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Figure 7 1 mortgage funding in various types of

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Figure 7-1: Mortgage Funding in Various Countries
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91 7.1.2 Types of Mortgage Products Table 7-1 shows the typical mortgage characteristics in different countries (columns 2-5) and the types of mortgage products that were available (the last three columns) as of 2005. In the United States, the standard mortgage product is the 30-year fixed-rate, self-amortizing, pre- payable mortgage. Nominal payments are fixed, and borrowers are protected from fluctuations in interest rates. If rates rise, payments are unchanged. If rates decline, borrowers typically have the option to refinance at no explicit cost (except for the normal transactions costs of the refinance process). The market share of fixed-rate mortgages (FRMs) fluctuates over time, but has averaged around 70% in the United States. 48 Denmark, the home of the covered bond, is the only other country where the pre-payable 30-year FRM is widely popular. Table 7-1: Mortgage Terms across Different Countries 49 In many other countries, such as the United Kingdom, Canada, and Australia (which also have reasonably well-developed securitization markets), long-term fixed rate mortgage products are not widely available. The default product is an adjustable-rate mortgage (ARM), where the interest rate is tied to the short-term government interest rate, or a “hybrid mortgage”, which
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92 has a short initial period of a fixed rate followed by an extended period of variable rates. The latter are popular in Canada, Germany, and the Netherlands. Japan has fixed-term loans, where the borrower has the option to choose a new fixed rate or an adjustable rate at the end of the first fixed-rate period. Also, many countries have prepayment fees (last column). The dominant form of mortgage is closely tied to the funding mechanism. In countries with deposit-based funding, adjustable rate products are more common because they provide the banks that hold the mortgages on their balance sheets with a better match for their short- term adjustable rate deposits, exposing the banks to less interest-rate risk. In contrast, 30-year pre-payable mortgages expose banks to substantial maturity mismatch and interest-rate risk. These risks are hard to hedge. Hence, banks are eager to sell off such loans to the secondary market in the form of MBS, rather than holding them. This is true for the United States and Denmark although, as mentioned in chapter 2, a considerable amount of MBS were held within the banking sector . In the United States, the government support through the GSEs was crucial to get the securitization market off the ground in the 1970s. In the U.K. also, where banks have begun to employ various forms of securitization to fund mortgage risks, there has been some rise in the fixed-rate and hybrid-form mortgages.
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