Mortgage Backed Securities
Description
This article is from the Investing Articles: Bonds series.
Mortgage Backed Securities
Mortgage-backed bonds are among the best known agency bonds. They're backed by pools of mortgages and issued by different organizations
These are debt obligations backed by a pool of mortgages. They usually have a pass through feature. Ginnie Mae's are the most popular type of this security. Investors have an 'undivided' interest in the pool. The investor doesn't own any particular mortgage. Rather, he has a proportionate interest in the cash flow generated by the entire pool. When we talk about a pass through feature, we mean that multi-payments of interest, principal, and sometimes pre-payment of mortgages, are passed through to the investor. Ginnie Mae's (Government National Mortgage Association) are comprised of VA guaranteed loans or FHA insured mortgages and are backed by the full faith and credit of the U.S. Government. Payments are received monthly by the investor.
Freddie Mac's (Federal Home Mortgage Corporation) are another type of pass through. Freddie Mac's are 'Participation Certificates or PC's. These are comprised of FHOMC conventional mortgages on single family homes. Freddie Mac's are not guaranteed by the full faith and credit of the U.S. Government. Therefore, the yield of Freddie Mac's is a little better than Ginnie Mae's.
Fannie Mae's (FNMA) are similar to Freddie Mac's in that they are both participation certificates. Fannie Mae's consist of some conventional mortgages and FHA insured mortgages. Fannie Mae's are not guaranteed by the full faith and credit of the U.S. Government. However, it is unlikely that the government would permit them to default. The yields on Fannie Mae's are slightly better than Ginnie Mae's.
Collateralized Mortgage Obligations (CMO) are bonds that are collateralized by mortgages or mortgage backed securities. Unlike a traditional pass through, like we discussed above, a CMO has a stated maturity. There are short term, intermediate term, and long term, CMO's. Most of the mortgages are traditional mortgages which are not VA or FHA mortgages. As the principal on the mortgages is being paid off, it is used exclusively for the newest maturity in sequence until each maturity has been paid off.
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