Mortgage Bonds: Defined And Explained
When you close on a home, your mortgage takes on a life of its own.
After closing, your mortgage lender is likely to immediately sell your home loan in a group of other mortgages known as a mortgage bond. These bonds are then sold for investment in the secondary mortgage market.
This happens because lenders need to liquidate the mortgages they hold so that they can offer future mortgages. The mortgages sold as mortgage bonds are a type of mortgage-backed security (MBS), and are secured by residential (as opposed to commercial) property.
Mortgage Bond Definition
Mortgage bonds are investment products traded on the open market and secured by residential real estate as collateral. Lenders sell a mortgage bond to real estate investors who then receive interest payments until the loans are paid off.
Essentially, mortgage bonds are a pool of mortgages that are backed by real estate and real property for investment.
How Mortgage Bonds Work
The sale of your mortgage takes place immediately after your home’s closing. When sold, mortgages are bundled to create a mortgage bond, and shares of these bundles are sold to investors in the secondary mortgage market.
Mortgage bonds are generally considered a safe investment because they’re secured by real property. In other words, if a homeowner defaults on the loan or is unable to make payments, the property can be sold to recover the debt. The ability to sell property in exchange for cash makes mortgage bonds a low-risk investment.
What Are Government-Sponsored Enterprises?
A government-sponsored enterprise is a financial services corporation created by the United States government. They’re created to enhance the flow of credit to specific sectors of the economy. In this case, Fannie Mae and Freddie Mac are two government-sponsored enterprises that help the real estate market be more efficient and transparent, thus reducing the risk to investors. They help MBS investors, as well as homeowners, safely and securely invest in real estate.
The mission of a government-sponsored enterprise is to encourage homeownership and ensure liquidity in the housing market.
In real estate, government-sponsored enterprises guarantee qualified mortgages. This implicit guarantee from the government aims to ensure that the investments won’t be allowed to fail which makes them less risky and ultimately more attractive to certain investors.
Who Buys Mortgage Bonds?
Mortgage bonds have very little risk because they’re backed by the full faith of the U.S. federal government. This makes them attractive to some investors who are looking to grow their money sustainably. Investors seek safety and a reliable income like mortgage bonds and mortgage-backed securities because of the steady stream of interest payments made by homeowners.
Investors Seeking Safety
Overall, mortgage bonds are considered safer than most corporate bonds because the debt is secured by real property that can be taken in foreclosure and sold to pay off the debt.
When given the option, many investors seeking safety will choose mortgage bonds over U.S. Treasury bonds because they’re secured by real property. This makes mortgage-backed securities slightly safer for investors than U.S. Treasury bonds.
Additionally, when an investor seeks to diversify their portfolio, real estate tends to be a consistent addition to their investments. Mortgage-backed securities have historically provided yields due to their cash flows and liquidity. They’re also easy to diversify geographically. For example, if the housing market in one state was falling, an MBS can help to alleviate the risk by purchasing mortgages from around the country.
Investors Seeking Reliable Income
When you take out a mortgage, you’ll be expected to pay the principal as well as the interest on the mortgage. The interest paid by homeowners to mortgage services throughout the life of their mortgages becomes income to the investors who purchased mortgage-backed securities.
If mortgagees didn’t have to pay the principal and interest on their homes, then MBS wouldn’t be attractive investments. Therefore, the Dodd-Frank Act was created in 2010 as a reaction to the 2008 financial crisis.
The Dodd-Frank Act is a law that places strict regulations on lenders and banks to help protect consumers and prevent recessions. The law helps to ensure borrowers have sufficient income to pay their debts before taking out a mortgage and to decrease the likelihood of defaulting on mortgages.
Laws like the Dodd-Frank Act help to ensure that real estate is a reliable, income-producing investment. Real estate investors receive monthly interest payments and often see growth on the value of their portfolios over time. Their monthly returns consist of both interest and principal, but the amount they receive can vary each month. The amount of interest they receive is dependent on the amount of principal in the mortgage pool.
Pros And Cons Of Mortgage Bonds
- If the homeowner defaults, the investor is protected
- Borrowers can borrow larger amounts at lower costs
- Carry lower interest rates than typical corporate bonds
- Mortgage bonds can be securitized
- Lower yield than corporate bonds
- Risk of losing the collateral
The Bottom Line: Your Mortgage Has A Life Of Its Own
When you purchase a home, you aren’t likely to think about the journey your mortgage loan will take after closing. A mortgage can be bought and sold multiple times over its lifetime.
Immediately following the closing of your home, a mortgage can be bonded and sold, and shares of it can be sold as well. This won’t have an impact on your mortgage payments or term.
Mortgage bonds are a pool of mortgages that are backed by real estate and real property. These bonds are incredibly attractive to investors who seek secure, consistent growth in their investments. This is because mortgage-backed securities are protected by a guarantee by the U.S. government and are secured by real property. If a mortgagee stops paying their mortgage, the property can be sold to recover the debt owed.
If you’re curious about building your own investment portfolio, get started with our guide on how to invest in real estate.