Mortgage Backed Securities

As a homeowner or homebuyer, you won’t likely deal with mortgage backed securities directly. But they still affect you. A mortgage backed security is a type of debt obligation wherein the holder of the security receives money from mortgage payments. Mortgage backed securities can be bought and sold like stocks and mutual funds. So, when you take out a mortgage loan from a bank, the bank is the one who receives your payments initially. The bank can then turn around and sell the rights to collect your mortgage payments as part of a mortgage backed security. Most mortgage backed securities are bundles of several different debt obligations. The investor will give the bank an upfront sum for the mortgage. In this way, the bank no longer has to worry about whether or not it’s going to see income from your mortgage - now, it’s the investors problem.

Mortgage Backed Securities and Consumer Interest Rates

For you, this is good, because it means the bank has less risk associated with your mortgage loan. With less risk, they can offer you a lower interest rate. Not only that, they can originate more loans without waiting to accumulate more capital over the years. Meanwhile, to you, it makes little to no difference. You still owe the same amount on your home, you still make the same payments each month, and you still lose your home if you can’t make your payments.

Who Buys Mortgage Backed Securities?

Mortgage backed securities are bought by investment banks and other private investors, but they are also purchased by the government and government sponsored enterprises. Why does the government buy mortgage backed securities? Simple: to increase the amount of money available to lenders so they can originate more loans. The government has traditionally seen mortgage backed securities as a safe bet, since housing prices historically have gone up and even if a borrower defaults, the home can be sold to mitigate losses. However, as we’ve seen from the recent housing crisis, mortgage backed securities are by no means a surefire investment.

All of this is important to you as a borrower because the government prefers to only buy mortgage backed securities that are secured by a certain type of mortgages - namely, mortgages that are less risky. In the industry, these are called "conforming loans." Because conforming loans can be sold to government sponsored enterprises, or in some extreme cases, the Federal Reserve itself, it’s in the private lender’s best interest to ensure that the loans it originates meet government standards. In other words, if your mortgage is a conforming loan, you will get a lower interest rate.

So what if the government stops buying mortgage backed securities? The general consensus is that if less mortgage backed securities are being bought and sold, then interest rates will go up. For that reason, it pays to keep an eye on what the government and private investment banks are doing with mortgage backed securities.