Frequently Asked Questions about the Mortgage Market

What makes interest rates move?  Mortgage interest rates are based on the yields of mortgage-backed securities (MBSs), or mortgage bonds. These bonds are bought and sold daily by corporate, government, and individual investors. Bond yields, just like stock prices, fluctuate often. Though there is no direct correlation between MBSs and government bonds, the 10-year US Treasury bond’s movement has historically mimicked that of 30 year fixed mortgage rates.

What factors affect the bond market?  Such a multitude of variables affect bond prices that graduate theses are written on the topic. We can only offer a cursory explanation here. The bond market is affected by inflation, international economic conditions, movement in other investment markets, and economic announcements from the government (jobs report, housing report, GDP, consumer price index, etc.), to name just a few factors. In addition, news about a particular bond issuer’s credit rating or general business activities will affect that bond’s price.

What is a mortgage-backed security?  It is a financial instrument backed by a group of mortgages; therefore, the investment return is funded by homeowners' mortgage payments. If you own a mortgage bond, you have a small ownership interest in a pool of mortgages, of which your own home loan may even be a part.

Who issues mortgage-backed securities?  The Government-Sponsored Enterprises (GSAs), including the ones under Federal conservatorship currently, issue various types of MBSs. The GSAs include Fannie Mae, Freddie Mac, Ginnie Mae and Farmer Mac. Private entities also issue MBSs, including major national banks and real estate investment trusts (REITs).

How is a mortgage-backed security generated?  A lender originates a home loan and sells it to an entity that will assign the mortgage to a special purpose vehicle (SPV), often an independent subsidiary of a larger, more complex entity - Fannie Mae, for example. The SPV bundles, or securitizes, that loan with other debt of similar characteristics (risk) into pools in which individuals and companies can invest.

Why are mortgages securitized in the first place? Why can’t a lender simply lend its own funds and hold the Notes?  If a lender had a fixed amount of assets and loaned it all out, that lender would have to not only wait a few decades to realize the return on its investment, all the while paying to administer the accounts (sending out statements, IRS reporting, processing payments, etc.), but would also run out of funds quickly, prohibiting the lender from making more loans until outstanding loans had been repaid. This would result in a tight credit market. For the home buyer, that means higher down payment requirements, higher asset reserve requirements, higher credit score requirements, shorter mortgage terms, and higher interest rates on loans. For the whole economy, that means less homeownership. When investors purchase MBSs, they are effectively replacing lender capital so lenders can continually make mortgages widely available and affordable to home buyers and home owners. This system is pivotal to sustaining our economy.

For more information, please contact a Midwest Mortgage Capital Mortgage Consultant today!