HOW THE PRIMARY AND SECONDARY MORTGAGE MARKET WORK

HOW THE PRIMARY AND SECONDARY MORTGAGE MARKET WORK • • What can I expect to Learn about the Primary and Secondary Mortgage Market Subject matter in no particular order What is the Primary Mortgage Market What is the Secondary Mortgage Market Why are both Markets Important to the US Economy Why are loans sold on the Secondary Mortgage Market Where does the money come from to purchase these mortgages Why are mortgages allowed to be bought and sold What are MBS’s (Mortgage Backed Securities) Why were the secondary mortgage markets created

HOW THE PRIMARY AND SECONDARY MORTGAGE MARKET WORK What can I expect to Learn about the Primary and Secondary Mortgage Market Today we will take a logical approach to the flow of money and mortgage loans between the primary and secondary mortgage market The Secondary Mortgage Market is NOT about second mortgages! We will be learning about mortgage assets being bought and sold in the market place and WHY

HOW THE PRIMARY AND SECONDARY MORTGAGE MARKET WORK P&I is the part of a PITI payment that the investors are interested in purchasing Principal & Interest = $4, 026 Taxes = $ 200 Insurance = $ 150 PMI (not accurate) = $ 375 (Based on LTV and Credit score) TOTAL PITI Payment = $4, 751

HOW THE PRIMARY AND SECONDARY MORTGAGE MARKET WORK How can a mortgage be SOLD? Mortgage instruments ARE assets that can be bought and sold just like any other asset. Basically, the parts of the mortgage that are sold are the note and mortgage. That changes NOTHING about the mortgage agreement the borrowers have with their original lender.

HOW THE PRIMARY AND SECONDARY MORTGAGE MARKET WORK

HOW THE PRIMARY AND SECONDARY MORTGAGE MARKET WORK

HOW THE PRIMARY AND SECONDARY MORTGAGE MARKET WORK

HOW THE PRIMARY AND SECONDARY MORTGAGE MARKET WORK WHY was the Secondary Mortgage Market Created? Simple answer…… To create LIQUIDITY in the market place. Let’s take a trip down memory lane to the 70’s

HOW THE PRIMARY AND SECONDARY MORTGAGE MARKET WORK WHY was the Secondary Mortgage Market Created? All banks need deposit money in order to lend. The more deposit money a bank has, the more it can lend and presumably the more money it can earn. Back in the 70’s (and earlier) banks were highly regulated (savings and loan banks).

HOW THE PRIMARY AND SECONDARY MORTGAGE MARKET WORK WHY was the Secondary Mortgage Market Created? All these bank were only allowed to pay the same interest rate to depositors. So how would they compete for your money? Some of us remember the days where the banks would offer gifts such as toasters or green stamps.

POLLING QUESTION #1 How does the sale of the mortgage affect the original mortgage agreement? A. B. C. D. The Rate of Interest May Change The Principal Amount May Change The Rate as well as Principal Amounts change No changes

HOW THE PRIMARY AND SECONDARY MORTGAGE MARKET WORK WHY was the Secondary Mortgage Market Created? Let’s assume that a bank has $1, 000 to lend. They decide to lend on mortgage loans as they are a safe type of loan. The collateral does not run away. Let’s assume that the bank is paying depositors 5% interest for their money. Since the banks are regulated, this 5% cost of funds will never change for the bank.

HOW THE PRIMARY AND SECONDARY MORTGAGE MARKET WORK WHY was the Secondary Mortgage Market Created? The bank decides to make 30 year FIXED rate mortgage loans at 7%. The bank also decided to HOLD onto and service the loans so all monthly payments come to them.

HOW THE PRIMARY AND SECONDARY MORTGAGE MARKET WORK WHY was the Secondary Mortgage Market Created? In this example the bank is earning a 2% margin. The bank feels pretty safe because they know they are collecting 7% for 30 years on money that cost them 5% and their cost will basically not change. However, in the early 80’s the government deregulated these banks so they could compete in the open market place for depositors money.

HOW THE PRIMARY AND SECONDARY MORTGAGE MARKET WORK WHY was the Secondary Mortgage Market Created? Now banks had to start offering higher interest rates to keep their depositors so there was a war between banks. Banks started offering higher and higher interest rates to the depositors. This caused many banks to bleed MONEY!

HOW THE PRIMARY AND SECONDARY MORTGAGE MARKET WORK WHY was the Secondary Mortgage Market Created? Banks were offering as high as 15% to depositors but the banks were only collecting 7% on all the 30 year mortgage loans they had on their books (called portfolio lending). Since these were FIXED rate loans, the banks were not allowed to increase the interest rate charged to the borrowers.

HOW THE PRIMARY AND SECONDARY MORTGAGE MARKET WORK WHY was the Secondary Mortgage Market Created? Put simply, the banks cost of funds to lend was at 15% and the amount they earned was 7%. That’s upside down! Many banks were not using the benefits of the secondary mortgage market to mitigate their risks and they got burned.

HOW THE PRIMARY AND SECONDARY MORTGAGE MARKET WORK WHY was the Secondary Mortgage Market Created? Today, MOST lenders SELL their loans to the secondary mortgage market, shifting most of the risk to these entities and their investors. The secondary mortgage market is a multi-trillion dollar industry. Aprox. 70% of all homes in the USA have a mortgage.

HOW THE PRIMARY AND SECONDARY MORTGAGE MARKET WORK

HOW THE PRIMARY AND SECONDARY MORTGAGE MARKET WORK HOW DOES THE FICO SCORE IMPACT MORTGAGE LOANS The HIGHER the RISK the borrower presents to the lender, the HIGHER the interest rate will be on the loan. Therefore, with all else being equal for two different borrowers EXCEPT for credit score, the borrower with the LOWER FICO score will pay a higher interest rate because they present a higher risk to the lender. Now for the full explanation of WHY they present a higher risk.

HOW THE PRIMARY AND SECONDARY MORTGAGE MARKET WORK HOW DOES THE FICO SCORE IMPACT MORTGAGE LOANS For insurance and other forms of statistics you have a rule that is called “The Law of Large Numbers”. That means that the larger the sample is the closer you are to a perfect answer. In other words, if there were only 100 people that lived in the USA and we asked all 100 if they were Republican or Democrat and they all answered we would have a perfect % of each. Lets’ say 48 said Republican and 52 said Democrat. That would translate to 48% of the population is Republican and 52% of the population is Democrat.

POLLING QUESTION #2 What is the base reason for the Secondary Mortgage Market? A. B. C. D. To Generate Volume of Trade To Make Market Move Faster To Maintain Liquidity in the Market To Yield Strong Profits for Traders

HOW THE PRIMARY AND SECONDARY MORTGAGE MARKET WORK HOW DOES THE FICO SCORE IMPACT MORTGAGE LOANS But the population in the USA is more like 350 MILLION. How do you get accurate numbers. Scientifically or mathematically you take a large enough SAMPLE of the population. The people at FICO have access to MILLIONS of credit reports and how they have performed for more than 50 years. They have a VERY LARGE sample so their margin of error is small. The example I am about to give you is not based on true and accurate numbers. It is just to give you an idea of how risk works in lending. Feel free to Google the true numbers if you like but the true numbers are not necessary for the EXAMPLE. It’s the CONCEPT that is important here.

HOW THE PRIMARY AND SECONDARY MORTGAGE MARKET WORK HOW DOES THE FICO SCORE IMPACT MORTGAGE LOANS Let’s say that we are a lender. We have $300, 000 to lend. We lend our money as follows: 800 FICO 700 FICO 600 FICO Question: What does the FICO score ACTUALLY mean? Statistics have shown that more borrowers in the lower score category will go 90 days late in the following year than those in the higher score category.

HOW THE PRIMARY AND SECONDARY MORTGAGE MARKET WORK HOW DOES THE FICO SCORE IMPACT MORTGAGE LOANS All that the FICO score is saying is “What is the likelihood that a borrower will go 90 days late in the next year”. Let’s say that in the 800 category that only 1 person goes 90 days late next year and in the 700 it will be 3 and in the 600 FICO it will be 10 that go 90 days late. We are going to lend each score category 100 million dollars like this: 100 borrowers in each category borrow 1 million dollars each. That’s a total of 100 million per FICO category and a TOTAL of 300 million in loans. As the score goes down, the interest rate will increase.

HOW THE PRIMARY AND SECONDARY MORTGAGE MARKET WORK HOW DOES THE FICO SCORE IMPACT MORTGAGE LOANS For Instance: Particulars How many borrowers Amount of each loan Total lent in each category Interest Rate for each FICO After one year 90 day late Earning interest on Collection agents needed Lawyers to Foreclose 800 FICO 700 FICO 600 FICO 100 100 1 Million 100 Million 5. 00% 6. 00% 7. 50% 1 Person 3 People 10 People 99 Million 97 Million 90 Million 1 2 5

HOW THE PRIMARY AND SECONDARY MORTGAGE MARKET WORK HOW DOES THE FICO SCORE IMPACT MORTGAGE LOANS As you can see, the lower 600 FICO score category may be EARNING a higher interest rate on the face, but after you take into account that so many people in the 600 category are not paying and the expense of hiring more collectors and attorneys to try to recouple that lost revenue, at the end of the day you make about the same as giving 5% interest to your 800 FICO category.

HOW THE PRIMARY AND SECONDARY MORTGAGE MARKET WORK HOW DOES THE FICO SCORE IMPACT MORTGAGE LOANS And that my friends… in the words of the famous radio broadcaster …. Is the rest of the story! Let’s take a look at how lenders get paid. Upfront Points (from borrower) Backend Points (from investors) Combination of both

HOW THE PRIMARY AND SECONDARY MORTGAGE MARKET WORK Example Borrower

HOW THE PRIMARY AND SECONDARY MORTGAGE MARKET WORK

HOW THE PRIMARY AND SECONDARY MORTGAGE MARKET WORK Please tell me how much money in dollars that this loan would earn for the lender: Loan Amount: Interest Rate: Lock Period: Type of Loan: Property: Purchase or Refi: LTV: $100, 000 6. 375% 15 Days 30 Year FIXED Investment – Single Family Purchase LTV >80% <= 90% NOO

HOW THE PRIMARY AND SECONDARY MORTGAGE MARKET WORK Please tell me how much money in dollars that this loan would earn for the lender: Loan Amount: Interest Rate: Lock Period: Type of Loan: Property: Purchase or Refi: LTV: $100, 000 6. 375% 15 Days 30 Year FIXED Investment – Single Family Purchase LTV >80% <= 90% NOO Did you guess ZERO? ZERO is the correct answer!

POLLING QUESTION #3 What is FICO? A. B. C. D. A Financial Intermediary A Credit Rating Company A Accreditation Organization A Credit Risk Bearer Unit of Government

HOW THE PRIMARY AND SECONDARY MORTGAGE MARKET WORK TELL US ONE THING YOU LEARNED TODAY As I go around the room, please tell the class one thing that you learned today about the Primary and Secondary mortgage market that you did not know before you got here!

HOW THE PRIMARY AND SECONDARY MORTGAGE MARKET WORK

HOW THE PRIMARY AND SECONDARY MORTGAGE MARKET WORK You can order a copy of Doug Vairos book on Amazon Kindle for $2. 95 so you can send a copy to anyone you want as a gift! THANK YOU for your time today.

Doug Vairo www. loanofficerstore. com Cell: 646 -529 -2560