Mortgage bond explained

A mortgage-backed security is an asset-backed security that is guaranteed by a mortgage or a group of mortgages. The mortgages are pooled and sold to a group of people (such as a government agency or an investment bank) who securitize, or package, the loans into a security that investors can purchase. Residential bonds are normally considered as a separate class from commercial bonds, depending on whether the underlying asset is mortgages owned by borrowers or assets for commercial uses ranging from office space to multi-family structures.

Mortgage bond process

Because the principle is backed by a valued asset, mortgage bonds provide protection to the investor. Mortgage bondholders might sell the underlying property to compensate for the default and ensure dividend payment in the case of failure. The average mortgage bond, however, tends to produce a lower rate of return than standard corporate bonds, which are backed simply by the corporation’s promise and capacity to pay, due to its inherent safety.

When a person buys a house and pays for it with a mortgage, the lender almost never keeps the mortgage. Instead, it sells the mortgage to a third party, such as an investment bank or a government-sponsored company, on the secondary market (GSE). This company bundles the mortgage with a group of other loans and sells bonds backed by the mortgages.

The interest component of a homeowner’s mortgage payment is used to cover the return on these mortgage bonds. A mortgage bond is a secure and reliable income-producing asset as long as the majority of the homeowners in the mortgage pool keep up with their payments.

Advantages and disadvantages of a mortgage bond

Mortgage bonds have the drawback of having lower returns than corporate bonds since mortgages are securitized, making them safer investments. The bondholders would have a claim on the value of the homeowner’s property if the homeowner defaulted on his or her mortgage. Bondholders can be compensated by liquidating the property. Mortgage bonds have the added benefit of being a safer investment than, say, equities.

Investors of corporate bonds, on the other hand, have little or no remedy if the company defaults. As a result, companies must provide higher rates on bonds to encourage investors to take on the risk of unsecured debt. 

If you have any other questions regarding Mortgage Bonds, contact the mortgage experts at Mortgage Rates Today!