A mortgage pass-through is one type of mortgage-backed security (MBS). Mortgage securities allow investors to earn interest from a pool of home mortgages. Mortgage-backed securities can be structured into several types including pass-through and collateralized mortgage obligations (CMOs).
The pass-through MBS is the most basic form of mortgage-backed security. As homeowners with mortgage loans in the pool for a particular MBS make their monthly mortgage payments, the principal and interest amounts received by the pool are passed through to the investors in the mortgage bond. With a pass-through mortgage security, investors receive a monthly payment that consists of both interest on the investment and a partial return of principal.
Types of Pass-through Mortgage Bonds
The most common types of pass-through mortgage securities are bonds with the mortgages guaranteed by the Government National Mortgage Association -- Ginnie Mae -- or one of the government sponsored entities, Fannie Mae and Freddie Mac. Due to the implied or explicit U.S. government backing of the mortgages in pools of these mortgage securities, the bonds have AAA credit ratings.
Pass-through vs. CMO
A mortgage pass-through bond does nothing to the payment coming in from homeowners except divide the combined payments up for the size of the individual investments. A collateralized mortgage obligation (CMO) takes the pool of mortgages and slices the principal and interest payments into bonds with different rates, maturities and credit ratings. The quality and features of an individual CMO are controlled by the financial institution that created the bond from a mortgage pool. It is difficult for investors to judge the real quality of CMO, however. Aggressively sold CMOs were a major trigger for the 2007 financial crisis.
Pass-through Mortgage Bond Considerations
In contrast to many CMOs, pass-through securities are considered safer investments. The biggest concern with a pass-through bond is the principal repayment rate when interest rates change. If rates fall, the homeowners with loans paying into an MBS pool will refinance their loans, and investors will receive principal back faster that must be reinvested at lower rates. If rates rise, homeowners will keep their mortgages longer, stretching out the principal repayment for investors.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.