Besides terms and rates of mortgages, what types of mortgages are there? Currently there are Government Sponsored Entities (GSE), Government agencies, tenure and payment amount frequency types. The first is government sponsored entities which would include the associations Fannie Mae and Freddie Mac. These types have limits on maximum loan conforming limits. The government agencies are the federal housing administration (FHA) and the veterans administration which both ensure insured loans made by banks and other private lenders for home building and home buying. Tenure type refers to owner occupiers, second home and investment loans made for the buyer. The payment amount and frequency represents the amortization payments which include interest and principal, interest only and option ARM expenditures. The formula for mortgage amortizations is mortgage constant X Loan Amount which yields the payments. Mortgage constant is the interest rate per month or R (ie. 6-12%) divided by 1 – 1 / (1 + R)n in which n represents the term of the loan (ie. 360 months). The remaining balance is the present value of remaining payments, using interest rate on loan as a discounted rate.
The Loan to Value (LTV) ratio is the principle of loan/value of the property and it may also represent the current loan to value (CLTV) ratio as well. The current loan balance calculates using the sum of principal payments made to date. The current value of house is generally calculated using the house price index (HPI). The higher LTV ratio implies the higher risk of default. As the risk manager in the financial markets you will generally manage the operational, market and default risks of lending loans for mortgages. The operational risk implies accidents and malfunctions, the market risk represents the interest rates and currency risks, and the default risk is the borrowers chance of default. The main risk of lending loans for mortgages is the probability of default or PD. Models evaluate whether or not the risks are bad and if they are then it is known as loss of given default or LGD.
As the housing market continues its unpredictable velocity, the risk manager would evaluate whether or not it is in the best interest for the financial firm to invest in lending you a mortgage based on the economic growth. If the risk manager foresees a risky following couple of years in the housing market they will likely tighten lending, and vice versa they would likely loosen lending. During the climb to the bursting of the real estate bubble, it was the risk manager’s job to decide whether it would be wise to lend mortgages and majority did. Because of this however, many firms in the housing market were closed down due to the lack of demand these mortgages retained when unemployment rose and the owners of these homes were forced to default. The biggest remark my retired risk manager and Real Estate Econ Professor had to say was that “housing prices go up and down – everywhere”; because of this we should not expect for the housing markets to continue to rise if that is the trend, but rather we should try to factor in the fact that the housing market is capable of anything in which we may only foresee the housing market after it has already occurred.
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