Mortgage Bonds: Definition, Function And Guide To The Mortgage Bond Market
Katie Ziraldo3-minute read
May 24, 2021
Those who are new to financial investments may be surprised to learn just how many investment opportunities are out there. The wide range of options can be exciting, but also overwhelming when you’re trying to make the best use of your money.
One relatively safe, secure investment option lies in the mortgage bond market. But what exactly are mortgage bonds and how do they work? In this article, we will explore the basic pros, cons and overall impact of purchasing mortgage bonds.
What Is A Mortgage Bond?
Because mortgage bonds are backed by real property, they are often considered a low-risk investment, because in the case of foreclosure, the property can be sold to recover the debt. The sale of your mortgage usually occurs immediately after your home’s closing. When this happens, your mortgage is bundled with others, and shares of the bundle are sold to investors.
Investors can make money from mortgage bonds in a few ways. In addition to collecting interest on mortgage payments, investors can also earn money from payments toward the principal balance. And if the borrower defaults, the investor can even choose to foreclose on the home.
How Do Mortgage Bonds Work In The Real Estate Market?
It’s very rare for lenders to retain ownership of a mortgage. More likely, the lender secures mortgages into mortgage-backed securities (MBS) to sell in the secondary market, typically to investment banks or government-sponsored enterprises (GSE).
GSEs are financial services corporations that were created by the U.S. government in order to boost the flow of credit within the economy. The most notable of these GSEs are Fannie Mae and Freddie Mac, which assist the real estate market by helping investors and homeowners securely invest in real estate. Once the GSE is in possession of the mortgage, it packages it within a pool of other loans and begins issuing bonds with the mortgages as the backing.
How Can Bonds Affect Mortgage Rates?
Although corporations can issue private bonds, it is much more common for bonds to be provided by the federal government, referred to as Treasury bonds. Treasury bonds affect more than just the investor, as the bond market has a direct impact on mortgage rates. There is an inverse relationship between mortgage rates and the bond market – meaning if bond prices are low, rates will be high and vice versa.
This has to do with the supply and demand of the bond market. Most mortgage lenders aim to keep their interest rates a few notches higher than bond interest rates, as they tend to attract similar investors. But when bond prices drop, bond interest rates rise – which will ultimately lead to a rise in mortgage rates as well.
Should You Invest In The Mortgage Bond Market?
Now that you understand mortgage bonds and how they function in the real estate market, you may be wondering if this type of investment is viable for you. Before any financial investment, it’s crucial to look at both the benefits and potential drawbacks – so let’s take a look at the biggest pros and cons of investing in the mortgage bond market.
- Recurring interest payments from homeowners can provide reliable and safe income for investors
- Bondholders can sell off a foreclosed property if a borrower defaults on their mortgage
- Mortgage bonds are safer investments than treasury bonds because they are secured by real property and the U.S. government
- Yields tend to be lower than corporate bond yields
- Investors can lose money if a borrower pays off their loan early
- If a borrower defaults on their mortgage, investors risk losing the collateral
The Bottom Line
Because they’re secured by real property and GSEs, mortgage bonds are considered one of the most low-risk investment opportunities available. As always, we recommend taking a deep dive into your budget and finances before choosing to invest – but making the right investment can put you one step closer to a stronger financial future.
Want to continue learning about mortgages and homes? Read more homeowner tips in the Rocket Homes® Homeowner Guide!