With all the borrowing that we do today, it is hard to believe that prior to the 1930s,

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1 Hit the Books Instructions: As you read, trace over the words that are shaded and underlined. This will help you to understand and retain important information. With all the borrowing that we do today, it is hard to believe that prior to the 1930s, borrowing money to buy a home or anything else was considered a last straw. From a lender s point of view, the main reason to lend money was to be able to take over the property in foreclosure when the borrower was unable to make the payments. General unavailability of loans and the public s reluctance to borrow money were two major reasons that fewer than 20% of the population owned homes. In the late 1800s, mortgage lenders served as conduits to bring funds from capital surplus areas (mostly the east coast) to areas that had few or no financial institutions (the mid-western farm belt or the western states), thus allowing America to be successfully colonized. Some of these mortgage firms began selling debenture bonds (an unsecured bond whose holder has a claim on all assets not pledged specifically to secure other debt) to their eastern investors backed by the collateral of real estate mortgages on farmland. Some issued securities guaranteed for the repayment of principal and interest. Life insurance companies (local, on-site representatives) also became active in lending money for mortgages by originating and servicing the loans on behalf of the eastern firms. Return to the online lesson. Click Next to access and answer 1.

2 At the turn of the 20th century, the primary emphasis of mortgage banking was on farm lending, particularly in the Midwest and West, and in older sectors of the Southeast and Northeast. The average home sale was $4,000. Commodity prices and farm values were falling at the time, and there was a distinct need for greater credit in the agricultural sector. During this time, the government was creating a series of initiatives to assist the farm mortgage banking business, including the Federal Reserve Act of 1913 and the Federal Farm Loan Act of These acts implemented policies that significantly affected mortgage banking. In the 1920s, mortgage bond houses began growing rapidly by selling securities backed by the rising values of new office buildings and apartments, especially in large cities like Chicago, New York and Los Angeles. The Roaring Twenties was a time of great prosperity for Americans, and thousands of bond issues (for millions of dollars) were sold to small investors who had gotten into the bond-buying habit after World War I. These bonds were guaranteed by the underwriter of the bond or by mortgage guaranty companies. Because real estate was becoming so profitable and economic times were good, many people had an interest in mortgages, and there were no rules pertaining to housing finance. Return to the online lesson. Click Next to access and answer 2. In October of 1929, the Roaring Twenties came to an abrupt end with the crash of the stock market. In fact, this was the beginning of the longest and worst economic setback in the history of our country. The Great Depression saw reduced output and employment through By the end of this period, the field of private housing had suffered a complete collapse. Defaults and foreclosures were out of control, so the federal government created the Home Owners Loan Corporation (HOLC) in 1933 and the Federal Housing Administration (FHA) in 1934 to put much-needed rules in place and assist in rejuvenating the housing market.

3 FHA The HOLC refinanced in excess of $3 million dollars in shady and defaulted loans and introduced a new concept; long term loans. Prior to this, most mortgages were short term (3 to 5 years). The HOLC allowed borrowers to get 15-year self-amortizing mortgages on real estate properties. But the HOLC was only designed to be a temporary bailout for the economy, and stopped making loans in The FHA, however, was a permanent program created to help produce mortgage financing. FHA was formed for the following reasons: 1. Encourage wider home ownership 2. Improve housing standards 3. Create a better method of financing mortgage loans By sound use of government credit to insure mortgage loans, the goals of the FHA have been met, and without the government making a single loan. By offering to insure a single loan up to 80% of value (unheard of prior to this), the FHA was able to insist that the down payment be made with the borrower s own funds. This eliminated the need for second and sometimes third mortgages with higher interest rates to fund the 40% to 50% down payment. At that time, the FHA created models that have contributed to many of the lending practices in place today. These include: 80%, 90%, and 95% loans. 15 and 30 year loan terms. Current qualifying standards Unlike earlier practices of getting a loan because the lender knew you, today s lenders make sure that the borrower has the ability to pay the mortgage.

4 Housing standards With longer mortgage terms, the collateral had to last longer, so the FHA developed standards for housing foundations, heat, insulation and more. Mortgage insurance Created originally by the FHA to reduce the risk and to expand availability of funds, mortgage insurance is used today on conventional loans as well. Escrow accounts The FHA created the ability for a borrower to pay taxes and insurance a little at a time by including a portion of the amount due in the monthly mortgage payment. Not only did this make it easier for people to pay these items, but the lenders felt safer, knowing that the taxes and insurance would be paid promptly. Since its origin, the Federal Housing Administration has built a long list of good credits with its many contributions to the housing industry and financial assistance programs. While HOLC was a temporary solution for bailing out the economy, the FHA was designed to permanently change mortgage lending practices. Return to the online lesson. Click Next to access and answer 3. FNMA In 1933, the Federal Deposit Insurance Corporation (FDIC) was created. Because the federal government now insured banks and consumer deposit safety, the banks were able to lend money for longer terms. By 1938, life insurance companies were doing the same, purchasing and selling the lower-risk FHA mortgages in the secondary market. As a result of FHA s insuring mortgages, the Federal National Mortgage Association (FNMA, or Fannie Mae ) was formed in FNMA purchased FHA loans from mortgage lenders in order to free up FHA capital. This allowed the lenders to use their additional revenue from

5 servicing the loans for FNMA. Although not a government agency, FNMA has the implied backing of the United States government. However, in September 2008, the Federal Government assumed control of FNMA in order to stabilize the housing markets. Return to the online lesson. Click Next to access and answer 4. Mortgage Lending after World War II After nearly a decade of economic strife, and since most private construction was halted during World War II, real estate was badly underbuilt. As U.S. servicemen and women returned home after the war, they had to double up with other families or live in temporary shelters. VA By 1944, Congress realized the need to prepare for postwar growth. The Servicemen s Readjustment Act (the GI Bill ) was passed. With this, the Veterans Administration (VA) and the VA home loan guarantee program were established. The VA home loan guarantee program allowed eligible veterans to obtain low interest, high loan-to-value (LTV) loans to buy a home. Some were allowed to purchase homes with no down payment. Originally the VA loans were only available to veterans for two years after their return to civilian life; however, in 1946 Congress extended this time to 10 years because of the severe lack of housing. In 1948, FNMA began purchasing VA mortgages in addition to FHA mortgages. By 1950, there was such a demand for VA loans that Fannie Mae s resources dried up, and the agency stopped making advance purchase commitments to lenders. Housing production continued to soar into the 1950s, with over two-thirds of the new housing being constructed in the rapidly expanding

6 suburbs. Homeownership was now attractive and affordable. As you would expect, the number of lenders rapidly grew during this period. Mortgage lenders became the middlemen for large-scale national mortgage companies, life insurance companies, and savings and loans. They originated and sold loans to these entities as well as to Fannie Mae. Return to the online lesson. Click Next to access and answer 5. Fannie Mae was reorganized in 1954 due to government recommendations. The most important part of this reorganization was that Fannie Mae was partially privatized the owners (shareholders) were the mortgage companies that sold their loans to Fannie Mae. This allowed Fannie Mae to resume making advance purchase commitments to the originators. Fannie Mae s earnings came from two sources: 1. Guarantee fees (insurance premiums) 2. The spread between the cost to borrow and the yield on its mortgage investments. It issues mortgage-backed securities (MBS) with guaranteed payment of principal and interest to investors. Persistent expansion due to increasing family size (the arrival of the baby boomers ) continued to drive the housing market well into the 1960s. A good economy and many sources of mortgage capital fueled the housing sector. GNMA By 1966, America was entering into a more difficult economic time. A credit crunch came into play as interest rates were driven up by America s involvement in Vietnam. This cycle produced a slump in the housing market that shook the mortgage industry.

7 In 1968, Congress passed legislation to convert Fannie Mae into a quasi-private corporation, no longer subject to Federal budget constraints. The new law also created the Government National Mortgage Association (GNMA, or Ginnie Mae ) to take over Fannie Mae s functions of supporting federal housing initiatives. In addition, Ginnie Mae began servicing VA mortgages originated before Ginnie Mae s mission was to support the government s housing objectives by assisting the segment of the housing market for which conventional financing was not readily available. Ginnie Mae is a wholly owned government corporation. Return to the online lesson. Click Next to access and answer 6. The 1968 Housing Act provided strong support for FHA and VA mortgages. It also caused a surge in demand for subsidized financing of low-to-moderate income households. The surge lasted until 1973, when a scandal that plagued FHA during the Nixon administration finally caused the government to issue a temporary moratorium on FHA-issued subsidized mortgages. In place of FHA, mortgage bankers raised their volume of conventional mortgages. One of the biggest benefits of FHA mortgages is that they are self-insured. Conventional mortgages required private mortgage insurance (PMI) for higher LTVs. Many PMI companies came onto the scene in the early 1970s, which allowed more conventional mortgages to be originated with less risk to the investor. New regulations by the Federal Home Loan Bank in 1971 gave more options for low down payment financing and offered alternatives to FHA and VA mortgages.

8 Return to the online lesson. Click Next to access and answer 7. FHLMC To enable the Federal Home Loan Bank to purchase conventional mortgages, the Federal Home Loan Mortgage Corporation (FHLMC, or Freddie Mac ) was created in This new agency gave Fannie Mae competition in the secondary market. Between 1973 and 1975, the economy soured due to oil prices quadrupling, double-digit inflation and a severe economic recession. By the end of the 1970s the baby boomers were entering the work force, creating a boom in the economy. High interest rates and another deep recession in the early 1980s caused another crash. Due to these high interest rates, the housing market crumbled and interest rates were simply too high for most would-be homebuyers. To combat this slump, mortgage entities looked to give homebuyers other opportunities to borrow money with less cost. Adjustable-rate mortgages (ARMs) came onto the scene, with interest rates between 2% and 4% below a standard fixed rate mortgage. By 1988, ARMs represented over 58% of all mortgage originations. In the late 1980s and early 1990s, another new concept was gaining popularity the concept of wholesale origination. Acquiring mortgages through purchases from the lenders originating the mortgage could make money for the wholesale company. By mid to late 1980s, money began to flow freely again, with strong job growth and a strong real estate market. Swings continued, however, including the dip in October 1987 (a stock market crash, and many savings and loans being bailed out) and surging interest rates in the spring of At this time, in order to find additional ways to give the housing market a jumpstart, mortgage entities began offering blended ARMs, and again allowed for lower interest rates.

9 In the late 1990s and early 2000s, creative products such as interest-only and sub-prime loans, and automated underwriting were created to meet the growing demand of potential homebuyers. Return to the online lesson. Click Next to access and answer 8. Between 2007 and 2008, most of the flexible choices came to a halt with the collapse of the housing market and financial services sector. With many metro areas falling into declining markets and the mortgage foreclosure rate soaring, many financial institutions closed their doors to mortgage lending. In October 2008, Congress passed the Emergency Economic Stabilization Act of 2008, a $700 billion dollar bailout to stabilize the financial markets from total collapse. In addition, both FNMA and FHLMC were put into conservatorship (i.e., an alternative person or group is appointed by a judge to manage the financial operations of a person or company) by the U.S. government. These changes gave rise to additional government entities that shape and regulate the mortgage world we live in today. FNMA and FHLMC are fully backed by the U.S. government. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act) was signed into federal law in response to the 2008 mortgage and financial crisis. The Dodd- Frank Act was designed to create stable economic conditions in order to grow jobs, protect consumers, end bailouts and companies too big to fail, regulate Wall Street, and prevent any further financial crisis.

10 Return to the online lesson. Click Next to access and answer 9. With regard to customer protection, the Consumer Financial Protection Bureau (CFPB) was created as part of the Dodd-Frank Act. The main purpose of the CFPB is to help consumers understand the terms of their agreements with financial companies. From the CFPB website: The mission of the CFPB is to make markets for consumer financial products and services work for Americans whether they are applying for a mortgage, choosing among credit cards, or using any number of other consumer financial products. The CFPB was established by Congress and designed to protect consumers by carrying out federal consumer financial laws. In addition, they perform the following functions: Write rules, supervise companies, and enforce federal consumer financial protection laws Restrict unfair, deceptive, or abusive acts or practices Take consumer complaints Promote financial education Research consumer behavior Monitor financial markets for new risks to consumers Enforce laws that outlaw discrimination and other unfair treatment in consumer finance To learn more about the CFPB, visit their website at -

11 Return to the online lesson. Click Next to access and answer 10. Lesson Summary It is what we do easily and what we like to do that we do well." Orison Swett Marden Early 20th-century author of motivational books FNMA (Federal National Mortgage Association) purchased FHA loans from mortgage lenders in order to free up FHA capital. The VA (Veterans Administration) home loan guarantee program allowed eligible veterans to obtain low interest, high LTV (Loan-to-Value) loans to buy a home. The CFPB (Consumer Financial Protection Bureau) was established by Congress as part of the Dodd-Frank Act and serves to protect the financial interests of American consumers. The Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac) was created to enable the Federal Home Loan Bank to purchase conventional mortgages.

12 Notes COURSE II: UNDERSTANDING MORTGAGE BASICS I