 Sam
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 Posted: Fri Apr 09, 2004 12:46 am Post subject: Mortgage-Backed Securities (MBS) |
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Mortgage Backed Securities are parcels of mortgage loans grouped by the Government Sponsored Enterprises (GSEs) (Freddie Mac, Ginnie Mae and Fannie Mae) to be sold to the investors. These loans are pooled according to the categorization based on loan amount, term, type and amortization schedules.
What actually happens is, the loans are handed over to the government agencies after origination. These loans then are taken in bulk and sorted out into securities. These securities are sold like bonds. Every time you as a borrower make a monthly repayment, this amount (i.e. interest plus principal) is handed over to the GSEs and they pass it to the investors minus the servicing fees.
What are the benefits?
- To the investor:
- It is a steady income source. Even if the borrower does not make the payments on time you will get yours.
- Yields are higher. The credit rating for MBS is always AAA and so the rates are higher than the treasury rates. The credit worthiness is the same as treasuries but the rates are 1-2 % higher.
- It takes advantage of capital appreciation. When the rates fall, investor is not affected except in the case of pre-payment.
- Liquidity risk is least. Most of the MBS provide tax deferred savings account.
- These are either fully backed or sponsored by government agencies. So, even at lower rates the investors are always ready to buy the securities.
- To the mortgage industry:
- It is an integral part of mortgage banking. The returns on MBS help generate new funds and thus new mortgages.
- It sustains the mortgage cycle and keeps the housing industry intact. The MBS requires no credit checking and so they can be bought without hassles.
The MBS are of three types:
- Pass through participation certificates: Entitle the investor to a proportinately share of all principal and interest payments made on the pool of loan assets.
- Collaterized mortgage obligations: Designed to protect investors from various types of risk like prepayments, typically because homeowners refinance when interest rates fall.
- Private Label MBS: Securitize mortgages by some private institutions like brokerage firms, banks, and homebuilders.
It is the best investment instrument and the secondary mortgage market basically involves the transaction of MBS. If you have always wondered how the lender gets the money to finance your loan, the answer is MBS! |
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