What Are Mortgage Bonds And How Do They Work?

It may surprise you to learn that the home buying process isn’t over after you close on a mortgage. There might be nothing left for you to do, but in all likelihood, your lender will immediately sell your mortgage and add it to a pool of other mortgages.

This is what’s known as a mortgage bond, and it’s a type of mortgage-backed security (MBS). Mortgage bonds protect lenders and make it possible to invest in real estate at an affordable price point.

Mortgage Bond Definition

A mortgage bond is an investment backed by a pool of mortgages that a lender trades to another party. A mortgage bond is different from a mortgage loan, which is an agreement between a lender and a borrower that allows a borrower to own a property they could not purchase outright.

Lenders sell a mortgage bond to real estate investors, who receive periodic interest payments on mortgage loans until they’re paid off. An investor has a claim on the assets put up as collateral, which would be the houses, and can repossess them in the event of mortgage default.

Since a group of assets secures mortgage-backed bonds, this offers some protection to the bondholder. If a borrower defaults on their mortgage, the bondholder can sell the home and use proceeds from a foreclosure sale to ensure investors get paid.

Mortgage Bonds Remain A Major Part Of The US Economy

Those newer to the world of investing might question whether mortgage bonds remain an option. In fact, mortgage bonds are currently purchased and sold extensively in financial markets. Mortgage bonds provide a stable income stream and can be a great addition to an investment portfolio.

How Do Mortgage Bonds Work?

Before diving into the different types of mortgage bonds and their benefits, it’s important to understand how they work.

After a lender issues a mortgage loan to a borrower, the lender combines the mortgage with other mortgages and sells the bundle of mortgages to federal government agencies, government-sponsored enterprises (GSEs) or investment banks. The GSE or bank purchases the bundle and groups them with more mortgage loans into a “mortgage pool.” Then they sell them to investors as mortgage bonds.

Investors can earn a profit on mortgage bonds in two ways:

• Appreciation: As with any investment security, a mortgage bond’s value can fluctuate. You’ll earn additional revenue if you sell your mortgage bond once its value has appreciated.
• Regular interest payments: When a borrower makes monthly mortgage payments, the issuer pays out a chunk of the interest to shareholders.

Mortgage bonds are low-risk investments. They usually have a lower return rate than riskier investment options.

What Is The Relationship Between Bonds And Mortgage Rates?

Mortgages and the bond market have an inverse relationship with each other. If bonds are expensive, that means mortgage rates will be low. When bonds are inexpensive, mortgage rates will be high.

Are Mortgage Bonds A Safe Investment?   

Investors generally consider mortgage bonds a relatively safe investment because of the security that comes with real property. A bondholder can sell a foreclosed property to recoup losses.

Government-sponsored enterprises like Fannie Mae and Freddie Mac also help make mortgage bonds safer to invest in. By backing these investments, they make them lower risk.