Why Understanding Mortgage-Backed Securities Is Important
I’m Aaron Chapman, a mortgage banker who focuses on conventional lending for real estate investors. Since my entrance into the industry in 1997, I’ve heard a singular question over and over: “What is your rate?”
Many investors will spend enormous amounts of time shopping rates, trying to determine if they’re going up or down. The vast majority of rate shoppers are doing it so intermittently that they have no idea what drives rates. They’re of the impression that it’s the Fed, the 10-year treasury, or the mortgage bank they’re calling.
I’m writing my first post for the Best Ever blog to shed some light on what drives mortgage rates on a minute-by-minute basis. In my future posts, I’ll explain the previous week’s economic data and the effect it has had.
Mortgage-Backed Securities: An Overview
Mortgage-backed securities (MBS) are a type of investment that is made up of a pool of mortgages that may have been packaged together by a financial institution and sold to investors. The cash flows from the underlying mortgages are then used to pay investors in the form of interest and principal payments. MBS can be used by government agencies such as Fannie Mae, Freddie Mac, or by private financial institutions. They are often categorized based on the quality of the underlying mortgages, such as prime or subprime, and can provide investors with a steady stream of income over a specific period of time.
The Risks of Investing in MBS
MBS can be risky, however, since they're subject to default and prepayment risks. MBS are bonds that are backed by pools of mortgage loans. Investors buy these bonds with the expectation of receiving regular interest payments and the return of their principal when their mortgages are paid off. However, the performance of MBS is tied to the performance of the underlying mortgage loans, which can be affected by various economic factors.
Interest Rates and the Economy: How They Affect MBS
One factor that can affect MBS is interest rates and their effect on the economy. Mortgage rates typically increase when interest rates rise, making the cost of living more expensive for borrowers and affecting their ability to take out mortgages. As a result, the demand for new mortgages decreases, which can lead to a decrease and the value of MBS. Conversely, when interest rates decrease, the demand for mortgages may increase, and the value of MBS can go up.
Economic News and MBS: Positive and Negative Trends
Economic news releases can also impact the performance of MBS. For instance, if economic data such as jobs reports, inflation rates, or gross domestic products show data-positive trends, that may indicate a strong economy and increased consumer confidence. This can lead to a rise in interest rates, and subsequently, a decrease in demand for MBS.
On the other hand, if the economic data show negative trends or reports, the interest rates may decrease, and consequently, increase the demand for MBS. For instance, if the economy is struggling and job growth is slow, investors may move their money to safer assets such as bonds like MBS.
Additionally, the economic news may impact the credit quality of the borrowers, which can affect the performance of the mortgages backing the MBS. For example, if there is a sudden increase in the unemployment rate, some borrowers may find themselves unable to make mortgage payments, leading to a possible increase in foreclosure rates and decreasing the demand for MBS.
Keeping an Eye on Economic Developments
Economic news can impact the performance of MBS by affecting demand for new mortgages and overall interest rates. It's essential for investors to keep an eye on economic developments and assess how they must affect the underlying mortgage-backed securities.
My team and I look at the economic data that is set to come out each week and monitor the movement of the MBS itself to see if rates may be going up or going down. Given the recent history, as well as leading data coming into economic news releases, we do our best to inform investors of what could occur in an effort to give them the best possible data for making a decision to lock or continue floating.
About the Author:
Aaron Chapman is a veteran in the finance industry with expertise in complex transactions since 1997. He is ranked in the top 1% of over 300,000 licensed loan originators and closes over 100 transactions per month. Learn more at aaronbchapman.com.