE RESIDENTIAL MORTGAGE
A. Mortgage Interest Rates
One of the most important factors in the decision of the borrower of how much
and from whom to borrow is the interest rate on the loan.
Factors that affect the interest rate on the loan
1. Current long-term market rates
Long term rates are determined by the supply of and demand for long term funds,
which are in turn affected by a number of global, national and regional factors.
2. Term or Life of the mortgage
Generally, the longer-term mortgages have higher interest rates than short-term
mortgages. The usual mortgage lifetime is 15 to or 30 years. Because interest rate risk
falls as the term to maturity decreases, the interest rate on the15-year loan will be
substantially less than on the 30-year loan.
3. Number of Discount Points Paid
Discount points are interest payments made at the beginning of a loan. A loan with
one discount point means that the borrowers pays 1% of the loan amount at closing,
the moment when the borrower signs the loan paper and receives the proceeds of the
loan.
B. Loan Terms
Mortgage loan contracts contain many legal and financial terms, most of which protect
the lender from financial loss.
C. Collateral
One characteristic common to mortgage loans is the requirement that collateral, usually
the real estate being financed, be pledged as security.
D. Down Payment
To obtain a mortgage loan, the lender also requires the borrower to make a down
payment on the property that is to pay a portion of the purchase price. The balance of the
purchase price is paid by the loan proceeds. Down payments are intended to make
borrower less likely to default on the loan.
The down payment reduces moral hazard for the borrower. The amount of the down
payment depends on the type of mortgage loan. Many lenders require that the borrower
pays 5% of the purchase price; in other situations, up to 20% may be required.
E. Private Mortgage Insurance
Private Mortgage Insurance is an insurance policy that guarantees to make up any
discrepancy between the value of the property and the loan amount, should a default
occur.
For example, if the balance on your loan was P120,000 at the time of the default and the
property was worth P100,000, PMI would pay the lending institutions P20,000.
F. Borrowers Qualification
Before granting a mortgage loan, the lender will determine whether the borrowers
qualifies for it. Qualifying for a mortgage loan is different from qualifying for a bank
loan because most lenders sell their mortgage loans to one of a few government agencies
in the secondary mortgage market.
AMORTIZATION OF MORTGAGE LOAN
Mortgage loan borrowers generally agree to pay a monthly amount of principal and
interest that will be fully amortized by its maturity.
Amortization in real estate refers to the process of paying off your mortgage loan with
regular monthly payments. These payments are made in equal installments over the life of the
loan, though the amount of the payment consisting of principal and interest can vary. The
amortization period refers to how long it will take to pay off your mortgage in full.
TYPES OF MORTGAGE LOANS
1. Conventional Mortgages
These are originated by banks or other mortgage lenders but are not guaranteed by
government or government controlled entities. Most lenders through now insure
many conventional loans against default or they require the borrower to obtain
private insurance on loans.
2. Insured mortgages
These mortgages are originated by banks or other mortgage lende4s but are not
guaranteed by either government or government controlled entities
3. Fixed-rate Mortgages
In fixed rate mortgages, the interest rate and the monthly payment do not vary
over the life of the mortgages
4. Adjustable rate Mortgages
The interest rate on adjustable mortgage is tied to some market interest rate and
therefore changes over time. ARMs usually have limits, called caps on how high
(or low) the interest rate can move in one year and during the term of the loan.
5. Graduated-Payment Mortgages
These mortgages are useful for home buyers who expect their income to rise.
THE GPM has lower payments in the first few years, then the payments may not
even be sufficient to cover the interest due, in which case the principal balance
increases.
6. Growing Equity Mortgage
With the GEM, the payment will initially be the same on/an conventional
mortgages. Over time, however the payment will increase. This increase will
reduce the principal more quickly than the conventional payment stream would.
7. Shared Appreciation Mortgages (SAMs)
In a SAM, the lender lowers the interest rate in the mortgage in exchange for a
share of any appreciation in the real estate (if the property sells for more than a
stated amount, the lender is entitled to a portion of the gain)
8. Equity Participation Mortgage (EPM)
In EPM, an outside investor shares in the appreciation of the property. This
investor will either provide a portion of the purchase price of the property to
supplement te monthly payment. In return, the investor receives a portion of any
appreciation of the property
9. Second Mortgage
These are loans that are secured by the same real estate that is used to secure the
first mortgage. The second mortgage is junior to the original loan which means
that should a default occur, the second mortgage holder will be paid only after the
original loan has been paid off, if sufficient funds remain.
10. Reverse Annuity Mortgages (RAMs)
In a RAM, the bank advances funds to the owner on a monthly schedule to enable
him to meet living expenses he hereby increasing the balance of the loan in which
in secured by the real estate. The borrower does not make payments against the
loan and continues to live in his home. When the borrowers dies, the estate sells
the property to pay the debt.
SECURITIZATION OF MORTGAGES
Problems when intermediaries sell mortgage to secondary market
Mortgages are usually too small to be wholesale instruments
Mortgages are not standardized. They have different terms to maturity, interest rates and
contract term. Thus it is difficult to bundle large number of mortgages together and
Mortgage loans are relatively costly to service. The lenders must collect monthly
payments , often advances payment of property taxes and insurance premiums and
service accounts
Mortgages have unknown default risk. Investors in mortgages do not want to spend a lot
of time and effort in evaluating the credit of borrowers
Mortgage - backed security - is a security that is collateralized by a pool of mortgage loans.
This is also known as securitized mortgage.
Securitization is the process of transforming illiquid assets into marketable capital market
instruments.
Mortgage pass through - a security that has the borrower’s mortgage pass through the trustee
before being disbursed to the investors in the mortgage-pass through. If borrowers pre-pay their
loans, investors receive more principal than expected
Benefits derived from Securitized Mortgage (SM)
• SM has reduced the problem and risks caused by the regional lending institutions’
sensitivity to local economic fluctuations
• Borrowers now have access to a national capital market
• Investors can enjoy the low-risk and long-term nature of investing in mortgage without
having to service the loan
• Mortgage rates are now more open to national and international influences. As a
consequences, mortgage rates are more volatile than they were in the past.
References:
https://www.investopedia.com/terms/m/mortgage.asp
https://www.rocketmortgage.com/learn/mortgage-amortization#:~:text=Amortization%20in
%20real%20estate%20refers,principal%20and%20interest%20can%20vary.
To compute the yearly payment for a fully amortized mortgage, we can use the formula for an annuity
to determine the annual payment amount. Given the loan amount 𝑃=5,000,000P=5,000,000, annual
interest rate 𝑟=6%r=6%, and loan term 𝑛=10n=10 years, we can calculate the annual payment as
follows:
The formula for the annual payment A on an amortizing loan is:
P=5,000,000
r=0.06
n=10
Amortization Schedule
Year Beginning Balance (PHP) Annual Payment (PHP) Interest (6%) (PHP) Principal (PHP) Ending Balance (PHP)
1 5,000,000.00 679,332.44 300,000.00 379,332.44 4,620,667.56
2 4,620,667.56 679,332.44 277,240.05 402,092.39 4,218,575.17
3 4,218,575.17 679,332.44 253,114.51 426,217.93 3,792,357.24
4 3,792,357.24 679,332.44 227,541.43 451,791.01 3,340,566.23
5 3,340,566.23 679,332.44 200,433.97 478,898.47 2,861,667.76
6 2,861,667.76 679,332.44 171,700.07 507,632.37 2,354,035.39
7 2,354,035.39 679,332.44 141,242.12 538,090.32 1,815,945.07
8 1,815,945.07 679,332.44 108,956.70 570,375.74 1,245,569.33
9 1,245,569.33 679,332.44 74,734.16 604,598.28 640,971.05
10 640,971.05 679,332.44 38,458.26 640,874.18 96.87
Explanation
Year: The specific year of the loan term.
Beginning Balance: The outstanding loan balance at the start of the year.
Annual Payment: The fixed annual payment amount.
Interest: The interest amount for the year (6% of the beginning balance).
Principal: The portion of the annual payment that goes towards reducing the principal balance.
Ending Balance: The remaining loan balance after the annual payment.
This table demonstrates the process of fully amortizing the loan over a 10-year period with consistent
annual payments.
