20287250 a Financial Analysis of Consumer Mortgage Decisions

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S P E C I A L R E P O R T

A Financial Analysis o

Consumer Mortgage DecisionsAndrew J. Kalotay and Qi Fu



A Financial Analysis of Consumer Mortgage Decisions

© Rch Ini Hing Amic Jn 2009. All igh v.

A Finncil Anlyi Cnm Mgg Dciin

Andrew J. KalotayAnw Kly Aci, Inc.

61 Bwy, Si 1400

Nw Yk NY 10006

(212) 482-0900

x: (212) 482-0529mil: [email protected]

Qi FuAnw Kly Aci, Inc.

61 Bwy, Si 1400

Nw Yk NY 10006

(212) 482-0900

x: (212) 482-0529

mil: [email protected]



4 A Financial Analysis of Consumer Mortgage Decisions


Research Institute for Housing AmericaBoard of Trustees

Chair

T Byc, Eq.

Radian Group Inc.

Michl Bmn

CW Capital

Nnc Mll

Wells Fargo

Ew L. Hly

Avanath Capital Partners LLC

Sv Gv

Principal Real Estate Investors

Dn Ycm

IMortgage

Staff

Jy Binkmnn, Ph.D.

Senior Vice President, Research and Business Development

Chief Economist

Mortgage Bankers Association

Michl Fnni, Ph.D.

Vice President, Research and Economics

Mortgage Bankers Association





Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

Chapter 1: Choosing the Right Mortgage . . . . . . . . . . . 9C Sc Mgg. . . . . . . . . . . . . . . . . . . 9

Wh’ Miing m APR? . . . . . . . . . . . . . . . . . . 11

Incing APRPl. . . . . . . . . . . . . . . . . . . . . 13

Tx Cniin . . . . . . . . . . . . . . . . . . . . . . 16

Th Rik N Bing Abl Rinnc . . . . . 17

Bm Lin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

Chapter 2: The Economics of Refinancing . . . . . . . . . 21

Hw D T Dci Whn Cll Bn? . 21

Rinncing Eicincy . . . . . . . . . . . . . . . . . . . . . . 22C Si . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26

Bm Lin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28

Chapter 3: When to Pay Down a Mortgage. . . . . . . . . 29

Pying Dwn Mgg v. Inving. . . . . . . . . . . 29

Unning Rik . . . . . . . . . . . . . . . . . . . . . . 29

A Cl Lk Mgg Inving . . . . . . . . 30

Ty Bn n Mni . . . . . . . . . . . . . . . . 31

Th Invmn Dciin . . . . . . . . . . . . . . . . . . 32

Rik Cniin Inving in Mni . . . . 33

Tx Rik. . . . . . . . . . . . . . . . . . . . . . . . . . . . 33

Hizn Rik . . . . . . . . . . . . . . . . . . . . . . . . 34

Ci Ec . . . . . . . . . . . . . . . . . . . . . . . . 35

Bm Lin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36

Appendix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37

Ovviw Mgg Tminlgy . . . . . . . . . . . 37

Mgg Ln . . . . . . . . . . . . . . . . . . . . . . . . . 37Pincipl n In . . . . . . . . . . . . . . . . . . . . 37

Annl Pcng R (APR) . . . . . . . . . . . . . 38

Ppymn . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38

Tx Tmn Mgg. . . . . . . . . . . . . . . 39

In Pymn. . . . . . . . . . . . . . . . . . . . . . 39

Pin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39

Mgg Mk Picipn . . . . . . . . . . . . . . . . 40

Bw . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40

Mgg Bk n h Ln Oic. . . . . . . 40

Oigin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40Lning Dciin. . . . . . . . . . . . . . . . . . . . . . . . 40

Svic . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41

In . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41

Sciizin Pc . . . . . . . . . . . . . . . . . . . . 41

Inv . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42

In R . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42

US Ty R . . . . . . . . . . . . . . . . . . . . . . . 42

Mgg R . . . . . . . . . . . . . . . . . . . . . . . . . 44

Mgg Sc . . . . . . . . . . . . . . . . . . . . . . . . 47

Fix- Mgg . . . . . . . . . . . . . . . . . . . . . 47

Ajbl- mgg (ARM) . . . . . . . . . . . 48

Hybi ARM. . . . . . . . . . . . . . . . . . . . . . . . . . . 50

Jmb Mgg . . . . . . . . . . . . . . . . . . . . . . . . 50

Scn Mgg n Hm Eqiy Ln . . . . 50

Glossary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51

References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56

Mnging Y Mgg . . . . . . . . . . . . . . . . . . . 56

Mgg Mk Siic . . . . . . . . . . . . . . . . . . 56

Tx Tmn Mgg . . . . . . . . . . . . . . . . . 56

Th Sbpim Mgg Cii . . . . . . . . . . . . . . . . 56

Mgg Anlyic . . . . . . . . . . . . . . . . . . . . . . . . 56

Fix Incm Fnmnl . . . . . . . . . . . . . . . . . . 57

Wh’ n h Wb? . . . . . . . . . . . . . . . . . . . . . . . . 57

Inmin Sc . . . . . . . . . . . . . . . . . . . . . . . . 57

Opin-B Mgg Clcl . . . . . . . . . . . 57

Tbl Cnn





Bying hm i h ingl bigg invmn ciin m Amicn. Bc m by

n hv h ch py h pch pic pn, hy blig k mgg ln. Th

l h bn mn wi ng mgg pc i bw’ vi ch lw

n ik pnc. Mgg lning h bn by h gvnmn in mlipl wy in

pp hmwnhip, incling by mking mgg in x cibl.

Inc chic, hwv, inc cmplxiy — ching h igh mgg n mnging i cn

b chllng. Fnly, h wll-n l h cp n mnicipl

mng b n h cn b p hmwn mnging hi mgg.

Cp pnibl mnging hi im’ bwing pil n gy. J

lik hmby, hy n ci whn bw, hw c b, whn innc bn whn py b. I hy hi wll, hy cn v hi im l mny; i n, h c

cl b cnibl. Hmwn c imil chllng in mnging hi hm ln, n hy

cn pply h m chniq by cp .

In m c, ingl cniin, bwing hizn — h lngh im bw xpc

hv ln ning — cn c hgh m h g. F xmpl, i pnil hmby

knw h h h i mving in iv y, i mk n n n in lng-m ix-

mgg. Lng-m ix- ln cy high hn h-m ln, phnmnn

w will ic in m il l. In, 5 / 1 7 / 1 hybi jbl- mgg (ARM)migh b b chic. (A 7 / 1 im chin in c h pjc mv cc whn hm

pic p.) Evn hgh h l 30-y ln, hy hv h vng lw ix-

h i iv vn y, n hy kp ch lw mngbl bc h 30-y

mizin pincipl.

Incin





Hwv, vn i bw i nly cniing lng-m ix- mgg, ching m mng

h in ix- mgg cn l b cmplx n pnilly cning. H

gin, ingl c — hw mch cn h bw cmbly py ch mnh — nw h

il. A 15-y mgg innc will qi lg mnhly pymn hn 30-y mgg

bc h mizin.

On h h hn, 15-y mgg lwy lw hn 30-y mgg . Th n

hi i h h bw’ pin innc ny im, cmmn ll n ix-

mgg, h l im vl n h ln. W will l ic hi in g il l.

Sphiic bw my l ngi mix-n-mch mgg yp in ingl cnc.

F xmpl, hy my bw p h cnc pincipl n ARM n nh p ix-

ln.

Evn i w cnin lv lng-m cnvninl ix- mgg, h vibl ch

pin n n-c c qi h nlyi. W nlyz h vibl in Chp 1.

Onc h mgg i in plc, h bw c h nging qin i n whn innc. I

clin inncing, h i ng v cing ly. On h h hn, i h bw

wi n g p, h i g v h mi ppniy. Thi ilmm n h lin

i ic in Chp 2.

Chp 3 xmin h cmmn pcic pying wn mgg whnv pl ch i vilbl.

Shl h hmwn h ch inv in h inmn in? Th nw will b

illmining.





L’ k pin p h y hv lng bwing hizn1 n n vin h

in ik ci wih ARM. Hving ci n 30-y ix- mgg, y ill

c wih ng pibilii in m h bwn mgg n pn c.

Cost Structure of MortgagesAll mgg invlv cling c. Th cni ln , mgg bk , il ,

cling gn ( lwy’) , x, cing , c. Y cn py h c pck

(binging chck cling) n hv hm c m h mn bw, h cing h

ln pc civ. A m cn pin i py cling c v im vi high in

. Thi yp c i mk no-closing costs mortgage, no-cost mortgage (NCM).

Ln qi icl cling c n c hm in h clclin h annual

percentage rate (APR) h ln.

Mgg n q wih discount points h pi pn — pin i n pcn

h pincipl h ln. Th m icn pin h bw i willing py, h lw h

mgg will b. W will mgg wih n pn pin par mortgage, n n

h incl pin discount mortgage. Pin l c in h clclin APR in

mk ppl--ppl cmpin c in mgg c h m m.

1 The length o time a borrower expects to have a loan outstanding.

Chp 1:

Ching h Righ Mgg





In h xmpl h llw, impliciy, w will lwy pn cling c pcn

pincipl. Fig 1–1 hw mn icn mgg by bnk. F xmpl, i y

ch py n x 0.75 pcn h ln mn in iin cling c ( l 2.75

pcn pn), h mgg wl b lw by 0.25 pcn, 25 bi pin. 2

Figure 1–1

30-year Fixed-rate Mortgage Alternatives (2 percent Closing Cost)Upront Cost (%) Mortgage Rate (%) APR (%)

2.00 (Par) 6.000 6.146

2.75 (Discount) 5.750 5.947

4.50 (Discount) 5.500 5.817

In p n icn mgg, y cl p premium mortgage wh i high

hn mk b limin xplici pn cling c. Th gnlly cll n-c mgg

(NCM) mnin li. In Fig 1–2, h APR pmim mgg (6.500 pcn) i high

hn h p n (6.146 pcn).

Figure 1–230-year Fixed-rate Mortgage Alternatives (2 percent Closing Cost)

Upront Cost (%) Mortgage Rate (%) APR (%)

2.00 (Par) 6.000 6.146

0.00 (Premium / NCM) 6.500 6.500

On pblm wih h APR hwn in h bv bl i h i n k in ccn h bw’

personal cost — h cnibl im n invlv in pplying n cling ln. Whil

bjciv n hgn b mnbl inclin in APR clclin, pnl c i

qi l h bw n will b c in icin in hi mnl. Fig 1–3 hw

h APR, j pnl c 0.5 pcn, p, icn n pmim mgg. F

xmpl, h n wih 2.75 pcn pin (3.25 pcn l pn) h n APR, pnl

c, 5.983 pcn. Hwv, w hll n mn, vn wih hi jmn APR

n lly lc h c mgg.

Figure 1–3

30-year Fixed-rate Mortgage Alternatives (2 percent Closing Cost, 0.5 percent Personal Cost)

Total Upront Costs (%) Mortgage Rate (%) APR Including Personal Cost (%)

0.50 (Premium / NCM) 6.500 6.538

2.50 (Par) 6.000 6.183

3.25 (Discount) 5.750 5.983

5.00 (Discount) 5.500 5.854

2 A basis point is 1/100th o a percentage point.





What’s Missing from APR?Fig 1–3 iply h APR h bv-mnin pmim, p n icn mgg

king in ccn h l pn c h ln. A i glnc, i my pp h h 5.5

pcn icn mgg i h b l h — i APR i h lw, mingly inicing

h lw vll c y.

Hwv, APR n ll h whl y bc i i b n h mpin h h ln min

ning h ni m. In ix incm plnc, hi i knwn yield to maturity. O c

h cl li h ln cn n b mch h, innc, y my mv n py

h ln by lling h h. T cp h c hi, w m l lk h effective yield.

T nn hw civ yil pn n h cl li h mgg ln, lk Fig 1–4.

I h li i 10 y lng, hn h 5.5 pcn icn mgg clly h h lw civ

yil; i h li i bwn y n nin y, hn h 5.75 pcn icn mgg h

h lw civ yil; b i h li h mgg i l hn y, hn h pmim

n-c mgg i h winn. Hnc, h h h bwing hizn, h l pn xpn

y hl py.

Figure 1–4

Front Loading (Points, Closing Costs) Works Only Over Long Loan Lie

5.50

6.50

7.50

8.50

9.50

10.50

11.50

0 5 10 15 20 25 30

E f f e c t i v e Y i e l d ( % )

Mortgage Life (Years)

Premium/6.50%

Par/6.00%

Discount/5.75%

Discount/5.50%

Thi xmpl ill h impnc h bw’ im hizn in lcing mgg. A

mnin li, i y cin h y will py h ln wihin w y (bc y

pln mv, c.), y migh cni hybi ARM ch 5 / 1. Al, y hl minimiz

pn c.





On h h hn, i y hv lng bwing hizn n n’ xpc ppy h mgg,

pying iinl pin icn ix- mgg my seem b h b l. Wh’

miing m clclin i h c h civ yil n k in ccn h pibiliy

h clin in mgg my pmp y cnmiclly innc.

I g wn, h bw pying pmim n v m hn h bw pying

icn . Th, i in p, h blended cost pmim ix- mgg

n i plcmn inncing my b lw hn h bln c icn ix-

mgg n i plcmn, n will cinly b lw hn h c hling icn ix-

mgg i miy.

Sinc n n knw h c in ( Fig 1–5 hiicl ppciv)

n inc, in h ypicl c, y nlikly hv n blly cin bwing hizn, hw

hl hmby ci which mgg g? W will xpl h nw h qin in

h nx cin.

Figure 1–5

Interest Rates are Volatile (Historical One-year Treasury Rate)

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

18.00

Apr-57 Apr-62 Apr-67 Apr-72 Apr-77 Apr-82 Apr-87 Apr-92 Apr-97 Apr-02 Apr-07 Apr-12

R a t e ( % )

Source: Federal Reserve





Introducing APRPlus

Whil APR i l truth in lending icl which xp h ky c ci wih

mgg, i n giv cmpl pic h mgg lcin ciin. M mgg llw

h bw ppy ny im wih pnly. In h wl innc, hi i n

pin. Th vl hi pin i igniicn n cn b qnii in mny m; in c, m

bw civ lw mgg by ging h pin ppy by ccping ppymnpnly. In h nml c, hwv, bw civly civ bh h ln pc n

vlbl pin innc which hl l b c in h clclin APR. W will

hi option-adjusted APR APRPlus.

T ill hi cncp, l’ y y hpping $100,000 30-y ix- mgg. I

w ig pn cling c impliciy, y civ $100,000 pl h pin innc

h mgg ny im. Th vl h pin pn n in vliliy n h cn

lvl in — inmin n gnlly h ingip m hmwn. L’ m

nw h h vl h pin i $5,000. Th h vl civ by y i $105,000.

Aming h ln i 6 pcn, bc w ig cling c, h APR h ln i l

6 pcn. Hwv, i w k in ccn h vl h pin, h APRPl i 5.47 pcn.

A cmping vi mgg q, y hl lc h mgg wih h lw APRPl.3

Figure 1–6

Renancing Option More Valuable or Higher Rate Mortgages with Longer Remaining Lie

(30-year Fixed-rate Mortgages, 2 percent Closing Costs)

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

10.0

0 5 10 15 20 25 30

O p t i o n V a l u e ( % o

f P r i n c i p a l )

Remaining Life of Mortgage (Years)

5.0%

5.5%

6.0%

6.5%

A Fig 1–6 hw, h high h mgg mining m, h g h pnil ving

m inncing n h h g h pin vl. F xmpl, i h 20 y

l in h 6.50 pcn mgg, i pin vl i nly 8 pcn pincipl.

3 APRPlus can be calculated using Andrew Kalotay Associates, Inc.’s Mortgage Selector at www.kalotay.com/calculators.





Th h c cing pin vl. A Fig 1–7 hw, i h in nvinmn

i m vlil ( pim n in , cnl h Appnix), h pin vl will b g

bc h inc pibiliy clining lw ngh pmp cnmic inncing.

Al, lw cling c inc pin vl whil high ncin c imp inncing,

h lwing pin vl.

Th chciic h inncing pin xplin wll-knwn c b mgg —

h in ix- mgg ypiclly inc wih h m h ln. A Fig A–6

in h Appnix hw, hiiclly 30-y ix- mgg hv lwy bn high hn

15-y ix- mgg .

Sm bv hv pi h h mgg yil cv imply mimic h Ty yil cv.

B hi gmn il whn n bv n pw-lping mgg yil cv pviling vn

whn h Ty cv w inv, in 1982.

Figure 1–7

Option Value vs. Volatility (New 30-year Fixed-rate Mortgages, 2 percent Closing Costs)

1.0

3.0

5.0

7.0

9.0

11.0

9 10 11 12 13 14 15 16

O p t i o n

V a l u e ( % o

f P r i n c i p a l )

Interest Rate Volatility (%)

5.0%

5.5%

6.0%

6.5%

A hin li, h l xplnin li in h inncing pin. Ln chg pmim —

bv h hicl pinl — cmpn h bw’ igh innc v h

li h ln.





Fig 1–8 hw im hw mch pmim ln chg h inncing pin.

Th 30-y ix- mgg h h lg pin vl, b 60 bp, n h h high

mgg bc h bw h h m ppnii innc i in p. Th

5 / 1 hybi ARM h h mll pin vl b 24 bp, bc i cnv livly qickly

n-y ARM wh lw miclly whn in clin. Alhgh h n-

y ARM i n n hi gph, i wl hv n vn lw pin vl hn h h 5 / 1 ARM.

An ining pin i h whil h 15-y ix- mgg h high pin vl hn h

7 / 1 n 5 / 1 hybi ARM, i h lw pin vl hn h 10 / 1 hybi. Th n hi

i, vn hgh h 10 / 1 hybi ARM h ix- pi nly 10 y, i i miz v

30-y chl; h i pincipl c lw hn 15-y ix-

mgg, lving h mgg wih high pnil ving m inncing.

Wih h vl h inncing pin in min, l’ vii ix- mgg chic. Fig

1–9 hw h APRPl h bv-mnin p, icn n pmim mgg. Pvily,

wih cniing h inncing pin, h 5.5 pcn icn mgg h h lw APR

n pp b h b l hmby wih lng-m bwing hizn. B nw,

whn w cni h vl h inncing pin, h b vll l i h 5.75 pcn icn

mgg, which h h lw APRPl. Rmkbly, h APRPl h mgg i qi imil,

vying wihin ng m 10 bi pin, inicing h mk’ wn h inncing

pin vl.

Figure 1–8

Mortgage Rate Premium or Renancing Option

(12 percent Volatility, Flat 6 percent Yield Curve, 2 percent Closing Cost)

30-year FRM

15-year FRM

10/1 Hybrid ARM

7/1 Hybrid ARM

5/1 Hybrid ARM

20

30

40

50

60

6.2 6.3 6.4 6.5 6.6

C

o s t o f R e f i O p t i o n ( b p s )

Market Rate (%)





Figure 1–9

30-year Fixed-rate Mortgage Alternatives (2 percent Closing Cost, 0.5 percent Personal Cost)

Total Upront Costs (%) Mortgage Rate (%) APR Including Personal Cost (%) APRPlus (%)

0.50 (Premium / NCM) 6.500 6.538 5.518

2.50 (Par) 6.000 6.183 5.480

3.25 (Discount) 5.750 5.983 5.429

5.00 (Discount) 5.500 5.854 5.451

Hw mch lw wl ln hv g n n NCM q i b cmpiiv? Fig 1–10

hw h hv lw APRPl hn h 5.75 pcn icn mgg, h NCM m

b b 6.4 pcn lw.

Figure 1–10

APRPlus o No-cost Mortgages

5.2

5.3

5.4

5.5

5.6

5.7

5.8

6.2 6.3 6.4 6.5 6.6

A P R P l u s ( % )

No-cost Mortgage Rate (%)

"No Cost" Mortgage

6% Par Mortgage

Tax Considerations

A h cniin i h c x. In h c mgg, in pymn n pn

pin x-cibl, b h miclln cling c n. (F m inmin cncning

h x mn mgg, h Appnix.) Un h mwk cib bv, w cn

ily cmp h -x APRPl.





Figure 1–11

30-year Fixed-rate Mortgage Alternatives

(2 percent Closing Cost, 0.5 percent Personal Cost, 35 percent Tax Rate)

Total Upront Costs (%) Mortgage Rate (%) APR Including Personal Cost (%) APRPlus (%) Ater-tax APRPlus (%)

0.50 (NCM) 6.500 6.538 5.518 5.705

2.50 (Par) 6.000 6.183 5.480 5.604

3.25 (Discount) 5.750 5.983 5.429 5.499

5.00 (Discount) 5.500 5.854 5.451 5.441

Th chic h mgg hl b m n n -x bi, x c bh ch lw n

pin vl. Fig 1–11 hw h h -x APRPl bw wih 35 pcn x

i lw h 5.5 pcn icn mgg, bc h x bk n h lg pn

pymn pin.4

W cn l cni h bk-vn NCM n n -x APRPl bi. A Fig 1–12

hw, h NCM m b b 6.22 pcn lw i b b l hn h 5.5

pcn icn mgg.

Figure 1–12

Ater-tax APRPlus o No-cost Mortgages (35 percent Tax Rate)

5.3

5.4

5.5

5.6

5.7

5.8

6.1 6.2 6.3 6.4 6.5

A f t e r - t a

x A P R P l u s (

% )

No-cost Mortgage Rate (%)

"No Cost" Mortgage

6% Par Mortgage

5.5% Discount Mortgage

The Risk of Not Being Able to Refinance

A ly 2009, mgg n hiicl lw. Hwv, h clin in hmvl, h l jb n igh nwiing n, mny mgg hv n bn bl

k vng hi by inncing. S hw y c hi ik in ccn whn y

hpping mgg?

4 Assumes the tax break on points is immediate and not received over the lie o the loan.





Incinlly, n h iniinl i h m cniin i in h c lw-g bn

i, wh my n b bl n clin in ci. In h cp bn mk, h

blih wy ccn hi ik i lw in vliliy, h pcing lw

pin vl.

Th m i cn b ppli in h mgg mk; bw (pcilly bw wih p

ci) wh cncn b clin in hi hm vl iin hi ci hl

lw vliliy whn mking h pin nlyi.

Figure 1–13

30-year Fixed-rate Mortgage Alternatives at Various Volatilities

(2 percent Closing Costs, 0.5 percent Personal)

Total Upront Costs (%) Mortgage Rate (%) APRPlus (%) at 5% Vol APRPlus (%) at 15% Vol APRPlus (%) at 30% Vol

0.50 (NCM) 6.500 6.331 5.518 4.166

2.50 (Par) 6.000 6.122 5.480 4.389

3.25 (Discount) 5.750 5.994 5.429 4.372

5.00 (Discount) 5.500 5.939 5.451 4.422

A hwn in Fig 1–13, lw vliliy / w ci v pying pn pin v p mgg

NCM (lhgh h i pcicl pblm h bw wih wk ci i nlikly b

bl py pin), whil high vliliy / b ci v NCM.

Bottom LineAnnl pcng (APR) my b l gh m cmp lniv mgg

c, b i cn b impv by incping h bw’ pnl c n h vl

h pin innc. Th mgg wih h lw APRPl, which incl h c, my

b in m h n wih h lw nominal APR. Sinc mgg in n pin x-

cibl, h m cc liv m mgg c i x-j APRPl: h mgg

wih h lw c win.





Mortgage Insurance vs. Piggyback Loansand Portfolio-Based Borrowing

F mny hmby h bigg iicly in h mgg lning pc i h wn pymn.

Th n ccml lg mn ch, lly 20 pcn h ppy vl, cn b

iicl n icging, pcilly in high-pic l mk. Hwv, h wpin hlp bw pch hm wih wn pymn l hn 20 pcn.

Ln n qi mortgage insurance (MI) whn h hmby pch hm wih

ln--vl (LTV) i g hn 80 pcn. Th hmby py h plicy whil h

ln i h bniciy. I h bw l n h ln h cl, h mgg

innc plicy imb h ln. Th mn h pmim pn n h iz h

ln, h pcng h wn pymn, h bw’ ci c n whh h in

i piv pblic.

Piggyback loans livly nw innvin n imil hm qiy ln. Th bw

k w ln: pimy ln 80 pcn h hm’ vl n cn mgg

h h mn n. F xmpl, n c i cll h 80 / 15 / 5 ngmn;

h bw cn k mgg 80 pcn h hm vl, piggybck ln 15

pcn h hm vl n mk 5 pcn wn pymn. Hnc ging piggybck ln

limin h n mgg innc.

Th piggybck ln cn b ih ix- hm qiy ln hm qiy lin ci

(HELOC). A wih hm qiy ln, h piggybck lly h high hn h i

mgg, lhgh HELOC n b vibl n hnc hv lw iniil hn

ix- piggybck.

A cining n in h mgg cn i portfolio-based borrowing. A bw cl bin,

n ingl cnc, $200,000 ix- i mgg, $100,000 jbl- cnmgg wih n nnl n $50,000 10-y in-nly lin. Clcling -x

APRPl cn b bi chllng i qi nlyi ch ln; hn wigh vging

h ling .

F y, piggybck ln h big vng bc h mgg in n bh ln w

x-cibl whil mgg innc pymn w n. B inc 2007, mgg innc

h bcm x-cibl bw wh p cin cii (cnl h Rnc

pciic inmin).

Th h vng mgg innc: MI pmim pymn ix whil piggybck

ln my hv vibl ; MI i cnclbl i h bw’ LTV i p blw 80 pcnwhil piggybck ln bvily n; MI n c h hm qiy whil piggybck ln

my ic cc qiy; in c bw l, MI l h h vng

cvg pincipl n in h ln; n, lly, hving j n ln ypiclly mk

h hmbying pc n impl.

Th, h chic whh p mgg innc piggybck ngmn will

vy c bw wh hl, c, p h l xpniv pin.





Chp 2:

Th Ecnmic Rinncing

S, y hv mgg. Tim p n clin. Hw y ci whn innc? I

g lw y c, y gipp by refi remorse. On h h hn, i y n’ c n

g h h wy, y gniz v h mi ppniy.

Hiiclly lw in in cn y hv l n nm vlm inncing

cnvninl inil mgg. Mny hmwn imply ly n l hmb, ch

“Rinnc n mgg 50 bi pin lw hn my ning mgg .”

B l hmb b-bh ppch h ign pnilly ciicl il — cling c,

xmpl. Cni h c wh in hv bn clining y y. I cling

c igniicn, y 3 pcn h mining pincipl, n y innc vy im h i

50 bi pin p in , y my nv lly cv h cmliv cling xpn inc.

O c, bv b, n n h ix n wh in ging. S, wih l

hmb, wh hl y ? Thi chp will hw hw ppch h pblm lik ix-

incm pinl.

How Do Treasurers Decide When to Call Bonds?I y inv in bn h cn b called by h i — h i, m in ll b miy

— hn y wl b n h ppi i mgg ln yp ncin. Y wl b

h ln, n h cpin, gncy mnicipliy h i h cllbl bn wl b h

bw. Hw h in h iniin ci whn cll n n h bn (h

qivln y ciing whn innc y mgg)?





Th m phiic cncp cll call efficiency. Simply p, hi i h ch

v (in pn vl m), by plcing high cpn bn wih lw cpn bn, xp

pcng h pin vl bing givn p. Sinc h nw bn cn l b cll, h l

pin vl i h inc bwn h cll pin h ning bn n h nw bn.

Cll icincy cnn xc 100 pcn. I h pcng i high ngh, y 95 pcn, pn

will cll h bn. Sm i ini n cping h ni l pin vl.

Th ppl hi ppch i h i k in ccn h vliliy in bc h

vl ny pin pn n vliliy. A li, h in i ncin.

Th pciv mgni h nciny (in vliliy, in chnicl plnc) i ky

minn h vl h pin cll.

Refinancing EfficiencyL’ hw w cn pply hi hinking inncing mgg. A mgg, ll, i lik cllbl

mizing bn. Th bw’ pin ppy n innc wih pnly i nlg h

cll pin wn by h i cllbl bn. In plc cll icincy, l’ in refinancing

efficiency.

Refinancing Efficiency = Present Value of Cashflow Savings / Loss of Option Value

(M cnm n ily knw hw clcl h pn vl ch lw ving, n

mnin hw vl inncing pin. B will bcm ppn l, y n n

— h clcl vilbl, ch h n hwn in Fig 2–1, h will g h pnch

lin h ch bn.)

A inncing icincy 95 pcn mn h h hmwn cp ving ql 95 pcn

l pin vl. A inl bw hl innc whn icincy ch 100 pcn (h

mximm inbl vl, l knwn optimal refinancing). Hwv, hmwn wh i

ik-v my ci c lighly blw 100 pcn.

T ill hw inncing icincy wk, l’ y h 30-y ix- mgg

i cnly 5.75 pcn. Fig 2–2 hw h ch lw ving v l pin vl

i ning mgg wih nging m 6 pcn 6.4 pcn. A ic in h

Understanding the Costs and Benefits of Prepayment Penalties

In hi cin w m h y hv n ppymn pnly n n ci i h

pvn y m inncing nh pim mgg. Ppymn pnli livly

in pim mgg b w m cmmn in bpim mgg.





pvi chp, h high h h ning mgg, h g h pin vl. Th

bw wih h 6.4 pcn mgg bvily n v h m m inncing, whil

h 6 pcn bw v h l.

A w mv w h high n ning mgg , h w lin pning ving

n l pin vl ppch n hn jin ch h. Hnc, h 6.3 pcn mgg, by

inncing, cp 100 pcn l pin vl. A Fig 2–3 hw, h inncing icincy

glly inc nil i ch mximm 100 pcn ning mgg wih

g hn 6.3 pcn. Rik-v mgg migh cni inncing i hi ning

mgg j v 6.2 pcn, chiving inncing icincy 95 pcn.

Figure 2–1

Renancing Eciency Calculator

Th pvi xmpl i b n n mpin 1.5 pcn cling c. Fig 2–4 hw hw

h cling c ply ky l in hi ciin. F 6 pcn 30-y ix- mgg wih 26

y mining, i h cling c inncing 1.5 pcn h mgg, h h

clin by nly b 55 bi pin icin inncing. B i h inncing c i high,

hn lg in c i qi ch h 95 pcn inncing icincy hhl.

I h cling c 3 pcn, h hhl icin inncing i b 88 bi pin,

inc m hn 30 bi pin.





Fig 2–5 gin ill h igniicnc cling c. F h m 6 pcn mgg, i cling

c 1 pcn, h qi c in in i nly 43 bi pin chiv icin

inncing. Th hhl glly inc h cling c inc.

Sinc h cibiliy mgg in bnilly impc h cnmic mgg ln,

h inncing ciin hl b nlyz n n -x bi (j w cmmn i

im mgg ciin). Kp in min h whil mgg in pymn n icn pin

x-cibl, cling c n. In iin, icn pin pi n inncing mgg

lm nv cibl in ll in h m y, n m b p v h m h nw

mgg (m b hi in h Appnix).

Figure 2–2

30-year Mortgages with 26 Years Remaining Renanced with 30-year 5.75 percent Mortgage

(1.5 percent Closing Cost, 16 percent Volatility)

0.0

1.0

2.0

3.0

4.0

5.0

6.00 6.05 6.10 6.15 6.20 6.25 6.30 6.35 6.40

% o

f O u t s t a n d i n g P r i n c i p a l

Rate on Outstanding Mortgage (%)

Change in Option Value

PV of Cashflow Savings

Figure 2–3

Renancing Eciency o 30-year Mortgages with 26 Years Remaining Renanced

with 30-year 5.75 percent Mortgage (1.5 percent Closing Cost, 16 percent Volatility)

20

40

60

80

100

6.00 6.05 6.10 6.15 6.20 6.25 6.30 6.35 6.40

R e f i n a n c i n g E f f i c i e n c y ( % )


Refi Efficiency

95% Efficiency





A Fig 2–6 hw, wih cniing x, 6.2 pcn mgg wl hv 95 pcn

icincy i innc in 5.75 pcn mgg. B x 35 pcn h m inncing

i l hn 90 pcn icin.

Figure 2–4

Optimal Renancing or 6 percent Outstanding 30-year Mortgage with 26 Years Remaining

20

40

60

80

100

25 35 45 55 65 75 85

R e f i n a

n c i n g E f f i c i e n c y ( % )

Interest Rate Decline (bps)

1.5% closing cost

3% closing cost

95% Efficiency

Figure 2–5

Optimum Renancing Threshold Depends on Closing Cost

(6 percent Outstanding 30-year Mortgage with 26 Years Remaining)

40

50

60

70

80

90

0.75 1.00 1.25 1.50 1.75 2.00 2.25 2.50 2.75 3.00 3.25

I n t e r e

s t R a t e D e c l i n e ( b p s )

Closing Cost (% Principal Remaining)





Figure 2–6

Renancing Eciency Beore- and Ater-tax o 30-year Mortgages

with 26 Years Remaining Renanced with 30-year 5.75 percent Mortgage

(1.5 percent Closing Cost, 16 percent Volatility, 35 percent Tax Rate)

20

40

60

80

100

6.00 6.05 6.10 6.15 6.20 6.25 6.30 6.35 6.40

R e f i n a n c i n g E f f i c i e n c y ( % )


Before-Tax

After-Tax

95% Efficiency

Case StudiesL’ k n xmpl: y hv 30-y mgg 5.25 pcn wih 26 y mining n

pincipl blnc $100,000. A ln innc in 5 pcn 30-y mgg wih

1 pcn cling c ( $1,000). Shl y i?

A h Fig 2–7 hw, h mnhly ch ving ( cling c) i $47. Th inncing icincy

in hi c, i 90 pcn — lw wn cin. Y giving p mch pin vl (i..

pnil ving). Y hl inily wi.

Figure 2–7

Remaining principal: $100,000 5.25%

New mortgage: 0% discount points, 1% closing costs 5%

Monthly savings: $47

Renancing Eciency: $1,394 / $1,594 = 87% 90%

OK, But Not Optimal





Chp 3:

Whn Py Dwn Mgg

Paying Down a Mortgage vs. InvestingW nw n iin h m wl lik b in — iing n bnil mn

pl ch, xmpl bn n inhinc. Hw inv i? Sck l

pibilii. Th invmn hv high xpc n, b hy l cy high ik.

An lniv hmwn i py wn hi mgg. R in h iny curtailment,

i h i ppl bc i h pychlgicl p cying b. Pying wn mgg

i lik ny h invmn, b in in, ivin cpil ppciin, h inv

imply g n in m ving in mgg in. A Bnjmin Fnklin p i, “A pnny

v i pnny n.”

I pying wn mgg h b wy p h x mny wk? A h h lniv

h qlly b which cn l pvi high n? W will xmin h qin blw.

Understanding Risk

Any invmn ciin qi n nning h ik invlv. Th i n m i

cash flow risk. Gnlly, h high h ik, h high h xpc n. F xmpl, ck

vlil n n’ gn cpil pvin b hv pnilly high n. On h

h hn, U.S. Ty bn l- bc h pincipl n in gn,

b hi n livly lw. Inving in y wn mgg i l l- — y

ving in n pincipl pymn.

B h h bl ik. Y my n ch n mgncy mim in h . I y

inv in ck, n h mk clin, y my hv ll l. Evn l- bn my

hv liqiin vl l hn pincipl i y ll im whn high. Tking

hm qiy ln i pibiliy, b hi qi g ci n cl b xpniv. All h

m horizon risk.





Tax risk, h pibiliy h x chng, in n chnging h -x n y invmn,

i l cniin ic blw.

On iinl hgh: pying wn y mgg cn hv bnicil c n y ci,

i mn h y hv cc ch.

A Closer Look at Mortgage Investing Ln n ll hi mgg h inv in h inncil mk. Hmwn pying

wn hi mgg in imil piin ch inv. Inv civ pincipl

n in pymn. I y py wn y mgg, y v h pymn h y wl

hv m.

Figure 3–1

Wholesale Value o Mortgages When the Prevailing Fixed-rate Mortgage Rate is 7 percent

96

97

98

99

100

101

102

6.0 6.5 7.0 7.5 8.0

P r i c e ( % o

f P a r )

Rate of Outstanding Mortgage (%)

B h i n ccil inc bwn pying wn y wn mgg n bying mn

l’. Th pic h y py y wn mgg i h mn h y w, b h pic h

n inv py mgg i min by h mk.

F xmpl, y y hv 6.5 pcn 30-y ix- mgg wih $100,000 mining. I h

pviling 30-y ix- mgg i 7 pcn, hn n inv cn by 7 pcn 30-y

ix- mgg $100,000. Clly, h wl n py h m 6.5 pcn mgg. A

Fig 3–1 hw, h migh py nly $98,000 i. I y bgh y wn 6.5 pcn mgg,

hwv, y wl hv py vy ll h $100,000!





Treasury Bonds and Munis

W m h ing pin xmining lniv invmn i qi imil ik

pil h inving in y wn mgg. Ty bn n pibiliy, b hi ini lly xbl. S i y by 5.5 pcn Ty bn n py x h 35 pcn,

y after-tax yield i nly b 3.6 pcn (5.5% × (1–0.35)).

In c, w cn gnlly limin Ti m cniin whn hinking b lniv

invmn. Clly h ll ih n ci h U.S. gvnmn will lwy nil i bw

lw hn h pi by hmwn. Th i y ning mgg i bv

mk, i -x yil will b high hn h Ty bn. I y ning mgg

i bnilly blw mk, Ti my high -x yil b, w hll ,

hy highly nlikly pvi b n hn cmpbl mnicipl bn (mni) nly x i vy lw.

L’ nw xmin mni n lniv invmn. AAA- mni cn b cni lm

l- n h cmpbl inving in y wn mgg. In n mni i gnlly

xmp m l (n mim n lcl) x. Bc hi vbl x mn,

mni yil l hn xbl bn imil ci n miy.

An xcpin hi cc ing h ving n ln cii in h ly 1980. Whil

in w n ll-im high, mny bnk w ck wih 30-y ix- mgg

wih lw . Sm bnk bw h pin by bck hi mgg

icn, xmpl, pying nly $90,000 i mgg wih $100,000 mining.

Hwv, h bw wh k h l my hv bn nplnly pi in

h h IRS cni hi icn py b b wi-. Th inc bwn

wh hy w n wh hy pi w cni xbl incm in h m y h

bybck cc. Th mny hmwn hi n n b ch w l.





Figure 3–2

Muni Yields Are More Attractive Relative to Treasuries

or Longer-Term Securities Yields as o June 22, 2007

3.70

3.90

4.10

4.30

4.50

4.70

4.90

5.10

5.30

5.50

0 5 10 15 20 25 30

Y i e l d ( % )

Term (years)

Treasury

AAA Muni

Th i n impn inc bwn mni n Ty bn — lng-m mni lly hv

call option h i nlg h ppymn pin in mgg. A w ic in Chp

1, h igh innc h c — bw py high mgg hn hy wl hv

wih ch n pin. Likwi, inc h cll pin llw mniciplii n hi bn

lw whn in clin, inv mn high yil. Ply hi n, h

yil lng m mni i lg pcn h yil cmpbl miy Ty bn

hn cn b bv h mni n Ty bn. F xmpl, in Fig 3–2, h 30-y

mni yil i 91 pcn h 30-y Ty bn yil whil h 2-y mni yil i 78 pcn

h cmpbl Ty bn yil.

The Investment Decision

L’ y y cl inv in y wn mgg wih 10 y mining li, in 5.5 pcn

10-y Ty bn in 5 pcn 10-y AAA- mni.5 I y ning mgg

, y 6 pcn, i blw cn mgg , imply min i -x yil n cmp

i h h Ty bn n mni.

Hw h -x yil ch lniv invmn cmp? Th -x yil, 35

pcn x , ) y 6 pcn mgg, b) 5.5 pcn Ty bn n c) 5 pcn

mni 3.9 pcn, 3.6 pcn, n 5 pcn pcivly. Nic h h -x mni yil i

nc by y x , bc h in i x-xmp. Clly, h mni invmn giv

y h b -x n in hi c.

5 The secondary muni market is very illiquid; investors should consider buying only new issues.





I y xiing mgg i high hn cn mgg , h i p in y nlyi hl

b, “Wh wl my -x mgg (yil) b i I innc?” Thi -x yil hl

c in cling c.

T kp hing impl, w will lk h cn -cll no-cost mortgage (NCM) rate. In h

wl n lnch, hi i imply h cmpn h ln bbing h cling

c. Chp 1 ic hi yp mgg in m il.

I y cl innc wih n-c 10 / 1 jbl- mgg 6.5 pcn (ming y will

py i in 10 y), h -x yil n y nw mgg wl b 4.2 pcn 35 pcn

x (6.5% × (1–0.35)). Thi i ill lw hn h 5 pcn mni yil; h h mni l win

in hi c. A y cn , Ty bn n civ in ih cni.

Risk Considerations of Investing in Munis

Tax Risk

On ik i cin y incm x which cl inc h -x n y

mgg. F xmpl, i y x c m 35 pcn (Fig 3–3) 15 pcn (Fig

3–4), h -x c (yil) 6.5 pcn mgg wl inc m b 4.2 pcn

5.5 pcn (6.5% × (1–0.85)) y, h pcing high n hn h 5 pcn mni.

Figure 3–3

Ater-tax Yields at 35 percent Tax Rate

0.0

1.0

2.0

3.0

4.0

5.0

6.0

6.5% Mortgage 5.5% Treasury 5% Muni

Y i e l d ( % )

Investments with 10-year Horizons





Figure 3–4

Ater-Tax Yields at 15 percent Tax Rate

0.0

1.0

2.0

3.0

4.0

5.0

6.0

6.5% Mortgage 5.5% Treasury 5% Muni

Y i e l d ( % )

Investments with 10-year Horizons

Horizon Risk

Spp h whn y mgg h 10 y l miy y pch 10-y mni. F

m nnicip n h y l, wih 7 y l n h mgg, y hv ll h

h, y jb lcin. I in hv inc, y will b pying y mgg

p which i m hn i’ wh. Hwv, y mni invmn will b wh l hn p. Y

nw hv pp l ql h inc bwn p n h vl y mni invmn.6

6 A variation o this is an assumable mortgage, which gives the homebuyer the ability to take over rom the seller as long as the lender

o that mortgage approves. This would not be a problem i you had a portable mortgage. This type o mortgage would allow you tokeep the terms o your original mortgage but change the propert y by which it is secured. Portable mortgages are relatively rare in theU.S. but are prevalent in some other countries.





Figure 3–5

Sensitivity o Seven-year Muni Bond Price to Changes in Rates

94.0

96.0

98.0

100.0

102.0

0 0.2 0.4 0.6 0.8 1 1.2 1.4

P r i c e ( % P

a r )

Increase in Interest Rate (%)

Fig 3–5 hw h in inc, h mk pic h mni y hling will

c bc inv will mn high yil. F innc, i 1 pcn, h pic

h mni wl clin 97.70.

Hw b y mgg? A inc, h mk vl y mgg l clin.

Unfortunately, you cannot benefit from this decline because your mortgage must be repaid at par.

Whil mni mk- cii y wn mgg i n

Th lip i hi i whn in clin. I y inv in cllbl mni, hy my b cll

wy n y g y mny bck. Thi p y bck in h iin y w in h hichp — y’ iing n ch. Simply h y nlyi n ci whh n inv gin.

Credit Effects

Lly, y hl b in min h pibl bnicil c n y ci i y py wn y

mgg.





Bottom LineTh i pychlgicl pipiin (n pibl ci bni) pying wn y mgg

i y hv pl ch in hn. Hwv, in mny c, i my b m inv lwh. Tw

pimy cniin cing y chic invmn y x n y invmn

hizn.

Sinc Ty bn lwy lw hn cn mgg , hy gnlly n wh

cniing n lniv invmn n n -x bi. I y ning mgg i

mch blw cn mk lvl, i i cncivbl h y cn g b -x yil m

Ty bn. B, nl y x i vy lw, mni cin b Ti.

Th mni likly b h invmn chic. B y ci y hl viy h hi

yil xc:

• h -x yil y cn mgg (i y i blw mk),

• h -x yil impli by h cn NCM i y mgg i bv mk.

Y hl b w cin ik ci wih inving in mni. I y in y nly

n h mny, y my hv ll l i high. A cn pin b in min i h

i y x clin mni my n lng yil m hn y mgg n n -x bi.

Finlly, i h mni cll y will g y mny bck li hn nicip. In hi iin,

h vy l, y cn py wn y mgg. I y hv h lxibiliy innc, ming

h mgg hv l clin ppinly, y cl cnim h mni yil cnin

xc h -x yil nw NCM b inving.

F inv lcn inv in ingl i’ bn, mni xchng- n (ETF), which

l x-xmp, hv mg pibl lniv. B h my b v hizn ik. Th

vl h n h invmn hizn i npicbl.





Appnix

Overview of Mortgage Terminology

Mortgage LoanA mgg i lgl cnc bwn ln n bw invlving ln c by lin n

m pcii l ppy. Wih ny mgg, bw will b qi py h ll

mn pincipl xn pl in v n g pn m. Th m i l mn

h ln il n i in h n wll in hi mnl. A mgg blig h bw

mk pmin i pymn in h in xchng ln pn, n giv h

ln h igh cl i h bw (mgg) il mk h cnc pymn

l. Th ln (mgg) cn iz h ppy in cv h npi b.

Principal and Interest

Th m mgg i h im v which h mgg i chl b pi. Th mn

bw i h pincipl. In i pi h cnc n h ning pincipl. Th

mgg my b ix, y 6 pcn, ing h m h ln, i my vy ccing

n g-pn ml.

Th pincipl mgg nmlly miz, h i, py glly ing h m h ln,

h hn in i niy h n h m. Mgg pymn mnhly. Ech pymn

cv h in n h ning pincipl h cncl lng wih h miz

pincipl.

F innc, pp h h i ix 6 pcn nnlly, 0.5 pcn mnhly, n h

mining pincipl i $100,000, hn h in nx mnh will b $500. Spp h

h h inllmn pymn i $900. Thn, h inc ($400) i h mn miz

pincipl incl in h pymn. Th h mining pincipl h llwing mnh i $99,600

which c h in cmpnn h nx pymn b cmmnly inc h pincipl

cmpnn in kp h l inllmn lvl $900.





Annual Percentage Rate (APR)

Ap m in, mgg gnlly hv m pn c. Th nnl pcng (APR)

i h h mgg king in ccn h pn c wll h pincipl n in

pymn h ln. Th, h APR i lwy high hn h nminl mgg (h nly

xcpin bing n-c mgg). Ln qi, p h h in lning ,

icl h APR in iin h nminl mgg . Sinc pn c vy, APR i inn nbl bw cmp in mgg in niz wy. B APR n ll h

whl y bc i n k in ccn h bw’ pin innc.

I i l hlpl cni h x-j APR which lc h c h x-cibiliy

mgg in pymn. F xmpl, i h mgg i 6 pcn n h mgg’ x

i 35 pcn, hn h x-j APR i clly nly 3.9 pcn (= 0.65 × 6%).

Prepayment

Th ln mgg ypiclly gn h hmwn h pin ppy h mgg in whl in p ny im. Bc h ppymn pin gn h hmwn, h ln cnn

b cin h mgg ’ ch lw. A 30-y mgg cn n hv n cl

li l hn n y 30 y. Th nciny b h ch lw h ln h

ppymn pin i cll ppymn ik.

Ppymn cn cc mny n. Fi, hmwn m py h ni mgg whn

hy ll hi hm. Scn, in h c hmwn wh cnn m hi mgg bligin,

h ppy i p n l. Th pc m h l py h mgg ,

in h c n in mgg, h in py pin h mgg blnc. Thi,i h ppy i y by m cph, h innc pc ih bil

h ppy py h mgg. Fh, bw my ci py m hn hi mnhly

inllmn in py wn ning pincipl hn chl. Thi yp ppymn

i mim cll curtailment. Finlly, h bw my innc h mgg whn mgg

ll icinly blw h cnc .





Tax Treatment of Mortgages

Interest Payment

Gnlly, hm mgg in i ny in pi n ln c n hm n my b

c m xbl incm (bjc icin, cnl Rnc il). Th ln my b:

•

mgg by hm cn hm,

• cn mgg hm qiy ln n h m hm.

In iin, l pymn chg n mgg pymn n mgg ppymn pnly chg

my l b c pvi h pnly i n pciic vic pm c inc in

cnncin wih y mgg ln.

Figure A–1

Top Marginal Income Tax Rate in the U.S.

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

1913 1923 1933 1943 1953 1963 1973 1983 1993 2003

T a x R a t e

Year

Source: Urban Institute and Brookings Institution: Tax Policy Center

Points

Th m points i cib cin chg pi, pi, by bw bin

hm mgg. Pin ypiclly pi by h bw bin lw n mgg n

in m h ln’ cling c (which not cibl).

F nw hm pch, gnlly h ll mn pin cannot b c in h y pi.

Bc h IRS viw pin ppi in, h cin pin m b p v h

m h mgg.

Likwi inncing, pin gnlly n cibl in ll in h m y n m b

p v h m h nw ln.





I h pin cin i p v h li h mgg, h mining blnc h pin my

b c in h y h mgg n ppymn, inncing cl. Hwv, i

h mgg i innc wih h m ln, h mining blnc h pin m b p

v h m h nw ln.

Mortgage Market ParticipantsTh mortgage market, wh mgg igin n in h m pl mgg-bck

cii, i h lg p h ci mk in h Uni S. Th mgg mk h

ngn igniicn cl chng inc h 1980. Rpi innvin hv cc in m

bh h ign nw mgg n h vlpmn cii l inv ing

pl mgg clll. Thi cin xplin h wking h mgg mk m

h bw h inv.

Borrower A hmby wh n bw ch pch hm, n xiing hmwn wh wn

innc, h p in h mgg mk.

Mortgage Broker and Loan Officer

Whn hpping n ln ppciv bw ypiclly h vic mortgage broker

loan officer. Th bk i n inpnn gn wih chnnl mny in ln; h

ln ic i n mply h ln. Whil bk n ln ic pm imil ncin,

hy vy in m lgl, gly n cmpnin npin.

Originator

Th lning iniin i cll h mortgage originator imply h lender. Oigin incl

cmmcil bnk, hi, mgg bnk n, m cnly, icn bkg h wih

bnking m. Ln my hl igin ln in hi pli ll hm in h cny

mgg mk.

Lending Decision

Ky minn h ln’ ciin mk h ln ci c, b--incm (DTI)

i n ln--vl (LTV) i.

Th ci c i nmicl vl h pn h ciwhin pn — h high

h c h m likly i i h h pn will py hi h b in imly mnn. A ci

c i clcl m ci p inmin. Th m wily knwn ci c in h U.S. i

h Fi Ic Cpin (FICO) ci c.





Th DTI, h i mnhly l b pymn (mgg, l x pymn, ci c,

c.) mnhly incm, i m h biliy h pplicn mk mnhly pymn. Th

lw h i, h g h liklih h h pplicn will b bl m h qi pymn.

Th LTV i h i h mn h ln h mk ( ppi) vl h ppy. Th

lw hi i, h m pcin h ln h i h pplicn l n h ppy m

b p n l.

Servicer

Svicing mgg ln invlv miniiv k ch cllcing mnhly pymn n

wing h pc wn h ln. Svic cn b nii l h igin,

b n cmpni h pch h mortgage servicing rights (MSRs) m h igin.

Servicing fee, ix pcng h ning pincipl blnc, i c m h cllc

mnhly pymn n in cmpnin by h vic.

Insurer

Th ln my qi bw wih n LTV i g hn 80 pcn bin mortgage

insurance gin l. Th mn in will b m pcng h ln n my clin

h LTV i clin. Alhgh h ln imp h innc qimn, i c i bn

by h bw.

On wy bw g n hi qimn i bw 80 pcn h vl hi

ppy vi pimy ln n bw h hgh piggyback loan.

Mgg innc my b pvi by piv in by gvnmn gncy. Th l

gnci h pvi hi innc qlii bw h Fl Hing Aminiin

(FHA), Dpmn Vn Ai (DVA) n Rl Hing Svic (RHS).

Securitization Process

A mgg b impl linhip bwn hmwn n bnk. Th bnk wl

mk h ln i ii wih h ciwhin h bw n h ppil h ppy.

Th bnk’ pi wl iv m h inc bwn i lning n i bwing , n

vicing c.

Ty i i n pcic pl mgg wih imil chciic n pckg hm in

mortgage-backed securities (MBS) which bqnly l inv. Thi pc i knwn

securitization. I llw ln k h ln hi bk n p ch bgin h

lning cycl nw.





Whl ln l n ing nh cny mk n. Whl ln l invlv h l

pl ln m mgg ln nh iniin, lly pmim. Thi mn

igin cn liz n immi pi by lling h pl ln high hn c vl. A

wih ciizin, h l whl ln p ch, h llwing h ln mk nw ln.

Th cmpni c by h Uni S Cng h igniicnly vnc h vlpmn

h cny mgg mk by pviing mchnim ciizing pl mgg n

lling hm inv h government-sponsored enterprises (GSEs). Exmpl Fnni

M, Fi Mc, Ginni M n h Fl Hm Ln Bnk (FHLB).

Investor

Inv in h mgg mk h inivil n iniin h by mgg-bck

cii, pl mgg whl ln. Th lg inv in MBS GSE, ign inv,

ml n, hg n, innc cmpni n pnin n. Mgg pl n whl ln

lgly hl by GSE.

Interest RatesMgg by ln b n nmb c. M impn i h gnl lvl

risk-free rates in h mk, which i h in b cii cni b

l ik. In h Uni S, h in cii i by h U.S. Ty i cni

b h ik- . W will xplin h linhip h Treasury rates mgg n

h ik ci wih in .

US Treasury Rates

Fig A–2 iply h hiy h 10-y Ty yil inc 1953. Obvily i h bn highly

vlil, m b 3 pcn in 1953, ching b 15 pcn in 1981 n lling blw 4 pcn

in 2005. Interest rate risk i c by h bic pblm h in cn b vlil, n h i

i xmly iicl ccly c hi icin. A m in ik v

im pi, by inncil pinl, i h interest rate volatility.

Fig A–3 iply h hiy h n-y Ty yil, l inc 1953. Th n-y Ty

yil i ypiclly n inic h-m in . A h gph hw, v h m

pi im, h-m hv bn m vlil hn lng-m n.





Figure A–2

Historical 10-year U.S. Treasury Rate

0

2

4

6

8

10

12

14

16

18


R a t e ( % )

Year


In chng lly n by basis points (bps) which 1/100h pcng. F

xmpl, i h in inc m 5 pcn 6.5 pcn, h h inc by 150 bp.

Figure A–3

Historical One-year U.S. Treasury Rate

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

18.00


R a t e ( % )

Year






B h i m in hn h yil ingl miy (m), ch 10 y n

y. A ny im, h i n inivil in / yil cpning ny pcii miy.

In iin h 10-y n n-y Ty yil, h i h-mnh, iv-y n 30-y

Ty yil, c.

Fig A–4 iply cllcin h Ty yil, which i knwn h term structure of

interest rates, h yield curve, m p y. N h in iin hi gnl lvl, h

hp h cv l vy in. F xmpl, in 1982 h yil cv w vll qi

high n h hp w wnw lping m h 10-y m h 30-y m; n in 1993

h lvl w mch lw b h hp w clly pw lping; in 2008 h lvl i vn lw

n h hp h yil cv i ill pw lping b mwh l.

Mortgage Rates

B in min h h hwn bv h yil U.S. Ty cii, h hn

mgg . Fig A–5 hw h hiicl vg ln 15-y ix- mgg,

30-y ix- mgg n n-y ARM.

Figure A–4

Term Structure o Interest Rates (1982, 1993 and 2008 Treasury Yields)

0

2

4

6

8

10

12

14

0 5 10 15 20 25 30

R a t e ( % )

Term

1982

1993

2008


A mnin b, cmpiiv c in h inncil mk gnlly min in .

Mgg gnlly xc Ty imil mii n h l h

iinc n hi. Fi, ci: Ty cii l ik n mgg

cinly n. Scn, liqiiy: Ti hmgn bl cii n mgg n

(lhgh hy cn b ciiz, b c). Thily, pinliy: whil Ti pinl,





mgg cn b ppi ny im n h mk cmpn h ln h c hi

pin by chging high mgg .

Th gph 10-y n n-y Ty iply in h pvi cin piclly

impn in lin mgg . Th 30-y ix- mgg pn n h

10-y Ty , n h h n-y ARM i lly inx h n-y Ty

n-y Lnn Inbnk O R (LIBOR).

I my m mk iniiv n h h n-y ARM i pnn n h n-y Ty

, bc ll, h n-y ARM i nc y; b hi i l bc h n-

y ARM i lly pgg pmim margin h-m in inx ch

h n-y Ty .

Figure A–5

Historical Average U.S. Mortgage Rates

0.00

2.00

4.00

6.00

8.00

10.00

12.00

Jan-90 Jan-92 Jan-94 Jan-96 Jan-98 Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12

R a t e ( % )

Year

15-Year FRM

30-Year FRM

1-Year ARM

Source: HSH Associates

Hwv, y my k, why h 30-y ix- mgg pn n h 10-y h

hn h 30-y Ty ? Th w n hi. Fi, mgg miz n hi

pincipl c v im whil Ty cii n n hi pincipl min cnnhgh h li h ln. Scn, mnin b, h cl li pl 30-y

mgg i in liy cl 10 y hn 30 y. Th, h 30-y ix- mgg

i m cmpbl h 10-y Ty .





Fig A–6 hw h hiy h inc bwn 10-y Ty n h 30-y ix-

mgg . Thi inc i wh h mk chg l ik, liqiiy n h

pinliy mgg ln. A h gph hw, lhgh h inc h vi, h 30-y

vg ix- mgg h lwy bn high hn h 10-y Ty .

Figure A–6

Dierence Between 30-year Fixed-rate Mortgage Rate and 10-year Treasury Rate

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50


R a t e ( % )

Year

Source: Federal Reserve; HSH Associates

Figure A–7

Dierence Between One-year ARM Rate and One-year Treasury Rate

-1.00

0.00

1.00

2.00

3.00

4.00

5.00


R a t e ( % )

Year

Source: Federal Reserve; HSH Associates





Similly, Fig A–7 hw, h n-y vg ARM i lly high hn h n-y

Ty . Th ccinl xcpin m m h c h ARM lly q

wih points, n ln n vy lw teaser rates ncg bw ccp ARM

(ic in h llwing cin).

Mortgage StructuresRinil mgg y in lg nmb vii. A bw cn ch mng

in mii wih 15- n 30-y mgg bing h m cmmn. Th in cn

b ix, jbl cmbinin h w in h c hybi ARM. Th pincipl cn b

miz in vl wy: cnvninl, blln pymn, ngiv mizin, in-nly, c.

Anh vibl i h iz h mgg — cnvninl, jmb p jmb. Th l

cn mgg n hm qiy ln.

Fixed-rate Mortgage Fixed-rate mortgages ign h bw py ql mnhly inllmn, cniing

in n pincipl, v h m h mgg. Th n m 15 n 30 y, h

l bing h m cmmn. A Fig A–8 n A–9 hw, h lng h m h mgg,

h lw h mnhly pymn, hnc h lw ch lw bn. (N h pymn n ix-

ln cn chng inc in ppy x mn hmwn innc , b

h mn h pymn ging w pincipl n in will min ix.)

Figure A–8

Monthly Payments or $100,000 Fixed-rate Mortgages

6.0% 6.5% 7.0% 7.5% 8.0% 8.5% 9.0% 9.5% 10.0%

15-year $844 $871 $899 $927 $956 $985 $1,014 $1,044 $1,075

30-year $600 $632 $665 $699 $734 $769 $805 $841 $878

I h m h mgg i lng, h mnhly mizin will b l, will h mnhly

pymn. F hi n bw n p 30-y mgg 15-y mgg. On h

h hn, Fig A–10 n A–11 hw, h l in pi v h li 30-y ln

will b mch g hn h 15-y ln.

Fix- mgg lly miz, h i, h mizin chl i ign h

h l chl mnhly pymn h ln, h ning mgg blnc i z. A FigA–12 hw, h pin h mnhly mgg pymn ppli in clin ch mnh,

h pin ppli cing h mgg blnc inc.





Adjustable-rate mortgage (ARM)

Th h cmmn yp mgg c i h adjustable-rate mortgage (ARM). ARM

ypiclly hv 30-y m. Th mgg ARM i piiclly; xmpl, vy ix

mnh, n y iv y. Th mizin i h h l mnhly pymn i cnn

bwn . Th in n ARM i ql n index / reference rate ch h

1-y Ty pl pmim, margin, which lly min cnn hgh h li h ln. Th inx pl h mgin i h fully indexed rate. S, xmpl, i h im

h in h 1-y Ty bill i 4.25 pcn n h mgin i 150 bi pin

hn h ARM nx y will b 5.75 pcn. Oh cmmn inic nc

incl h Lnn Inbnk O R (LIBOR) n h Cnn Miy Ty yil.

Figure A–9

Monthly Payments or $100,000 Fixed-rate Mortgages

$400

$500

$600

$700

$800

$900

$1,000

$1,100

$1,200

5.5% 6.0% 6.5% 7.0% 7.5% 8.0% 8.5% 9.0% 9.5% 10.0% 10.5%

M o n t h l y P a y m e n t

Interest Rate

15-year

30-year

Figure A–10

Total Interest or $100,000 Fixed-rate Mortgages

6.0% 6.5% 7.0% 7.5% 8.0% 8.5% 9.0% 9.5% 10.0%

15-year $51,894 $56,799 $61,789 $66,862 $72,017 $77,253 $82,568 $87,960 $93,429

30 -year $115,838 $127,544 $139,509 $151,717 $164,155 $176,809 $189,664 $202,708 $215,926

T ncg bw ccp ARM, mgg igin n n iniil l hn

h pviling lly inx . Thi blw-mk iniil i cll discounted index rate,

m cmmnly knwn teaser rate. Thi i l h n why, in Fig A–7, h n-y

vg ARM i mim lw hn h n-y Ty .





Amng h cmmn ARM period caps which limi h mn h h mgg

my inc h n lifetime caps which h mximm v h m h

ln. F xmpl, pi cp my limi h inc in ny givn y 100 200 bp whil

liim cp my b 10 pcn, which h ARM cn nv xc hgh h li h ln.

Figure A–11

Total Interest or $100,000 Fixed-rate Mortgages

$-

$50,000

$100,000

$150,000

$200,000

$250,000

5.5% 6.0% 6.5% 7.0% 7.5% 8.0% 8.5% 9.0% 9.5% 10.0% 10.5%

T o t a l I n t e r e s t

Interest Rate

15-year

30-year

Figure A–12

Monthly Mortgage Cashfow Breakdown ($100,000, 6.5 percent, 30-year)

$-

$100

$200

$300

$400

$500

$600

$700

0 5 10 15 20 25 30

M o n t h l y P a y m e n t

Years

Principal Retired

Interest Paid

Total Cashflow





Hybrid ARM

Th ix- mgg n n ARM cn b cmbin in h m hybrid ARM.

Th in hybi i iniilly ix nmb y (lly iv, vn 10 y);

w h i nnlly, j i wl b n iny ARM.

Hybi ARM by hi iniil ix pi n jmn pi, xmpl 3 / 1

n ARM wih h-y ix pi n bqn n-y jmn pi h

mining 27 y. Th h hybi ARM hi m ix- pymn chl n

jing pymn chl i knwn h first reset date.

Jumbo Mortgage

A jumbo mortgage i n wh pincipl xc h mximm -cll conforming mortgages

h h gvnmn-pn npi, Fnni M n Fi Mc, hiz by

(cnl h Rnc il).

Jmb mgg ln high ik ln / inv. Thi i bc i jmb mgg

ln l, i i h ll lxy inc qickly ll pic. Th, h vg in

n jmb mgg ypiclly high hn h cnming mgg.

Second Mortgage and Home Equity Loan

Second mortgages n home equity loans ln in which h bw h qiy in hi

hm clll. Th equity h hm i h inc bwn h im vl h hm

n h mining pincipl h i mgg. A cn mgg m b lmp m ln; h

ln i lly, b n lwy, h m hn h i mgg. A hm qiy ln cn ih lmp m ln vlving lin ci.

M hm qiy ln qi g xclln ci hiy; h ln--vl (LTV) i h

i mgg n h cmbin LTV i l m b nbly lw.





Gly

adjustable-rate mortgages (arms):

Mgg wh piiclly,

xmpl, vy ix mnh, n y ivy. Th mizin i h h l

mnhly pymn i cnn bwn

y.

after-tax aPrPlus: Th APRPl king

in ccn h c incm x.

after-tax yield: S tax-adjusted APR.

amortization: Th pying pincipl

glly ing h m h ln hhn in i niy h n h m.

amortization schedule: Th chl

which h pincipl n mizing

ln i pi .

annual Percentage rate (aPr):

Th yil--miy h mgg.

aPrPlus: Th APR king in cniin

h vl h inncing pin h

mgg.

assumable mortgage: Mgg h llw

h hmby k v m h ll

lng h ln h mgg ppv.

call oPtion: Th qivln h

ppymn pin mgg ln

iniinl b cii.

cash flow risk: Th ik ling invmn

ch lw l, mk vliliy, c.

cash-out refinancing: Whn hmwn

cn innc hi / h cn mgg n

plc i wih nw mgg ln h h

g pincipl hn h pvi n. Thi

i wy hmwn bin ch m

hi hm qiy.

closing costs: F pi h ln

cling, incling cmpnin h ln

wll il ch, lgl n n

lcl x. Exp ih in m ll

mn pcng pin.

conforming mortgage: Mgg wh

pincipl n xc h cnming limi,

h mximm ln blnc h Fnni M

n Fi Mc hiz by.

credit score: A nmicl vl h

pn h ciwhin pn —

h high h c h m likly h pn

will py hi h b in imly mnn.

A ci c i pimily b n ci

p inmin.





curtailment: Th yp ppymn wh

h bw py m hn h mnhly

inllmn in py wn ning

pincipl hn chl.

debt-to-income (dti) ratio: Th i

mnhly l b pymn (mgg,

l x pymn, ci c, c.)

mnhly incm. A m h biliy

h pplicn mk mnhly pymn.

default: Th il h bw mk

h cnc pymn.

discount mortgages: Mgg h

ln my in xchng n iinl

pn pcng h pincipl pin.

discounted index rate: Th l hnh lly inx h ln

ncg bw ch ARM, l

knwn teaser rate.

effective yield: Unlik yil--miy, hi

yil k in ccn h h ln my n

min ning i ni m.

equity: Th inc bwn h im

vl h hm n h mining pincipl

h i mgg.

first reset date: Th h hybi

ARM hi m ix- pymn chl

n jing pymn chl.

fixed-rate mortgages: Mgg, wih

p in , ign h bw

py ql mnhly inllmn cniing

in n pincipl v h m h

mgg. Fix- mgg h m

cmmn yp mgg c.

foreclosure: Th izing h mgg’

ppy in cv h npi b

in h c h bw iling mk h

cnc pymn.

fully amortized: Th mizin chl

i ign h h l chl

mnhly pymn h ln, h ning

mgg blnc i z.

fully indexed rate: Th ARM inx

pl h mgin. Th cnvninl mk

ARM. Hwv, mim ncg

bw ch ARM, ln

l hn hi knwn h icn inx

, .

government-sPonsored enterPrises

(gses): Cmpni c by h Uni

S Cng h igniicnly vnc h

vlpmn h cny mgg mk

by pviing mchnim ciizing

pl mgg n lling hm inv. Exmpl Fnni M, Fi

Mc, Ginni M n h Fl Hm Ln

Bnk (FHLB).

home equity loans: Ln in which h

bw h qiy in hi hm

clll. Unlik cn mgg, hm

qiy ln cn ih lmp m ln

lin ci.

horizon risk: Th ik ning in lng-m, illiqi invmn n ning h

inv n nh pp. Th ik i

pimily ci wih hving liqi

h invmn im whn i mk vl

i p.

hybrid arms: Mgg h cmbin h

ix- mgg n ARM.

Th in hybi i iniilly ix

nmb y (lly iv, vn

10 y); w h i nnlly,j i wl b n iny ARM.

index rate: A n in ch

Lnn Inbnk O R (LIBOR) h

ARM b n.





interest: Th pi h bw

mn pi h cnc n h

ning pincipl.

interest rate: Th mn in pi,

which my b ix, xmpl 6 pcn,

ing h m h ln i my vy

ccing n g-pn ml.

interest rate risk: Th bic pblm h

in vlil n i i xmly

iicl ccly c icin.

interest rate volatility: A m

by inncil pinl in ik

v im pi.

jumbo mortgages: Mgg wh

pincipl xc h cnming limi.

lender: S mortgage originator.

lifetime caPs: Th limi mximm in

v h m h ARM.

loan-to-value (ltv) ratio: Th i h

mn h ln h mk ( ppi)

vl h ppy.

margin: A pmim h h ARM ln

h inx bin h ARMin .

mortgage: A lgl cnc bwn ln

n bw invlving ln c by

lin n m pcii l ppy.

mortgage insurance (mi): Innc gin

l qi by ln bw wih

n LTV i g hn 80 pcn. Th

mn in will b m pcng h

ln n my clin h LTV i clin.

mortgage market: Th mk wh

mgg igin n in h m

pl mgg-bck cii (MBS).

mortgage originator: Th lning

iniin h pvi ln.

mortgage servicer: Enii h minik ch cllcing mnhly pymn

n wing pc wn h

mgg.

mortgage servicing fee: Cmpnin

h mgg vic. A ix pcng h

ning pincipl blnc h i c

m h cllc mnhly pymn.

mortgage servicing right (msr): Th

igh mini k ch cllcingmnhly pymn n wing pc

wn h mgg, n h igh b

cmpn by h mgg vicing .

mortgage-backed security (mbs): Pl

mgg wih imil chciic,

pckg by ln n l inv in

h inncil mk. S l securitization.

mortgagee: Th mgg ln.

mortgagor: Th mgg bw.

munis: Mnicipl x-xmp bn.

no-cost mortgage, or no-closing costs

mortgage (ncm): Mgg h ln

my bw h g ny xplici

pn c, in xchng high mgg

.

oPtimal refinancing: Th pin whn h

pn vl ch ving m inncingi ql h inc in h pin vl

h ning mgg n h nw

mgg.





Par mortgages: Sn mgg h

bk bw wih n iinl

icn pin.

Period caP: A limi h mn h h

ARM my inc h .

Personal costs: Th bw’ pnlim n pn in h lning pc,

l cni n xpni.

Piggyback loans: Simil hm qiy

ln n cn mgg. I h hmby’

LTV i g hn 80 pcn, h bw

my k cn mgg in iin

h i mgg, n lniv

iinl wn pymn mgg

innc.

Points: An iinl pn pcng

h pincipl h h ln chg h

bw in xchng lw-hn-p

mgg .

Portfolio-based borrowing: Whn

bw bin mlipl mgg c

n ingl cnc.

Premium mortgage: S no-cost mortgage.

PrePay: Th pying mgg in whl

in p by h bw b h n

i m.

PrePayment oPtion: Th pin ppying

h mgg gn by h ln h

bw; n innc whn

mgg hv clin.

PrePayment risk: Th nciny b h

ch lw h ln h ppymnpin gn h hmwn.

PrinciPal: Th mn bw h

mgg.

reference rate: S index rate.

refinance: Rplcmn n xiing

mgg wih nh n lw

in .

refinancing efficiency: Th i h

pn vl ch ving m inncing

h inc in h pin vl h

ning mgg n h nw mgg.

risk-free rate: Th in h i

cni by h inncil mk b

ci l ik. In h U.S.,

h Ty i gnlly cni

b h ik- .

second mortgages: Simil hm qiy

ln n piggybck ln, lmp m ln

in which h bw h qiy in hi

hm clll. Th ln i lly, b

n lwy, h m hn h i

mgg.

securitization: Th pc cing

mgg-bck cii (MBS) m pl

mgg wih imil chciic.

servicing fee: A ix pcng h

ning pincipl blnc i c

m h cllc mnhly pymn n

in cmpnin by h vic.

tax risk: Th ik ling -x

invmn n i h inv’

x c.

taxable equivalent aPrPlus: Th APRPl

king in ccn h c incm x.

tax-adjusted aPr: Th APR king in

ccn h c h x-cibiliy

mgg pymn.

teaser rate: S discounted index rate.

term: Th im v which h mgg i

chl b pi.

term structure of interest rates:

Th inivil in / yil cpning





ny pcii miy ny im, l

knw h yil cv.

treasury rates: Th b cii

i by h Uni S Ty. In h US,

h Ty gnlly cni

b h ik- .

yield curve: S m c in

.

yield-to-maturity: Th yil ming

h h ln min ning i

ni m.





References

Managing Your Mortgage

Clmn, J. (2007, Spmb 19). Riing

Wih Mgg? H’ Wh Y Shl

D. The Wall Street Journal, p. D1.

Cnm Hnbk n Ajbl-R

Mgg. (2006, Dcmb).

The Federal Reserve Board, m hp://www.

lv.gv/pb/m/m_nglih.hm

Mortgage Market Statistics

Flw Fn Accn h Uni S.

(2009). Federal Reserve Statistical Release,

Z.1, m hp://www.lv.gv/

l/z1/

Hiicl Mgg R. (2009).

HSH Associates, m hp://www.hh.cm/

mgh.hml

Tax Treatment o Mortgages

Hiicl Tp Tx R. (2007, Mch 13).

Urban Institute and Brookings Institution:

Tax Policy Center, m hp://www.xplicycn.g/xc/iplyc.

cm?Dci=213

Pblicin 936 — Min Cnn. (2009).

Internal Revenue Service, m hp://www.i.

gv/pblicin/p936/02.hml#0187

The Subprime Mortgage Crisis

Chmingph, S., Pnningn-C,

Anhny. (2006, Jny / Fby).The Evolution of the Subprime Mortgage

Market. Federal Reserve Bank of St. Louis

Review, 88(1), p. 31-56.

Nvill, L. (2007, Ocb). Sbpim hp.

Mortgage Risk, 17-19.

Sby, F., Schplch, T. (2007, Jn 21).

The Subprime Meltdown: A Primer. NERA

Economic Consulting, m hp://www.n.

cm/Pblicin.p?p_ID=3209

Wiln, M. (2006, Spmb). A whl nw

gm. Risk, m hp://www.ik.n/pblic/

hwPg.hml?pg=343547

Mortgage Analytics

Ell, R. (2006, Q3). Rinil Mgg

Dl. Philadelphia Fed Business Review.

Fbzzi, F. J. (2006). The Handbook of

Mortgage-Backed Securities, 6th edition.

Nw Yk: McGw-Hill.

Kly, A. (2006, Mch / Apil). I Th Finncil Engin in h H? Financial

Engineering News, m hp://kly.

cm/?q=ym/il/piv/FEN_FE_in_h_

h.p

Kly, A., & F, Q. (2008, My).

Mgg vicing igh n in

vliliy. Mortgage Risk, m hp://kly.

cm/?q=ym/il/piv/Mgg_

Svicing_Righ.p Kly, A., & Qin, J. (2007, Jn).

A pin n pin. OR / MS Today, m

hp://kly.cm/?q=ym/il/piv/

Pin_ORMSTy.p

Kly, A., & Qin, J. (2007, Ocb).

Th c n-c mgg. Mortgage

Risk, m hp://kly.cm/?q=ym/il/

piv/n_c_mgg.p

Kly, A., Yng, D., & Fbzzi, F. (2004).An pin-hic ppymn ml

mgg n mgg-bck cii.

International Journal of Theoretical and

Applied Finance, 7, 949-78, m hp://

kly.cm/?q=ym/il/piv/Opin_

Thic_%20Appch__MBS.p





Kly, A., Yng, D., & Fbzzi, F. (2008).

Opimm inncing: binging pinl

iciplin hhl innc. Applied

Financial Economics Letters, 4, 141-149, m

hp://kly.cm/?q=ym/il/piv/

Opiml_Mgg_Rinncing.p

Fixed Income Fundamentals

Fbzzi, F. J. (2000). The Handbook

of Fixed Income Securities, 6th edition.

Nw Yk: McGw-Hill.

Kly, A., Yng, D., & Fbzzi, F. (2007).

Rning icincy: gnliz ppch.

Applied Financial Economics Letters, 3,

141-146, m hp://kly.cm/?q=ym/

il/piv/Rning_Eicincy_AFEL.p

Schwz, R. J., & Smih J., C. W. (1990).

The Handbook of Currency and Interest

Rate Risk Management. Nw Yk: Nw Yk

Ini Finnc.

What’s on the Web?

Inormation Sources

Wikipedia. www.wikipi.g

RealEstateJournal.com.

www.ljnl.cm

Bankrate.com. www.bnk.cm

Home Loan Learning Center.

www.hmlnlningcn.cm

HSH Associates. www.hh.cm

Internal Revenue Service. www.i.gv

Federal Reserve Board: Mortgages.

www.lv.gv/cnmin/

mgg.hm

Research and Economics from the Mortgage

Bankers Association. www.mggbnk.

g/ch

The Federal Reserve Board of Governors

Statistics: Releases and Historical Data.

www.lv.gv/Rl

Research Institute for Housing America.

www.hingmic.g

Real Estate News — from CNNMoney.

hp://mny.cnn.cm/l_

Option-Based Mortgage Calculators

AKA Optimal Mortgage Refinancing

Calculator. hp://nlyic.kly.cm/

ivl/lgin.

AKA Mortgage Points Calculator.hp://nlyic.kly.cm/mgglc/

lgin.

NERA Mortgage Refinance Calculator.

hp://zwick.nb.g/innc





Andrew KalotayD. Anw Kly, h Pin Anw Kly Aci, i ling hiy n iniinl

b mngmn n ix-incm vlin. H i wily pblih in ling cmic n iny

jnl, wih m hn 50 icl hi ci n wi ng pic incling bn ning,

in iviv, h vlin bn wih mb pin, n inil mgg.

Hi innvin in ix-incm incl h cncp Rning Eicincy — l wily

mnging cllbl b, h Rch Bn — g cnvninl cllbl bn, n h

Vliliy Rcin M — hg civn ing n FAS 133.

B ning Anw Kly Aci, Any w Dic in h Bn Pli Anlyi Gp

Slmn Bh m 1981 ill 1990. Fm 1979 nil 1981 h w Sni Anly Dilln

R. B cming Wll S, h pvi inncil plnning AT&T n w invlv wih

pin ch n ym ngining Bll Lbi.

On h cmic i, Any w h n n i Dic h Cn Finnc n Tchnlgy,

g pgm in inncil ngining Plychnic Univiy. Pi h, h w P

Finnc Fhm Univiy. H h bn n jnc p h Whn Schl h

Univiy Pnnylvni n Clmbi Univiy. H l cnly v n ci i

n vl cmic jnl. Any civ hi BS n MS in Mhmic m Qn’

Univiy n hi PhD in Mhmic m h Univiy Tn.

In 1997 Any w inc in h Fix Incm Anly Sciy’ Hll Fm. Thi lc gp

incl Fich Blck, Hny Kmn, Jhn Bgl, Min Libwiz, n Willim G. H i

l ch mmb h Rik “Wh’ Wh.”

Qi FuQi F i Qniiv Anly / Bin Dvlpmn Aci Anw Kly Aci. H

h pblih ch n mgg vicing igh (MSR) n ppymn mling. Hi h

xpi incl inil mgg, MBS vlin, n h mnicipl bn mk.

Qi h pvily wk inncil vi lg inncil vic im. Qi hl BS in

Ecnmic n Pliicl Scinc m h Univiy Wicnin-Min, n MS in Mhmic

m Plychnic Ini Nw Yk Univiy.

20287250 a Financial Analysis of Consumer Mortgage Decisions

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