Many of us experienced in the stock market trading or have 401(k)s or private portfolios are familiar with the term “securities.” A security is a holder’s legal interest in a corporation, certificate, or note that may increase in financial value over time. Corporate stocks, mutual funds, bonds, certificates of deposit, and notes can be considered securities. The holder of these securities experience can experience gains and losses. Depending on the strength of the security, gains and profits will vary. Gains are evidenced by the growth of a holder’s stock portfolio, 401(k), CDs, or bonds. Also, dividend and annuity gains can be paid out as cash profits to the holders.
A mortgage backed security (MBS) is a bond financed by home mortgage payments. This is the essential concept behind the mortgage backed securities definition. The mortgage principal and interest paid by the homeowner is the principal and interest paid to the MBS holder. This is called “ mortgage pass-through,” which may also differentiate the MBS from other MBS programs that may have other features attached to it.
An investor who buys MBSs provides mortgage loans to the homebuyer (or business) as a consequence. The homeowner or mortgage loan holder controls the “cash flow” that goes to the MBS holder. As mentioned before, the homeowner pays off his mortgage’s principal and interest over a designated period of time, i.e., 15, 20, or 30 years. The mortgage loan holder may prepay their entire mortgage at any time, which may upset the timing of the MBS investor’s cash flow.
Mortgage prepayments usually occur when a house is sold or the homeowner decides to refinance his home with a second mortgage at a lower rate. This is a risk for the MBS investor. But mitigating this MBS risk is something called the “ option adjusted spread,” which means the MBS is tied to government bonds' trade spread.
Other catalysts that spur the prepayment option not tied to interest rates include real estate price inflation, unemployment, economic growth, mortgage risk aversions, and change in borrowing regulations.
Overall, MBSs are an attractive and safe investment vehicle. Good income coupled with capital appreciation and tax-deferred savings are the main advantages to investing in these security or bond types. Like bonds, MBSs trade dynamically with little risk to liquidity. Also, MBSs are likened to treasuries in that they are safe and even offer a higher return of from 1% to 2%.
But, as intimated before, MBS monthly income can vary due to falling interest rates. This fall in interest rates may cause a higher rise in prepayments. As a result this may shorten the term of an MBS, but the investors benefit from the gains anyway.
So, you appear interested. What companies offer mortgage backed securities? Companies that offer MBSs include the Government National Mortgage Association (Ginnie Mae), Federal Home Loan Mortgage Corporation (Freddie Mac), and the Federal National Mortgage Association (Fannie Mae). Each entity may be defined a bit differently depending on the security products each offers.
You can find more information regarding MBSs and even a mortgage backed securities tutorial on the Internet.