What Are Mortgage Backed Securities?
In March, the Federal Reserve announced that it would begin purchasing a total of $1.3 trillion of mortgage-backed securities. This amount represents about 38% of the Bloomberg U.S. MBS Index. In return for buying these securities, the Fed will allow maturing securities to roll off its balance sheet. It will also reinvest the maturing proceeds. Currently, the monthly cap for purchases is $30 billion, but that will increase to $35 billion by September.
Mortgage-backed securities are a kind of bond, similar to a savings or Treasury bond. They allow borrowers to access capital more inexpensively. However, they can also have a significant impact on whether or not a borrower qualifies for a conforming loan. This is because they affect the conforming loan qualification process and who gets the money.
Although the value of MBSs varies, they are generally liquid and are traded between investors and dealers. Liquidity is determined by a number of factors, including the age of the security and the amount of outstanding mortgages. The underlying mortgages of an MBS are weighted according to their balances. This is called the “weighted average maturity” and “weighted average life” – they are averages of mortgage-backed securities.
Mortgage backed securities come in two main types: pass-through securities and collateralized mortgage obligations. Pass-through mortgage-backed securities are structured as trusts and pay out the principal and interest payments to investors. They typically have stated maturities between five and 30 years. Collateralized mortgage obligations are more complex and contain several pools of mortgage-backed securities, each with their own set of rules and priorities.
Mortgage-backed securities (MBS) played a significant role in the 2008 financial crisis. In 2008, banks and lenders were under pressure to provide credit to high-risk borrowers. However, mortgage-backed securities failed to meet these expectations, leading to a housing market crash. With the housing market in a shambles, more people began walking away from their mortgages. This caused the value of conventional mortgages underpinning the MBS market to drop rapidly.
Another major risk associated with MBS is repayment. This is comparable to the “Call” risk in options. When interest rates are low, mortgage borrowers tend to repay a higher share of the outstanding principal. This lowers the maturity risk but increases the reinvestment risk, which can adversely impact your portfolio.
Mortgage backed securities are a great way to plan for the future, but they may not be appropriate for all situations. Traditional bonds with specified maturity dates can be used for planning purposes as well. A government-owned corporation called Ginnie Mae backs mortgage-backed securities, and it ensures that they are backed by the full faith and credit of the U.S. government.
A mortgage-backed security can diversify a portfolio and provide monthly payments. However, these investments are subject to collateralized mortgage risks. Homeowners may decide to refinance their mortgages, which could result in the repayment of the principal to investors. Additionally, investors are exposed to liquidity and market risk.