Level 1 CFA® Exam:
Residential Mortgage Loans & RMBS
Level 1 CFA Exam: Residential Mortgage Loansstar content check off when done
A mortgage loan (aka. mortgage) is a loan secured by the collateral of some real estate property.
If the borrower is not able to pay the principal and interest, the lender has the right to foreclose on the loan or – in other words – to take possession of the property and sell it. Because the market value of the property might be lower than the present value of payments that the borrower owes to the lender, we distinguish between 2 types of mortgage loans:
- recourse loans,
- non-recourse loans.
In the case of recourse loans if the bank forecloses on the loan it might require that the borrower pays the difference (shortfall) between the PV of outstanding loan payments (the outstanding mortgage balance) and the amount of money the bank received from selling the property.
In the case of non-recourse loans, the bank has no such right.
Mortgage Loans Characteristics
The characteristics of mortgage loans include:
- interest (fixed, variable (adjustable), convertible rates),
- amortization schedule, in other words how the loan principal is paid. We distinguished among: fully amortizing loans, partially amortizing loans with a balloon payment at the end, and interest-only mortgages.
- prepayment option and prepayment penalties,
- rights of the lender in case of foreclosure.
Usually, the value of the property that is used as the collateral is higher than the loan. The lower the loan-to-value ratio, the lower the risk that the lender bears, and vice versa. The higher the loan-to-value ratio, the higher the risk that the lender bears.
Level 1 CFA Exam: Residential Mortgage-Backed Securities (RMBS)star content check off when done
Credit Enhancements for Non-Agency RMBS
Because non-agency residential mortgage-backed securities are not guaranteed by the government or any GSE, they have credit risk. To reduce the risk and redistribute it among different investors, non-agency RMBS include credit enhancements.
Examples of internal credit enhancements include:
- credit tranching (senior/subordinated structure),
- reserve accounts.
An example of external credit enhancements:
Types of RMBS
Two main types of residential mortgage-based securities are:
- mortgage pass-through securities,
- collateralized mortgage obligations (*CMO*s).
We will discuss them in detail in the next two lessons.
Level 1 CFA Exam Takeaways: Residential Mortgage Loans & RMBSstar content check off when done
- A mortgage loan (aka. mortgage) is a loan secured by the collateral of some real estate property.
- We distinguish between 2 types of mortgage loans: (1) recourse loans and (2) non-recourse loans.
- We distinguished among: (1) fully amortizing loans, (2) partially amortizing loans with a balloon payment at the end, and (3) interest-only mortgages.
- There are 3 sectors of residential mortgage-backed securities: (1) RMBSs guaranteed by the federal agency, (2) RMBSs guaranteed by government-sponsored enterprises, and (3) non-agency RMBSs.
- 2 main types of residential mortgage-based securities are: (1) mortgage pass-through securities and (2) collateralized mortgage obligations (CMOs).