Learning Module 19: Mortgage-Backed Security (MBS) Instrument and Market Features
Fixed Income
Loan-to-Value Ratio (LTV)
\[ \text{LTV} = \frac{\text{Loan Amount}}{\text{House Price}} \]
- The ratio of the amount of the mortgage to the property’s value is called the loan-to-value ratio (LTV)
- The lower the LTV, the higher the borrower’s equity
- From the lender’s perspective, the higher the borrower’s equity, the less likely the borrower is to default.
- the lower the LTV, the more protection the lender has if the borrower does default and the lender repossesses and sells the property.
- When the loan is first taken out, the borrower’s equity in the property is equal to the down payment. Over time, the LTV changes: As the borrower makes mortgage payments, including principal repayments, the outstanding balance on the loan is reduced and as the market value of the property changes, the borrower’s equity also changes. LTV serves as a key measure both in residential and commercial mortgages.
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### Loan-to-Value Ratio (LTV)
$$
\text{LTV} = \frac{\text{Loan Amount}}{\text{House Price}}
$$
- The ratio of the amount of the mortgage to the property’s value is called
the loan-to-value ratio (LTV)
- The lower the LTV, the higher the borrower’s equity
- From the lender’s perspective, the higher the borrower’s equity, the less
likely the borrower is to default.
- the lower the LTV, the more protection the lender has if the borrower does
default and the lender repossesses and sells the property.
- When the loan is first taken out, the borrower’s equity in the property is
equal to the down payment. Over time, the LTV changes: As the borrower
makes mortgage payments, including principal repayments, the outstanding
balance on the loan is reduced and as the market value of the property
changes, the borrower’s equity also changes. LTV serves as a key measure
both in residential and commercial mortgages. Debt-to-Income Ratio (DTI)
\[ \text{TI} = \frac{\text{Monthly Debt Payment}}{\text{Monthly Pre - Tax Gross Income}} \]
- The capacity to sustain debt payments is another consideration. For residential lending, the metric is the debt-to-income ratio (DTI), which compares an individual’s monthly debt payments to their monthly pre-tax, gross income
- Lenders, including mortgage lenders, use the DTI to measure an individual’s ability to manage monthly payments and repay debts.
- A low DTI shows a balance between income and debt and suggests that the borrower could sustain additional debt.
- A high DTI ratio signals that the borrower may carry too much debt for the amount of income earned each month.
- Typically, lenders want to see low DTI ratios before extending loans to a potential borrower.
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### Debt-to-Income Ratio (DTI)
$$
\text{TI} =
\frac{\text{Monthly Debt Payment}}{\text{Monthly Pre - Tax Gross Income}}
$$
- The capacity to sustain debt payments is another consideration. For
residential lending, the metric is the debt-to-income ratio (DTI), which
compares an individual’s monthly debt payments to their monthly pre-tax,
gross income
- Lenders, including mortgage lenders, use the DTI to measure an individual’s
ability to manage monthly payments and repay debts.
- A low DTI shows a balance between income and debt and suggests that the
borrower could sustain additional debt.
- A high DTI ratio signals that the borrower may carry too much debt for the
amount of income earned each month.
- Typically, lenders want to see low DTI ratios before extending loans to a
potential borrower. Weighted Average Coupon Rate (WAC)
\[ WAC = i_A\left(\frac{CB_A}{\sum_{CB}}\right) + i_B\left(\frac{CB_B}{\sum_{CB}}\right) + i_C\left(\frac{CB_C}{\sum_{CB}}\right) + i_D\left(\frac{CB_D}{\sum_{CB}}\right) + i_E\left(\frac{CB_E}{\sum_{CB}}\right) \]
Where:
- \(i\): Interest Rate
- \(BB\): Beginning Balance
- \(CB\): Current Balance
- \(MM\): Number of Months to Maturity
- The WAC is calculated by weighting the mortgage rate of each mortgage in the pool by the percentage of the outstanding mortgage balance relative to the outstanding amount of all the mortgages in the pool.
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### Weighted Average Coupon Rate (WAC)
$$
WAC = i_A\left(\frac{CB_A}{\sum_{CB}}\right) +
i_B\left(\frac{CB_B}{\sum_{CB}}\right) +
i_C\left(\frac{CB_C}{\sum_{CB}}\right) +
i_D\left(\frac{CB_D}{\sum_{CB}}\right) +
i_E\left(\frac{CB_E}{\sum_{CB}}\right)
$$
Where:
- $i$: Interest Rate
- $BB$: Beginning Balance
- $CB$: Current Balance
- $MM$: Number of Months to Maturity
- The WAC is calculated by weighting the mortgage rate of each mortgage in
the pool by the percentage of the outstanding mortgage balance relative to
the outstanding amount of all the mortgages in the pool. Weighted Average Maturity (WAM)
\[ WAM = MM_A \left(\frac{CB_A}{\sum_{CB}}\right) + MM_B \left(\frac{CB_B}{\sum_{CB}}\right) + MM_C \left(\frac{CB_C}{\sum_{CB}}\right) \]
Where:
- \(i\): Interest Rate
- \(BB\): Beginning Balance
- \(CB\): Current Balance
- \(MM\): Number of Months to Maturity
- the WAM is calculated by weighting the remaining number of months to maturity of each mortgage in the pool by the outstanding mortgage balance relative to the outstanding amount of all the mortgages in the pool.
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### Weighted Average Maturity (WAM)
$$
WAM = MM_A \left(\frac{CB_A}{\sum_{CB}}\right) +
MM_B \left(\frac{CB_B}{\sum_{CB}}\right) +
MM_C \left(\frac{CB_C}{\sum_{CB}}\right)
$$
Where:
- $i$: Interest Rate
- $BB$: Beginning Balance
- $CB$: Current Balance
- $MM$: Number of Months to Maturity
- the WAM is calculated by weighting the remaining number of months to
maturity of each mortgage in the pool by the outstanding mortgage balance
relative to the outstanding amount of all the mortgages in the pool. Debt Service Coverage Ratio (DSCR)
DSCR or DSC Ratio
\[ \text{DSC} = \frac{\text{Net Operating Income}}{\text{Debt Service}} \]
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### Debt Service Coverage Ratio (DSCR)
DSCR or DSC Ratio
$$
\text{DSC} = \frac{\text{Net Operating Income}}{\text{Debt Service}}
$$Net Operating Income (NOI)
\[ \text{NOI} = (\text{Rental Income } - \text{ Cash Operating Expense}) - \text{Replacement reserves} \]
- NOI is defined as the rental income reduced by cash operating expenses and a non-cash replacement reserve reflecting the depreciation of the property over time.
- NOI excludes principal and interest payments on loans, capital expenditures, depreciation, and amortization.
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### Net Operating Income (NOI)
$$
\text{NOI} = (\text{Rental Income } - \text{ Cash Operating Expense}) -
\text{Replacement reserves}
$$
- NOI is defined as the rental income reduced by cash operating expenses and
a non-cash replacement reserve reflecting the depreciation of the property
over time.
- NOI excludes principal and interest payments on loans, capital expenditures,
depreciation, and amortization.