Section 6: The Secondary Mortgage Market
Conforming loan limits vary, depending on location and the number of units purchased with the property. If a one-unit property is being purchased, which of these limits may apply?
-$484,350 -$652,050 -$726,525
When interest rates FALL...
-...borrowing money becomes cheaper for consumers. They won't pay as much on interest. -Investors suffer from these lower interest payments. This means less money passes through to them.
When interest rates RISE...
-...borrowing money becomes more expensive for consumers as they'll have to pay more interest on their loans. -Investors benefit from these higher interest payments which eventually pass through to them.
QM Criteria
-Loan term of 30 years or fewer -Points and fees equal to or less than 3% of the loan amount
Let's assume a CMO follows the most common structure of sequential pay and has three tranches, none of which have been retired. Investors in which tranche(s) will get their hands on interest payments passed through the CMO?
-Tranche 1, 2, and 3
Ginnie Mae MBS Process
1. Lending institution packages mortgages 2. Lending institution issues an MBS 3. Ginnie Mae guarantees the MBS 4. Investors purchase shares of the MBS 5. Mortgage payments from borrowers flow through loan servicer to MBS to investors
What is a collateralized mortgage obligation?
A debt security holder
Farmer Mac
Buys agricultural loans or loans issued by rural lenders
When borrowers started missing mortgage payments, how did this affect collateralized mortgage obligations?
CMOs weren't collecting the expected principal and interest payments.
Mike is working with a client and manually submitting information about the loan and borrower to Fannie Mae to determine eligibility for purchase. A fixed rate mortgage will be used to purchase a single-family home that will be used as the borrower's primary residence. The LTV is 90%. The borrower has a 720 credit score with a 38% debt-to-income ratio. Would this loan be eligible for purchase?
Eligible
The secondary mortgage market buys loans from the primary market. In other words, it helps ______.
Ensure funds are available to borrowers
Federal Home Loan Bank is regulated by what agency?
Federal Housing Finance Agency
Ginnie Mae
Guarantees MBSs that contain loans issued or guaranteed by a U.S. government agency
What activity does Ginnie Mae perform?
Guarantees MBSs with the full faith and credit of the U.S.
Why did investors purchase CMOs prior to the 2007 financial crisis?
Housing price appreciation appeared to be a sure thing.
A lender benefits from selling loans to Fannie Mae by ______.
Increasing capital to offer loans with larger sale prices
What could be a consequence if there were no secondary mortgage market?
Lenders might not have funds available to make new loans to the public.
GSE-eligible Qualified Mortgage
Loan that meets all the requirements and can be purchased, insured, or guaranteed by a GSE, FHA, VA, or USDA.
Small Creditor Qualified Mortgage
Loan that meets all the requirements and is originated by a lender that makes 500 or fewer mortgages annually and has $2 billion or less in assets.
Imagine for a moment that the FHLB didn't exist. Which of the following is most likely?
Local banks would have fewer funds available to lend to consumers.
Conforming Loans
Meet all qualifying guidelines set by Fannie Mae and Freddie Mac, which include: Loan amount Down payment requirements Loan-to-value ratio Housing debt-to-income and/or total debt-to-income ratios
A group of loans packaged together, then sold to investors on the secondary market, is called a ______.
Mortgage-backed security
Of the secondary market players listed, which issue loans directly to consumers?
No one
Loan Types
-Renovation loans -Refinancing loans -Adjustable-rate mortgages -Fixed-rate mortgages
Primary Market
-Thrifts -Commercial banks -Credit Unions
Real Estate Mortgage Investment Conduit (REMIC)
A REMIC is a collateralized mortgage obligation (CMO) disguised as an entity or company. Some REMICs were created as a result of the Tax Reform Act of 1986. Given certain requirements are met, an election can be made with the IRS to create a REMIC. Most CMOs are REMICs because of the tax benefits a REMIC offers, mainly avoiding double taxation of income. As a result, from a federal income tax perspective, the REMIC is treated as a partnership. Income received by the REMIC is not taxed at the company level. Instead, after the income is passed through to investors, it becomes taxable.
If Freddie Mac didn't exist, which of the following would be a likely effect?
A decrease in the amount of credit available to loan originators
Horace recently purchased 1,000 shares of a security that's made up of hundreds of mortgages. The principal and interest that borrowers of these underlying mortgages pay are eventually passed through to Horace and the other investors. What did Horace purchase?
A mortgage-backed security
What is a government-sponsored enterprise?
A private company the U.S. Congress created to make certain borrowing easier and cheaper
Which of the following statements best describes a tranche?
A slice of a CMO that has specific rules for distributing income received from the collateral
Federal Home Loan Bank
Advances funds to member banks
The FHLB (Federal Home Loan Bank) is a secondary market player. What exactly does it do?
Advances funds to member banks.
Assuming a CMO uses the sequential pay structure, how is interest passed through from borrowers paid to investors?
All tranches receive interest payments.
Fannie Mae
Buys conventional loans, mainly from large commercial banks
Freddie Mac
Buys conventional loans, mainly from small banks or thrifts
In a loan to purchase which of the following property types is NOT eligible for purchase by Fannie Mae?
Commerical space
Non-Conforming Loans
Don't meet all qualifying guidelines set by Fannie Mae and Freddie Mac. Frequently are "jumbo loans," above the loan limit for government-backed loans.
Which of the following is a true statement about tranches?
Each tranche has specific rules for distributing income received from the collateral, and has differing balances, maturities, and risks.
Conventional loans from large commercial banks are the primary target for which secondary market player?
Fannie Mae
Of the institutions listed, which of these is viewed only as a secondary mortgage market player?
Fannie Mae
Which of the following entities buys primarily conventional loans from large commercial banks?
Fannie Mae
Credit flows to rural communities largely through the actions of _________.
Farmer Mac
We mentioned that the secondary mortgage market plays an important role in real estate finance. Let's imagine for a moment this market didn't exist. Which of these are possible outcomes?
Loan originators would have fewer funds available for lending. -Without the secondary mortgage market to keep credit flowing in the primary market, bad things would happen. Lending and the housing market would come to a halt, and the ripple effects of reduced homeownership would be felt throughout the economy.
General Qualified Mortgage
Loan that meets all the requirements set and has a debt-to-income ratio of 43% or less.
Which of the following is NOT a benefit government-sponsored enterprises receive?
Nonprofit status
Mike is working with another client and manually submitting information about the loan and borrower to Fannie Mae to determine eligibility for purchase. This borrower will be using a fixed rate mortgage to purchase a second home. LTV is 95%. The borrower has a 700 credit score with a 36% debt-to-income ratio. Would this loan be eligible for purchase?
Not eligible
A qualified mortgage is ______.
One that meets certain lending standards
While Fannie Mae considers total and housing debt-to-income ratios in its underwriting process, Freddie Mac considers ______.
Only total debt-to-income
Several actions take place on the secondary mortgage market. Which of these is a common activity?
Packaging loans into mortgage-backed securities
After a loan passes Freddie Mac's underwriting process, the institution may purchase the loan then package it into a mortgage-backed security (MBS) to be sold to investors. What term does Freddie Mac use to describe its MBS product?
Participation certificate (PC)
Which of these are established by the Federal Housing Finance Agency?
Percentage targets for loans made to low- to moderate-income borrowers
What are the types of institutions that issue loans directly to consumers commonly called?
Primary market players
Which of the following actions is completed by the secondary mortgage market?
Purchases loans from lending institutions.
How does Farmer Mac meet its goal of making credit available in rural communities?
Purchasing loans issued by agricultural and rural lenders
How do falling interest rates impact investors in mortgage-backed securities?
Returns on investments decrease.
Which of the following made mortgages attractive investments?
Rising home prices
Farmer Mac is a secondary market player. Who does Farmer Mac serve directly?
Rural lenders who then indirectly serve farmers, ranchers, and anyone in these agricultural and rural communities.
Institutions that purchase loans, package them into mortgage-backed securities, then sell these to investors may commonly be referred to as ______.
Secondary market players
What is the most common structure for a CMO?
Sequential pay
Mike Differentiates CMOs from REMICs
Sometimes you'll hear "CMO" and "REMIC" used interchangeably. But it's a little like fruit and apples. All REMICs are CMOs, but not all CMOs are REMICs.
______ sets conforming loan limits for mortgages.
The Federal Home Financing Agency
The secondary mortgage market serves a very important role related to real estate finance. Which of these statements best describes that role?
The secondary market purchases loans from primary lenders and helps keep credit available to loan originators.
At the risk of reducing Fannie Mae to a pool of tears, let's imagine a world without Freddie Mac for a moment. What would that world look like?
There'd be fewer funds available for real estate financing.
What role did CMOs play in the financial crisis of 2007?
They increased market speculation
Next, let's consider the principal portion of the payments. Again, assume this CMO has three tranches, none of which are retired. Investors in which tranche will get their hands on principal payments passed through the CMO?
Tranche 1
What are some reasons a lender would originate a loan just to turn around and sell it on the secondary market?
-Access to additional mortgage credit -For the collection fees
Mortgage Backed Securities (MBSs)
-Banks sell issued mortgages on the secondary market. -Secondary market institution groups these mortgages into a mortgage-backed security and sells shares of this security to investors. -Money received from investors is used by secondary market institutions to purchase additional loans. -Principal and interest payments 2 filter through from borrower to bank to MBS to investors (minus fees along the way).
Fannie Mae and Freddie Mac have several requirements for conforming loans. Which of these apply?
-Down payment -Housing or total debt-to-income ratio -Loan amount -Loan-to-value ratio
FHFA Conservatorship
-FHFA took over management and power from the boards. -Fannie Mae and Freddie Mac stock was purchased by the U.S. Treasury to keep them solvent. -The FHFA sued financial institutions who misrepresented the quality of the MBSs or their underlying mortgages.
Some secondary market players purchase loans, then package them into mortgage-backed securities to sell on the secondary market. Which three entities issue MBSs?
-Fannie Mae -Farmer Mac -Freddie Mac
The FHFA (Federal Housing Finance Agency) regulates certain secondary market players. Which institutions does the FHFA regulate?
-Fannie Mae -Freddie Mac -Federal Home Loan Bank
Which of these secondary market players are considered a GSE?
-Fannie Mae -Freddie Mac -Federal Home Loan Bank
Secondary Market
-Fannie Mae -Freddie Mac -Investors in MBSs
What Is Fannie Mae?
-Fannie Mae was established as the Federal National Mortgage Association (FNMA) in 1938. -Fannie Mae's goal is to help ensure that all communities have access to mortgage credit. -Fannie Mae packages the loans they purchase into mortgage-backed securities -Fannie Mae purchases FHA-insured and VA-guaranteed loan and conventional loans
In the previous question, we mentioned that GSEs make borrowing easier and more cost effective for certain areas of the economy. What three parties do GSEs serve?
-Farmers -Homeowners -Students
Ginnie Mae only guarantees MBSs that hold certain types of loans. Identify whether a MBS holding the types of loans listed would be guaranteed.
-Federal Housing Agency (FHA)-insured loans -HUD's Office of Public and Indian Housing issued loans -Loans originated by the Department of Agriculture's Rural Housing Service (RHS) -Loans guaranteed by the Department of Veterans Affairs (VA)
Freddie Mac Facts
-Freddie Mac was created as the Federal Home Loan Mortgage Corporation (FHLMC) in 1970. -Freddie Mac is a government-sponsored enterprise. -Freddie Mac issues mortgage-backed securities, but it doesn't issue loans.
Facts about Gov sponsored enterprises
-GSEs are private companies created by the U.S. Congress, not government agencies. -They make borrowing easier for certain sectors of the economy. -GSEs don't need to register securities or MBSs with the SEC. -They're exempt from paying local or state corporate income tax. -GSEs are regulated by the Federal Housing Finance Agency (FHFA).
CMO and Market Conditions
-Home prices were rising. -Loan originators used loose qualifying standards. -Private companies issued more and more CMOs.
So what happened after home prices fell?
-Homes lost value, making it tough to refinance. -Borrowers started missing mortgage payments, but couldn't refinance, causing an increase in foreclosures. -CMOs were no longer receiving payments from the underlying mortgages because many borrowers were in foreclosure. -CMO investors experienced large losses.
Suppose James recently took out a mortgage with his local state bank. Shortly after the loan was issued, the bank sold the loan on the secondary market, although it'll continue to service the loan. That loan was packaged with similar type loans into a mortgage-backed security. When James makes his monthly payments, which parties see this money?
-Loan servicer -MBS issuer -MBS investor
Identify whether these items are criteria Fannie Mae uses in their underwriting process.
-Location -Type of dwelling -Loan to value ration -Property type -Dent to income ratio -Down payment
A CMO is a security that is made up of certain things. Which of these might you find in a CMO?
-Mortgages -Mortgage-backed securities
The Consumer Financial Protection Bureau (CFPB) sets qualified mortgage rules. Here are some facts:
-Qualified mortgages are safer for consumers. -Qualified mortgages can't have risky or confusing features, or any surprises for consumers. -Consumers should be able to repay a qualified mortgage. -Consumers have more communication from lenders when they fall behind on their payments.
In addition to regulating the housing GSEs, and serving as conservator of Fannie Mae and Freddie Mac, the FHFA has other roles related to housing. Sort these items based on whether they apply to the FHFA.
-Sets conforming loan limits -Sets targets for the percentage of loans made to low- to moderate-income borrowers
Freddie Mac only purchases loans used to finance or refinance the purchase of certain types of properties. Which of these property types are eligible?
-Single family primary residence -Duplex -Single unit secondary home -Manufactured home
REMICs
-The Tax Reform Act of 1986 allows for the creation of REMICs. -A REMIC is treated as a partnership for federal income tax purposes. -A REMIC passes income through to investors and becomes taxable only at that point.
Here's a list of criteria. Sort through it to identify criteria used by Freddie Mac in its underwriting process.
-Total debt-to-income ratio -Loan to value ratio -Loan term -Loan term -Amortization type
MBSs and Interest Rates
-When loan interest rates are falling, borrowers benefit. Loans are cheaper, which translates into lower payments that are passed through to investors. -When loan interest rates are rising, MBS investors benefit. Loans are more expensive,which translates into higher payments passed through to investors.
Secondary Market Steps
1. Lending institution markets its loan to the secondary market 2. Secondary mortgage market institution purchases the loan 3. Loans are packaged into a mortgage-backed security 4. Investors purchase shares of the MBS 5. Money received from investors is used to purchase additional loans
Qualified mortgages require debt-to-income ratios of no more than ______.
43%
Bob is also making a purchase. He'll use an adjustable rate mortgage to purchase a duplex that will be used as an investment property. The LTV for this loan must be no more than _____ for it to remain eligible for Fannie Mae purchase.
75%
Andrea is also using a fixed-rate mortgage, but to purchase a second home that she'll use for weekend and vacation getaways. This loan may be eligible for purchase if the LTV is lower than _____
90%
David wants to purchase a single unit principal residence using a fixed-rate mortgage. His loan may be eligible for Fannie Mae purchase if the LTV ratio is no greater than ____
97%
