Homeowners and other property holders think about the mortgage often. It is among the largest of monthly expenses and, aside from the wealthy who pay all cash for their houses, is central to calculating cash flow. Few of them, then, concern themselves with where their remittances go beyond their home loan servicer. Yet these loans, so familiar to so many, also serve as profitable revenue generators for multiple classes of investors.
So, when mortgage payers write that monthly check, they not only pay a lender back with interest, but they also contribute to the financial portfolios of many other people.
Read More: The Pros & Cons of Mortgages
There Is Money in Debt
The bond market lacks the excitement and glamour of the stock market. The thrill of victory and agony of defeat come with greater volatility than bonds can offer, most of the time. From U.S. Treasuries to corporate to municipal bonds, investors select them often to diversify their holdings and provide a more predictable stream of income than other products allow.
Of course, with predictability comes modesty in gains. Only high-yield bonds bring more thrills and even a sense of danger. In the long run, that is the purpose of bond investment: to balance volatility with greater dependability.
That very reliability factor can be found in the type of debt a bond represents. Treasury bills reflect debt taken on by the U.S. government while municipal bonds, or "munis," perform the same function on behalf of cities and towns. Meanwhile, bonds issued by reputable and longstanding companies will carry greater financial confidence than those offered by recently established enterprises.
With the attractiveness of such investments resting on public trust and creditworthiness, it is understandable that mortgages, when bundled together, also serve as pass-through securities. In fact, mortgage-backed securities (MBS) are popular ways to add income.
Read More: Why Bonds Are Safer Than Stock
How Does a Mortgage Pass-Through Work?
A pass-through MBS always begins with the property owner making a mortgage payment to the lender, often through a servicing operation since many lenders opt not to process the reimbursements themselves. By itself, however, a $1,700 remittance is hardly sufficient to earn income for a slew of investors. So, mortgages are bound together in packages that are pooled as securities. a process known as securitization.
Over 1,000 individual property loans are bundled together based on loan terms, collateral and risk profiles. The action of combining so many mortgages is accomplished by a financial intermediary, like a bank or mutual fund, that purchases groupings of loans from lenders. On the other end of the MBS pass-through is the investor, who is paid monthly by the intermediary. As with the lender itself, investor receipts consist of interest as well as principal.
In the spring of 2021, over $10 trillion of mortgage debt was outstanding. The sheer amount of debt, along with mortgages of high interest rates, offers decent revenues for discerning investors. As long as borrowers are paying down their home loans, these mortgage pass-through security products will have a positive effect on cash flow.
Anything to Worry About?
Although a pass-through MBS can be considered a conservative investment, risk is always present, especially as long as people default on mortgages. This problem came to a head in 2007-2008 when masses of sub-prime mortgage pass-throughs collapsed due to thousands of defaults. The failures rippled through the entire U.S. economy and banking system.
Yes, defaults cause the securities to lose value but so does pre-payment, which lowers the total interest collected on a mortgage loan. Accordingly, investors do well to pay attention to economic trends.
Adam Luehrs is a writer during the day and a voracious reader at night. He focuses mostly on finance writing and has a passion for real estate, credit card deals, and investing.