Deck 22: The Residential Mortgage Market

Question 1

Mortgage loans can be classified based upon whether a credit guaranty associated with the loan is provided by the ________.

A) federal government, a government-sponsored enterprise, or a private entity.
B) the state government, a government-sponsored enterprise, or a private entity.
C) federal government, a state-sponsored enterprise, or a private entity.
D) the federal government, a government-sponsored enterprise, or a public entity.

Answer 1

A

Question 2

A loan originated where the borrow is of lower credit quality is classified as a ________.

A) prime loan.
B) credit guarantee.
C) lien status guarantee.
D) subprime loan.

Answer 2

D

Question 3

In recent years several types of nontraditional amortization schemes have become popular in the mortgage market. The most popular is the ________.

A) interest-only product.
B) hybrid-only product.
C) lockout period product.
D) ARM-only product.

Answer 3

D

Question 4

Which of the below statements is TRUE?

A) The two primary quantitative underwriting standards are (1) the payment-to-income ratio (PTI), and (2) the loan-to-value ratio (LTV).
B) The loan-to-value ratio (LTV) is the ratio of monthly payments to monthly income, which measures the ability of the applicant to make monthly payments (both mortgage and real estate tax payments).
C) The lower the loan-to-value ratio (LTV), the greater the likelihood that the applicant will be able to meet the required payments.
D) All of these

Question 5

The original mortgage balance (MB₀) is $350,000; and, the number of months of the mortgage loan (n) is 360. What is the monthly mortgage payment (MP) if the initial note rate (i) is 7.50%?

A) $842.15
B) $1,447.75
C) $2,378.95
D) $2,447.25

Question 6

The types of real estate properties that can be mortgaged includes ________.

A) single-family properties such as one- to four-family residential properties.
B) commercial properties like houses, condominiums, cooperatives, and apartments.
C) single-family properties such as income-producing properties like apartment buildings.
D) single-family properties such as shopping centers, hotels, and health care facilities (e.g., senior housing care facilities).

Question 7

Which of the below statements is TRUE?

A) For an fixed-rate mortgage (FRM), as the name implies, the note rate changes over the life of the loan.
B) A category of reference rates used in ARMs is the nominal rate.
C) The basic ARM is one that resets periodically and has no other terms that affect the monthly mortgage payment.
D) An unpopular form of an ARM is the hybrid ARM.

Question 8

The principal originators of residential mortgage loans are ________.

A) thrifts, commercial banks, and the government.
B) thrifts, commercial banks, and mortgage bankers.
C) thrifts, pension funds, and mortgage bankers.
D) the secondary market, commercial banks, and mortgage bankers.

Question 9

Although the sources of revenue attributable to the origination function are technically origination fees and secondary marketing profits, another potential source is ________.

A) servicing the mortgages they originate.
B) collecting monthly payments from mortgagors and forwarding proceeds to owners of the loan.
C) sending payment notices to mortgagors and reminding mortgagors when payments are overdue.
D) All of these

Question 10

The difference between the purchase price of the property and the amount borrowed is the borrower's ________. The LTV is the ratio of the amount of the loan to the market (or appraised) value of the ________. The ________, the greater the protection for the lender if the applicant defaults on the payments and the lender must repossess and sell the property.

A) upfront; loan; lower this ratio
B) down payment; property; lower this ratio
C) down payment; property; higher this ratio
D) upfront payment; loan; higher this ratio

Question 11

Which of the below statements is FALSE?

A) The mortgage originator cannot hold the mortgage in its investment portfolio.
B) Mortgage banking refers to the activity of originating mortgages.
C) These mortgage bankers, unlike banks and thrifts, typically do not invest in the mortgages that they originate, but derive their income from the origination fees.
D) Someone who wants to borrow funds to purchase a home will apply for a loan from a mortgage originator.

Question 12

The original mortgage balance (MB₀) is $250,000; and, the number of months of the mortgage loan (n) is 360. What is the monthly mortgage payment (MP) if the initial note rate (i) is 8.50%?

A) $1,842.15
B) $1,847.75
C) $1,922.28
D) None of these

Question 13

The ________ is the primary attribute used to characterize loans as either prime or subprime.

A) debit score
B) PIT score
C) LTV score
D) credit score

Question 14

Which of the below statements is FALSE?

A) If a lender decides to lend the funds, it sends a commitment letter to the applicant whereby this letter commits the lender to provide funds to the applicant.
B) At the time the application is submitted, the mortgage originator will give the applicant a choice among various types of mortgages.
C) Mortgage originators cannot sell the mortgage to an investor that wishes to hold the mortgage in its portfolio.
D) The interest rate that the originator will set on the loan, referred to as the note rate, will depend on the interest rate required by the investor who plans to purchase the mortgage.

Question 15

A mortgage ________.

A) is a collection of markets, which includes a primary (or origination) market and a secondary market where mortgages trade.
B) refers to real estate.
C) is a pledge of property to secure payment of a debt.
D) gives the borrower right to foreclose the loan and seize the property in order to ensure that it is repaid.

Question 16

________ calculate income ratios such as the PTI to assess the applicant's ability to pay. These ratios compare the ________ that the applicant would have to pay if the loan is granted to the applicant's monthly income.

A) Borrowers; monthly payment
B) Lenders; annual payment
C) Lenders; monthly payment
D) Borrowers; annual payment

Question 17

The ________ of a mortgage loan indicates the loan's seniority in the event of the forced liquidation of the property due to default by the obligor.

A) lien status
B) interest rate type
C) loan balances
D) credit classification

Question 18

Mortgage originators may generate income from mortgage activity ________.

A) by not charging an origination fee.
B) through charging application fees and certain processing fees.
C) by not selling a mortgage at a higher price than it originally cost.
D) All of these

Question 19

The LTV has proven to be a good predictor of default: the ________ the LTV, the ________ the likelihood of default.

A) higher; lesser
B) higher; greater
C) lower; greater
D) None of these

Question 20

Which of the below statements is FALSE?

A) In assessing the credit quality of a mortgage applicant, lenders look at various measures with the starting point being the applicant's credit score.
B) Basically, a credit score is a qualitative grade of the credit history of the borrower.
C) Several firms collect data on the payment histories of individuals from lending institutions and, using statistical models, evaluate and quantify individual creditworthiness in terms of a credit score.
D) Although the credit scores have different underlying methodologies, the scores generically are referred to as FICO scores where a higher FICO score indicates lower the credit risk.

Question 21

The amount of the payment made in excess of the monthly mortgage payment is called a prepayment.

Question 22

In regards the risks associated with mortgage origination, price risk is the risk that applicants or those who were issued commitment letters will not close (i.e., complete the transaction by purchasing the property with funds borrowed from the mortgage originator).

Question 23

Pipeline risk refers to what we call market risk and dropdown risk.

Question 24

________ is the risk associated with a mortgage's cash flow due to prepayments.

A) Price risk
B) Liquidity risk
C) Credit risk
D) Prepayment risk

Question 25

The maximum loan size for one- to four-family homes changes every year, based on the percentage change in the average home price (for both new and existing homes) published by the Federal Housing Finance Board.

Question 26

To protect against price risk, the originator could get a commitment from the GSE or the private conduit from which the mortgage originator plans to buy the mortgage.

Question 27

________ is the risk that the homeowner/borrower will default.

A) Price risk
B) Liquidity risk
C) Credit risk
D) All of these

Question 28

Homeowners seldom repay all or part of their mortgage balance prior to the scheduled maturity date.

Question 29

A component of the cash flow of a fixed-income instrument includes ________.

A) interest.
B) principal repayment (scheduled principal repayment or amortization).
C) prepayment.
D) All of these

Question 30

Prepayment risk is the risk associated with a mortgage's cash flow due to ________. More specifically, investors are concerned that borrowers will pay off a mortgage when prevailing mortgage rates fall ________ the loan's note rate.

A) bankruptcy; below
B) prepayments; above
C) prepayments; below
D) bankruptcy; above

Question 31

In regards the risks associated with mortgage origination, price risk refers to the adverse effects on the value of the pipeline if mortgage rates in the market rise.

Question 32

Freddie Mac and Fannie Mae receive a charter from the federal government that ________.

A) imposes no limits on their business activities.
B) disallows them to operate like other corporations.
C) allows them to operate with certain benefits that are available to other corporations.
D) provides liquidity and support to the Eurobond market.

Question 33

One of the underwriting standards is the loan balance at the time of origination. Conventional loans that meet the underwriting standards of the two GSEs are called conforming limits. But there are other important underwriting standards that must be satisfied. These include ________.

A) documentation and borrower credit history.
B) loan type (e.g., fixed rate, ARM) and type of property.
C) loan-to-value ratio by loan type and transaction type.
D) All of these

Question 34

The main risks faced by investors when investing in residential mortgage loans include ________.

A) prepayment risk and mortgage risk.
B) credit risk and liquidity risk.
C) price risk and mortgage risk.
D) nonsystematic risk and liquidity risk.

Question 35

Mortgage originators can protect themselves against fallout risk by entering into an agreement with a government-sponsored enterprises (GSE) or private conduit for mandatory rather than optional delivery of the mortgage.

Question 36

The principal investors in mortgage loans include ________.

A) and commercial banks.
B) thrifts and commercial banks.
C) life insurance companies and thrifts.
D) life insurance companies and pension funds.

Question 37

Fannie Mae and Freddie Mac can buy or sell any type of ________, but the mortgages that are packaged into securities are restricted to ________ and those that satisfy their underwriting guidelines.

A) commercial mortgage; corporate loans
B) residential mortgage; government loans
C) commercial mortgage; government loans
D) residential mortgage; corporate loans

Question 38

Which of the below statements is TRUE?

A) Loans that are backed by agencies of the federal government are referred to under the generic term of government loans and are guaranteed by the full faith and credit of the U.S. government.
B) In contrast to government loans, there are loans that have no explicit guaranty from the federal government and referred to in the market as conventional loans.
C) A conventional loan can be insured by a private mortgage insurer.
D) For government loans and the loans guaranteed by Freddie Mac and Fannie Mae, there are no real limits on the loan balance.

Question 39

Two government-sponsored enterprises and several private companies buy mortgages for purposes of pooling them and selling them to investors.

Question 40

Freddie Mac and Fannie Mae are GSEs whose mission is to provide liquidity and support to the ________.

A) liquidity-support market.
B) real estate market.
C) stock market.
D) mortgage market.

Question 41

Mortgage servicers include bank-related entities, thrift-related entities, and mortgage bankers. There are five sources of revenue from mortgage servicing. Describe two of these five sources.

Question 42

Can a borrower face penalties if a loan is prepaid? Discuss.

Question 43

All mortgage loans have a "due on sale" clause, which means that the remaining balance of the loan does not have to be paid when the house is sold.

Question 44

A type of prepayment in which the entire mortgage balance is paid off is called a partial prepayment or curtailment.

Question 45

Is prepayment risk like that faced by a bond investor? Discuss.

Question 46

Prepayment risk can be reduced if the mortgage is insured by a government agency or a private insurance company.

Question 47

The loan applications being processed and the commitments made by a mortgage originator together are called its pipeline. Pipeline risk refers to the risks associated with originating mortgages. This risk has two components. Name and describe the two components.

Question 48

Conventional loans in the market are referred to as conforming conventional loans and nonconforming conventional loans.

Question 49

Effectively, the borrower's right to prepay a loan in whole or in part without a penalty is a put option.

Question 50

Loans that qualify as conforming loans have a lesser probability of being purchased by Fannie Mae and Freddie Mac to be packaged into a mortgage-backed security.

Question 51

Qualifying for a conforming loan is important for both the borrower and the mortgage originator.

Question 52

What is the mission of Freddie Mac and Fannie Mae? What does their federal charter allow for?

Question 53

There are four main risks associated with investing in mortgages: credit risk, liquidity risk, price risk, and prepayment risk.

Question 54

Mortgages are liquid assets because they tend to have a large bid-ask spread.

Question 55

Because of prepayments, the investor is uncertain about the cash flows that will be realized from investing in a residential mortgage loan.

Question 56

What is prepayment risk? Discuss.

Question 57

The two primary quantitative underwriting standards are (1) the payment-to-income ratio (PTI), and (2) the loan-to-value ratio (LTV). Describe these two ratios.

Question 58

What does the lien status of a mortgage loan indicate?