Many banks that are into originating mortgages make it a point to sell Mortgage-backed securities to investors. There is a huge demand for these Mortgage-backed securities, which gives a lucrative opportunity to such banks to make money out of the fees that they receive.
Mortgage-backed securities are similar to bonds. The investors who own these get to share the amount received in the form of mortgage payments. When you buy agency-backed securities such as Ginnie Maes that are guaranteed by the FHA, your risks will be low. You can also go for securities issued by Freddie Mac and Fannie Mae.
When you buy an agency-backed security, you get a guarantee from the agency that you will get the promised interest and principal income, even if the home owner does not pay back his loan. Therefore these are considered as safe holdings. The yields that you get from these are better than what you get from the U.S. Treasury.
Non-agency securities issued by many private financial firms are usually high-risk and do not carry any guarantee. Many a times you may end up getting mortgages that are given to high-risk home owners who have no home equity and no income. The mortgage rates in such cases will be high, which is why they appeal to investors who seek higher yields.
With the market conditions and home prices improving, many non-agency securities are today viewed as safer investments. Mortgage lenders and Banks of today have stiff standards to follow when it comes to approving mortgages. They do not approve mortgages when it comes to people who have poor credit scores and those who do not have the income.
Non-agency backed securities can still be risky in the following circumstances:
- If for some reason the borrower suddenly loses his job and stops paying the mortgage
- If the home owner decides to go for refinancing
- When there is a fall in the mortgage rates
Yet most Mutual Funds and REITs prefer to own mortgages today instead of real estate.
If you are going for non-agency securities it is better to assess a few factors before jumping in
It is better and safer to go for MBS when the home prices are rising as the equity will be high. Home-owners who have no equity on their homes tend to default on their mortgage payments.
When the economic conditions are bad, it is better not to go for MBS. Most home owners may face unemployment during this time which can make them default on their payments.
When the mortgage rates are raising it is better not to venture into ARM (Adjustable Rate Mortgages) as the risk of default may be high. On the other hand there is always the risk of prepayment when the mortgage rates are falling.
All said and done, it is up to you whether you want to invest in mortgage backed securities or no. However, if you do decide on that, it is better to do a thorough research and look at the various factors before making an investment.
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