Today’s Agenda

! Mortgage contract design

Designing Residential Mortgages
! Fixed-rate mortgage terms and conditions
Lecture 3
! Average Percentage Rate and Truth in Lending
EW/MBA283 ! Adjustable-rate mortgages
Fall 2021 ! Other types of mortgages
! The risks of mortgages – to investors and
borrowers

© 2021 Nancy Wallace

Mortgage Terminology Structure of the Promissory Note

! Mortgage: A mortgage creates a collateral interest in ! Principal (loan amount)
property as security for the performance obligation.
! Promissory Note:This is the loan document that ! Interest rate
accompanies the mortgage, specifying the amount of ! Maturity date
money borrowed and the terms of repayment.
! Payment amount and payment structure
! Deed of Trust: A third party, a “trustee”, holds the
borrower’s real estate title for the lender's benefit until ! Loan charges, late fees, etc.
the loan is repaid. If default occurs the trustee may sell
the real estate to pay off the debt. ! Default conditions
! Deed to Secure Debt: Transfers title to the lender and ! Nature of liability (recourse or nonrecourse)
allows the lender to sell the property in case of default.
! Rights of prepayment (penalties)

© 2021 Nancy Wallace © 2021 Nancy Wallace

 Structure of the Mortgage/Deed of Trust Evolution of Default and Foreclosure
Delinquent:When borrower (mortgagor) fails to make timely payment.
! Funds for taxes and payments of property taxes !
! Default: Generic term usually meaning borrower has failed to fix delinquency.
Foreclosure:If the there is no remedy for the default, the borrower's title to the
! Hazard Insurance !
property is taken away and the property is sold to pay off the debt
! Equity of Redemption: Prior to property sale, the borrower has the right to pay the
! Mortgage Insurance balance due on the mortgage along with accrued interest and lender costs
! Statutory right of redemption: For a stated period after the foreclosure sale, the
! Preservation of Property borrower may reacquire property usually by paying the sales price plus accrued
interest, and lender's foreclosure costs (as determined by statute)
! Condemnation ! Foreclosure by judicial sale: Foreclosure through the courts, whereby a lender
sues to foreclose.
! Due-on-sale clause ! Foreclosure by power of sale: No judicial hearing or judgment is necessary and
the arrangements for the sale are made according to state statute.
Cramdowns: When a borrower files a Chapter 13 personal bankruptcy and the
! Default, Redemption, and Foreclosure !
court reduces the mortgage amount to reflect the current value of the property.
The mortgage is split into a secured loan for the new principal and an unsecured
loan for the balance.

© 2021 Nancy Wallace © 2021 Nancy Wallace

Contract Design:
Some Initial Observations Could I see a menu?
! Of course, borrower circumstances vary, so we would
! The forces of optimal contract design should cause expect a variety of mortgages to be available.
lenders to design mortgages to maximize borrower ! In practice, lenders offer a menu of choices.
benefits. Why? – Examples?
! Borrowers then self-select the best available mortgage .
! So why should the government pass laws about ! This assumes borrowers are well informed and rational.
mortgages?
! If not true, this motivates consumer protection
legislation.

© 2021 Nancy Wallace © 2021 Nancy Wallace

 Cash Flow Design:
Changing Payment Patterns Cash Flow Design: Principal Repayments
! Fixed Payment Mortgage has payment amount set at ! Amortization payments
Principal repayments = borrower's total payment minus accrued interest.
beginning and never changes. Other mortgages have
payment amounts that change over time. ! Negative amortization
Accrued but unpaid interest is added to principal so that the balance on
! Changes in payments can be set ex ante or ex post. the loan is growing. This occurs when total payment < accrued interest.
Payment changes may be for amount or maturity. ! Prepayment options
– Ex ante changes are illustrated by Graduated Payment Conditions under which borrower may accelerate payments.
Mortgages (GPMs)—payments rise by fixed percentage. ! Due on sale
This is requirement under which borrower must fully repay loan if the
– Ex post changes may depend on interest rates (ARMs),
underlying property is sold. (In contrast, very few loans are assumable,
Shared-Equity mortgage, inflation rates (PLAMs), or any
meaning the loan can be passed to next buyer).
other observable variable.

© 2021 Nancy Wallace © 2021 Nancy Wallace

Cash Flow Design: Constant Amortization Mortgage:

The CAM Mortgage as an Example Cash Flow
! Borrowers and lenders can adopt any cash flow pattern $100000 CAM, 10 year maturity, 6% annual rate
A B C D E
with regard to amortization. Going to Going to
! We have already seen the FRM (self-amortizing) and Period Payment Interest Principal Balance
0 100000
IOM (balloon amortization). 1 16000 6000 10000 90000
! Constant Amortization Mortgage (CAM): 1/N of 2 15400 5400 10000 80000
3 14800 4800 10000 70000
principal repaid each period: 4 14200 4200 10000 60000
– Each payment = (principal/N) + interest. 5 13600 3600 10000 50000
6 13000 3000 10000 40000
– This is also self-amortizing, but different from FRM. 7 12400 2400 10000 30000
– Result is that payment declines over time. 8 11800 1800 10000 20000
9 11200 1200 10000 10000
– How would borrowers compare CAM and FRM? 10 10600 600 10000 0
Lenders? =0.06* E (last) = B - C = E (last) - D
=10,000+.06*E(last)
© 2021 Nancy Wallace © 2021 Nancy Wallace
 Cash Flow Design: Accrued Interest Fixed Rate Mortgages: Fees and Points
! Borrowers and lenders can adopt any cash flow pattern, ! If lender charges 1 point, you receive only 99% of loan
given it is consistent with Truth in Lending (TIL) laws. ($99,000 on $100,000 loan); 2 points means 98%, etc.
TIL laws specify how Accrued Interest is computed: ! Loan payment still based on full $100,000 loan. This
! Accrued interest = contractual interest rate times means effective interest rate (= annual percentage rate
outstanding loan balance (usually time varying). APR) exceeds contract rate used to compute payment.
– Interest rates can be fixed or variable. ! Freddie Mac mortgage survey rates with points:
– There are also dual-rate mortgages:
Jan 28, 2016 30-Yr FRM 15-Yr FRM 5/1-Yr ARM
» One rate is the accrual rate (how much interest is due); Average Rates 3.79 % 3.07 % 2.90 %
» Other rate is the payment rate (determines payment); Fees & Points 0.6 0.5 0.5
Margin N/A N/A 2.74
» These loans may have negative amortization, which
occurs if loan payment < accrued interest.
5/1 ARM rate is fixed for 5 years, then ARM based on 1-year T-bill.
© 2021 Nancy Wallace © 2021 Nancy Wallace

Points and Coupon trade-off Wells Fargo Bank

(8/14/2020) Wells Fargo Mortgage Offer on 8/29/21

Loan Quote from Wells Borrower Information

Loan Amount $400,000 Loan Purpose Purchase
Interest Rate 3.125% House Value $500,000
Discount Points .50% Property Type Single Family
Lock-in-Period 45 Days Occupancy Primary
Payment Term 30 Years Property State CA
Downpayment 20% Property County Alameda
Closing Costs $7,579
Mortgage Ins. $0.00
Prem.

Loan distribution = $400,000 - $2,000 – $2,984.24 = $396,815.76

APR = 3.22%
© 2021 Nancy Wallace © 2021 Nancy Wallace
 Computing the Annual Percentage Rate Truth in Lending:
with Points and Fees Some of the Truth, Some of the Time
§ 226.14 Determination of annual percentage rate.
(a) General rule. The annual percentage rate is a measure of the cost of
credit, expressed as a yearly rate. An annual percentage rate shall be
considered accurate if it is not more than 1/8 of 1 percentage
point above or below the annual percentage rate determined in
accordance with this section.31a
31a An error in disclosure of the annual percentage rate shall not be a
violation of this regulation if: (1) The error resulted from an error in a
calculation tool used good faith by the creditor; and (2) upon
The Annual Percentage Rate (APR) is a legal concept discovery of the error, the creditor promptly discontinues use of that
calculation tool for disclosure purposes.
based on the Fed’s Regulation Z—the Truth in Lending
statute. Basically, it adds to the contract rate the effect (c) Annual percentage rate for periodic statements. The annual
of points and other fees, as shown above. percentage rate shall be computed by multiplying each periodic rate by
the number of periods in a year.

© 2021 Nancy Wallace © 2021 Nancy Wallace

Common Features on
Computing the Loan Balance After 10 Years Adjustable Rate Mortgages
! Mortgage payment resets with movements of a pre-determined
Notice that once loan is index: 3-Mo T-bill; 1-year constant-maturity Treasury rate;
made, points, fees, and APR LIBOR; COFI.
have no bearing on its value. – Cost of Funds Index (COFI11) is computed from the actual interest
expenses reported for a given month by financial institutions in
Arizona, California, and Nevada.
! Reset periods are usually monthly, or annual, including an
initial period of fixed rates.
! Life-of-loan caps required by Regulation Z “truth-in-lending”
legislation.
! Periodic interest rate and payment caps are common.
! May allow for negative amortization off the payment caps.

© 2021 Nancy Wallace © 2021 Nancy Wallace

 ARM Example:
Payment CAPS And Negative Amortization ARM Example/1
End of Balance Index Change Index Earned Earned Allowed Periods
! V0 = $70,000 Month At Date in plus Rate Payment Payment Left
Index margin Next 6 Next 6
! N = 30 Years 0 $70,000 7.20% 8.50% 8.50% $538.24 $538.24 360
! Adjustments for Payments & Interest Rates every 6 months.
! Index = 6 month Treasury Bill rate 6 $69,741 9.40% 2.20 10.70% 10.70% $649.92 $578.61 354
p.p. (7.5%
! Margin = 1.30% Cap)
! Payment Change Cap = 7.50% 12 $70,006 9.06% 1.86 10.36% 10.36% $636.34 $622.01 348
p.p. (7.5%
! No Interest Rate Change Cap Cap)
! Lifetime Rate Level Cap = 4.00% 18 $69,898 11.85% 4.65 13.15% 12.50% $749.77 $668.65 342
p.p. (4% (7.5%
! Every five years: payment cap lifted to fully amortize loan. Cap)
Cap)

Negative amortization
© 2021 Nancy Wallace © 2021 Nancy Wallace

ARM example with math and excel commands

(rounded to 100th place) ARM Example/3

! Notice at EOM 12: the first term is the present value of all
future payments from date 12 to date 360, while the second
terms is the future value of the payment deficiency from
date 6 to 12.
! Much Easier way:

V12 = FV(rate,nper,pmt,-pv)
V12 = FV(0.107/12,6,578.61,-69741.09)
V12 = $70,006.43

© 2021 Nancy Wallace © 2021 Nancy Wallace

 Wells Fargo Current Menu: Purchase
Mortgages: Sept/2020 What is the Wells Fargo ARM indexed to???

© 2021 Nancy Wallace © 2021 Nancy Wallace

Computing APR on ARMs

(5-Year ARM Example) Aside: ARMs and the Macroeconomy
At Origination At EOM 60 For an ARM whose initial
! Long-run FRM is unusual internationally.
Index rate (LIBOR) 0.875% 0.875% rate is different from the
Margin 2.250% 2.250%
fully indexed rate,
Beginning Balance $175,000 $154,502.06
Remaining Term 360 300
calculate the APR by ! Why would might lenders in other countries not be so excited
assuming that it will adjust
Teaser rate 0.50%None
to the fully indexed rate, about long-term fixed rate mortgages?
3.125%-0.50% =
Rate 2.625% 3.125% based on the level of the
Payment $702.89 $742.75 index at origination, as
Ending Balance EOM quickly as is possible ! Would fixed-rate mortgages or adjustable-rate mortgages
60 $154,502.06 0 under the terms of the
contract. increase the power of the Fed changing interest rates?
Points 1
Other Charges $2,000 (easy to calculate using
IRR function)
APR 3.12%

12*IRR(C0:C360)
C0 = $175,000*.99%-
$2000 -$171,250.00
C1-C60 $702.89
C61-C360 $742.75
© 2021 Nancy Wallace © 2021 Nancy Wallace
 International ARM Shares
U.S. ARM vs. FRM Market Share
Country ARM Share Fixed-rate Period Length
(%) (years)
Portugal 97.16
Finland 96.11
Australia 88.25

Source: Badarinza et al. (2015)

Spain 85.32 1.54
Ireland 81.55
Italy 70.66 5.78

© 2021 Nancy Wallace

Greece 63.14 3.38
Sweden 53.62
UK 46.93 2.22
Denmark 44.59 8.69
Netherlands 24.3 6.37
Belgium 23.15 11.78
Germany 15.88 9.08
© 2021 Nancy Wallace
Source: Urban Institute USA 8.46 22.76

Option-Based ARMs From Option ARMS to Predatory Lending

! These ARMs give borrower option to reduce payment ! Predatory Loans refer to loans made by unscrupulous lenders to
unsophisticated borrowers. Motives:
all the way down to a specified minimum. – Extract high interest rates and fees from the borrower and eventually
– If payment < accrued interest, then negative amortization. foreclose on the house. Target: Older homeowners with lots of
equity
– Advertised rates as low as a 1%, but this only determines – Charge high rates and fees to be able to sell the loan to investors at a
the minimum payment. The accrual rate is much higher. large profit. Let investors deal with default. Target: borrowers
stretching to buy a house they may not be able to afford
! The loans have effects on reported lender income: ! Features of predatory loans
– Total accrued interest is counted as income, even if not – Extremely high interest rates and fees.
paid. This assumes negative amortization will be repaid. – Very high prepayment penalties
– If loan defaults, then income accruals must be reversed. A – Inadequate disclosures
! Oakland, Georgia and other localities passed predatory lending laws
big fear is the loans will, indeed, have very high default making even MBS investors liable. But that led lenders not to do
rates. business there.
! Mortgage lenders, historically were covered by a patchwork of
regulation. Uniform standards and enforcement could more effectively
reduce the predatory lending problem. Addressed in Dodd-Frank.
© 2021 Nancy Wallace © 2021 Nancy Wallace
 Some More Alternative Mortgages Graduated Payment Mortgage
! So far we have considered IOM, FRM, CAM, and ARMs. ! Starting with initial payment of C0 at date 1, payments
But there are really an infinite choice for the total and/or grow at specified graduation rate of g:
amortization payment patterns. It all depends on the needs of
lenders and borrowers: C0 (1 + g )t -1
N
(1 + r )
V0 = å x= -1
! Graduate Payment Mortgages (GPMs) start with low
t =1 (1 + r )t (1 + g )
payments, then graduate to higher.
N
C0
! Price Level Adjusted Mortgages (PLAMs) keep payments (1 + g )V0 = å
constant in real terms. t =1 (1 + x )t
! Reverse Annuity Mortgages (RAMs) allow older borrowers
to tap home equity to provide for living expenses. ! To calculate the payment C0, put loan amount as if
! Shared Appreciation Mortgages (SAMs) allow a 3rd party to (1+g)V, and interest rate as if x.
pay part of the downpayment, then participate in price gains.
© 2021 Nancy Wallace © 2021 Nancy Wallace

Graduated Payment Mortgage (GPM):

A Way to Manage Affordability Price Level Adjusted Mortgages
GPM: $100,000 V, 10-year Maturity ! Provide two reason why inflation raises the initial
6% annual rate r, 5% annual growth g
x=((1+r)/(1+g))-1= 0.00952
payment on newly originated mortgages:
(1+g)V=
Payment = PMT(0.00952,10,-105000,0)
105000
11057.82
– 1)
A B C D E
Going to Going to – 2)
Period Payment Interest Principal Balance
0 100000.00 ! Once the mortgage is issued, why does inflation reduce
1
2
11057.82
11610.71
6000.00
5696.53
5057.82
5914.18
94942.18
89028.00
the payment burden of fixed rate mortgages.
3 12191.25 5341.68 6849.57 82178.44
4 12800.81 4930.71 7870.10 74308.34 ! Intuition on PLAM: have the balance of the mortgage
5
6
13440.85
14112.89
4458.50
3919.56
8982.35
10193.33
65325.99
55132.66
reset with inflation.
7
8
14818.53
15559.46
3307.96
2617.32
11510.58
12942.14
43622.08
30679.95
– Why does this solve the inflation problem?
9 16337.43 1840.80 14496.64 16183.31
10 17154.31 971.00 16183.31 0.00 – What are the risks for borrowers? For lenders?
=B(last) = =E(last)
*1.05 .06*E(last) =B-C -D
© 2021 Nancy Wallace © 2021 Nancy Wallace
 Price Level Adjusted Mortgages: Cash Flows Reverse Annuity Mortgages
! Consider older individual with a $100,000 fully paid house in
PLAM: V0=$100,000; N = 10 years
3% annual real rate of interest need of additional funds for current living.
PMT = 11723.05066 =PMT(0.03,10,-100000,0)
! She might be willing to forego right of bequest, but want to
A B C D E F G live in the house the remainder of her life.
Going to Going to Inflation Adjusted
Period Payment Interest Principal Balance Rate Balance Toll Free call 866.303.4326 for information
0 100000.00 100000.00
1 11723.05 3000.00 8723.05 91276.95 0.03 94015.26
If you are 62 years of age or older and own a home, you may qualify for a Reverse
2 12074.74 2820.46 9254.28 84760.97 0.15 97475.12
Mortgage. With a Reverse Mortgage:
3 13885.95 2924.25 10961.70 86513.42 0.10 95164.76 •You continue to own and live in your home as long as you want.
4 15274.55 2854.94 12419.61 82745.16 0.05 86882.41
•You make no monthly payments.
5 16038.28 2606.47 13431.80 73450.61 0.06 77857.65
6 17000.57 2335.73 14664.84 63192.80 -0.01 62560.87 •There are no credit or income requirements.
7 16830.57 1876.83 14953.74 47607.13 -0.05 45226.78 •Remaining equity goes to your heirs.
8 15989.04 1356.80 14632.24 30594.54 0.10 33654.00
9 17587.94 1009.62 16578.32 17075.67 0.03 17587.94
•Money received is tax-free.
10 18115.58 527.64 17587.94 0.00 0.00 •Money can be used to pay off existing mortgages, debt, make new purchases,
=E(last)*(1+F(last)) =.03*G(last) =B-C =G(last)-D Given =E*(1+F) travel, health care, investments, for anything you want!

© 2021 Nancy Wallace © 2021 Nancy Wallace

Reverse Annuity Mortgages, Example Shared Appreciation Mortgages

! PV = 100,000, N = 10 years, p = 5% (Housing Inflation) ! This mortgage provides the lender or co-investor with
! FV = 162,889 = house value after 10 years. compensation based on the change in house value.
! N = 10 years, r = 10% ! The lender/investor may even receive 100% of the price gain.
! Compute C = 10,221 = annual payments individual receives.
! At the end, the mortgage debt just equals the house value. ! What might be the appropriate mortgage rate in this case?
! Annuity alternative ! In standard cases, the lender receives a smaller percentage of
– Realistically, individuals cannot predict date of death. the gain, and a rate closer to the full nominal level.
– HUD plan allows individual to keep house until they leave; ! Complications:
– If you die or leave early, you (heirs) get any excess value. – Tax issues about capital gain versus interest income.
– If you stay on, bank takes risk that debt > house value. – Moral hazard issues on house maintenance and appraisal.
– As a result, banks are very conservative in their loans. – If co-investor is relative, family peace is at risk.
– HUD also imposes rules, such as counseling.

© 2021 Nancy Wallace © 2021 Nancy Wallace

 Summary:
Five Risk Factors Determining Contract Design Interest Rate Risk
! What is interest rate risk? How is it measured?
– Interest rate risk is the change in asset value arising from
1. Interest Rate Risk changing interest rates. Duration is a good measure.
! Interest rate risk depends on portfolio position.
2. Default Risk – If firm holds long duration FRMs, but funds with short-
term deposits, then there is interest rate risk.
3. Inflation Risk
! Interest rate risk should be priced.
4. Affordability to Borrowers – If economy's yield curve is upward sloping, then FRM
rates should be higher than ARM rates.
5. Tax, Regulatory, and Related Factors ! Prepayment options require higher interest rates.
! Interest rate risk may connect to other risks.
– ARMs reduce lender's rate risk but raise default risk.
© 2021 Nancy Wallace © 2021 Nancy Wallace

Default Risk Inflation Risk: Impact on Mortgage Payments

! How to measure default risk? ! High inflation creates higher nominal payments on
– Loan-to-value (LTV) ratio measure collateral risk. newly originated mortgages:
– Payment-to-income ratio measures borrower risk. – Higher interest rates and higher house prices both
– Variable payments are another risk factor. create rising initial mortgage payments over time.
! How to price default risk? – Borrower hurt even if income also rises at inflation
– Both higher interest rates and more fees can be used. rate.
! Adverse selection (AS) and Moral hazard (MH). ! High inflation also causes real payments on each
– AS occurs if riskiest borrowers select riskiest contracts; mortgage to decline over time:
MH occurs if borrowers with risky contracts become riskier.
– Use contract terms such as lower LTV to control behavior. – So initial high payment burden is removed over time.
! Other factors can also control default risk: – Why does this seem a bad way to design a mortgage?
– Recourse to other assets, impact on credit rating, etc. can help.
© 2021 Nancy Wallace © 2021 Nancy Wallace
 Affordability to Borrowers Tax, Regulatory, and Related Issues
! Common definition of affordability: 35% of before ! Tax code allows deduction for interest on first mortgages:
tax income covers loan payments, property taxes, – This benefits homes relative to autos, other durables.
and insurance. – Mortgage interest on home equity loans is also deductible,
but mortgage insurance premiums are not.
– Thus, by definition, loans with lower payments--due – There are complex rules regarding points deductibility.
to lower interest rates or to lower amortization--are ! Commercial real estate and securitization also have many
more “affordable”. tax issues—we will discuss these later.
! But affordable loans may be less desirable in other ! Many other Regulatory and Legal issues, examples:
dimensions such as default risk or liquidity. – Truth in Lending; Home Mortgage Disclosure (HMDA)
– Why might this apply to ARMs, GPMs, IOMs? – Insurance purchase rules (homeowners, catastrophe, title):
– Under what circumstances is it sensible to use ARMs » Title insurance has been particularly annoying due to
high cost and questionable business practices
to achieve affordability? GPMs? IOMs?

© 2021 Nancy Wallace © 2021 Nancy Wallace

Contract Risks for Alternative Instruments: Qualified Mortgage: part of the Dodd-Frank
Lender’s/Borrower’s Perspective Act Reforms
Risks$ FRM IOM GPM PLAM ARM ! Qualified Mortgage is a category of loans
– more stable features that help make it more likely that you'll be able
Interest Rate High/Low High/Low High/Low Low/High Low/High to afford your loan.
– lenders must make a good-faith effort to determine that you have the
Inflation Bad/Good Bad/Good Med/Med Good/Good Good/Good
ability to repay.
Default Low Mid High Mid High – Prohibits:
» An interest-only period,
Liquidity Good Good Fair Bad Fair » Negative amortization,
» Balloon payments,
Affordability Fair Good Best Best Best
» Loan terms that are longer than 30 years,
Tax/Regulate Good Best Good Complex Good » Debt to income ratio > 43%

© 2021 Nancy Wallace © 2021 Nancy Wallace

 Readings
! Polsky, Christensen, Ho, Ho, and Ismailos, “ The Dark Side
of the Sun: How PACE Financing has under-delivered green
benefits and harmed low-income homeowners,” Berkeley
Law, Environmental Law Clinic, February, 2021.
Property Assessed Clean Energy (PACE) ! Deason, Murphy, Issler, Wallace, and Schwartz, “
Residential PACE and property-related payments,”
Lawrence Berkeley National Laboratory, Energy Analysis
and Environmental Impacts Division, 2020.

© 2021 Nancy Wallace

Residential PACE (Property Assessed Clean Authorized through special assessment and
Energy) Loans special tax districts
! A potential solution to the short terms of home improvement loans and ! R-PACE financing makes use of voluntary special
the due on sale clauses in most residential mortgages. assessment districts or special tax districts established under
– “Solves” the mismatch between the long payback periods of energy state law to collect payments from participating households
efficient investments and the loan maturity.
via the property tax system over a number of years.
– RPACE loans stay with the house at sale and are paid as part of the
property tax. – California Assembly Bill 811 provides for creation of special
assessment districts.
! Residential PACE allows homeowners to finance energy efficiency,
renewable energy and other eligible improvements on their homes using – California Senate Bill 555, provides for the creation of special tax
private sources of capital. districts.
– PACE programs are typically enabled through state legislation and are ! The principal amount of the R-PACE tax assessment is the
authorized at the local government level. cost of the financed project plus capitalized financing charges
– Municipalities may directly administer residential PACE programs, or — interest and fees that accrue before repayment begins.
through public-private partnerships with one or more PACE providers.
! As of 2019, over 200,000 U.S. homeowners have made $5 billion in
RPACE loans.
© 2021 Nancy Wallace
© 2021 Nancy Wallace
 Eligibility Requirements Issues
! All property taxes for the assessed property are current for the previous three ! Federal Housing Finance Agency
years or since the current owner acquired the property, whichever period is
shorter. – The FHFA highlighted the fact that these R-PACE liens have priority
! The property is not subject to any involuntary lien in excess of $1,000.
ahead of prior-secured mortgage loans.
! The property is not subject to any notices of default. – Fannie and Freddie issued lender requirements clarifying that they
! The property owner is not in bankruptcy proceedings. would not purchase mortgages secured by first-lien R-PACE-
encumbered properties.
! The property owner is current on all mortgage debt.
! The party seeking financing is the holder of record on the property. ! Federal Housing Administration (FHA)
! The property is within the geographical boundaries of the PACE program. – In December 2017, FHA reversed its position, stating that it would no
! The Financing is for less than fifteen percent (15%) of the value of the property, longer allow FHA insurance on mortgages secured by properties
up to the first seven hundred thousand dollars ($700,000) of the value of the with R-PACE assessments.
property,
! The total mortgage-related debt and PACE Financing on the underlying property
does not exceed the value of the property.

© 2021 Nancy Wallace © 2021 Nancy Wallace

Issues Conclusions
! California loss reserve ! Basic fixed income building blocks enable a wide
– In March 2014 California established a $10 million loss variety of possible mortgage contracts that are
reserve to mitigate potential risks to certain first mortgage potentially suitable for different classes of
holders for homes with R-PACE assessments. borrowers.
(1) R-PACE losses resulting from the first mortgage lender’s payment of any R-
PACE assessments paid while in possession of the property, ! Basic U.S. mortgage contract is the FRM.
(2) in any forced sale for unpaid taxes or special assessments, losses incurred by the
first mortgage lender resulting from R-PACE assessments being paid before the ! Alternative mortgage contracts include: ARM,
outstanding balance.
GPM, RAM, etc.
! Staff at the FHFA indicated that the reserve was not
sufficient to address their ultimate concern with PACE’s ! Differing payment structures of these contracts
first-lien priority. g slightly in 2017 ($1.6 billion). expose lenders and borrowers to differing risk.

© 2021 Nancy Wallace © 2021 Nancy Wallace