Financial Markets and Institutions (2-downloads)

Type of Property

Mortgage Loans 

Issued ($ millions)

Proportion 

of Total (%)

One- to four-family dwelling

10,772

75.4

Multifamily dwelling

899

6.29

Commercial building

2,477

17.34

Farm

138

.97

Source: Federal Reserve Bulletin, 2010, Table 1.54.

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Chapter 14 The Mortgage Markets

325

As part of the recovery program from the Depression, the federal government

stepped in and restructured the mortgage market. The government took over delin-

quent balloon loans and allowed borrowers to repay them over long periods of time.

It is no surprise that these new types of loans were very popular. The surviving sav-

ings and loans began offering home buyers similar loans, and the high demand con-

tributed to restoring the health of the mortgage industry.

Characteristics of the Residential Mortgage

The modern mortgage lender has continued to refine the long-term loan to make it

more desirable to borrowers. Even in the past 20 years, both the nature of the lenders

and the instruments have undergone substantial changes. One of the biggest changes

is the development of an active secondary market for mortgage contracts. We will exam-

ine the nature of mortgage loan contracts and then look at their secondary market.

Twenty years ago, savings and loan institutions and the mortgage departments of

large banks originated most mortgage loans. Some were maintained in-house by the orig-

inator while others were sold to one of a few firms. These firms closely tracked delin-

quency rates and would refuse to continue buying loans from banks where delinquencies

were very high. More recently, many loan production offices arose that competed in real

estate financing. Some of these offices are subsidiaries of banks, and others are inde-

pendently owned. As a result of the competition for mortgage loans, borrowers could

choose from a variety of terms and options. Many of these mortgage businesses were

organized around the originate-to-distribute model where the broker originated the loan

and sold it to an investor as quickly as possible. This model increased the principal–agent

problem since the originator had little concern whether the loan was actually paid off.

Mortgage Interest Rates

The interest rate borrowers pay on their mortgages is probably the most important

factor in their decision of how much and from whom to borrow. The interest rate

on the loan is determined by three factors: current long-term market rates, the life

(term) of the mortgage, and the number of discount points paid.

1. Market rates. Long-term market rates are determined by the supply of and

demand for long-term funds, which are in turn influenced by a number of

global, national, and regional factors. As Figure 14.1 shows, mortgage rates

tend to stay above the less risky Treasury bonds most of the time but tend

to track along with them.

2. Term. Longer-term mortgages have higher interest rates than shorter-term

mortgages. The usual mortgage lifetime is either 15 or 30 years. Lenders also

offer 20-year loans, though they are not as popular. Because interest-rate risk

falls as the term to maturity decreases, the interest rate on the 15-year loan

will be substantially less than on the 30-year loan. For example, in May 2010,

the average 30-year mortgage rate was 4.75%, and the 15-year rate was 4.2%.