So what IS a Mortgage-Backed Security? (MBS)

So yesterday you found out that your bank may not actually own your mortgage anymore (even though they still "operate the storefront"). And you know that this amazing feat was accomplished through the securitization of your mortgage into what is known as a Mortgage-Backed Security or MBS for short.

housepicture.jpgBut let’s look at it from the investor’s side today! You can buy and sell these MBS’s all day long – but before you do that, it might help to learn a little bit more about their risk-return characteristics… :)

To cut right to the chase, MBS’s trade just like bonds. They have a price, coupon payment, yield and maturity date. But there is a LITTLE bit more to know – because they are actually very attractive investments for more conservative investors.  You see, most MBS’s are technically NHA MBS’s. (Yeah, I know the financial industry has a love for acronyms – or as I like to say "TFIHALFA" which stands for "The financial industry has a love for acronyms").

NHA stands for National Housing Act. The National Housing Act guarantees the insurance (which is provided by CMHC – the Canadian Mortgage and Housing Corporation) on the default of the payments on certain mortgages. Let me take a step back… For everyone reading who has a mortgage and understands that if they put down less than 25% of a down payment: you know that you had to purchase CMHC insurance, right? The insurance is strange because YOU pay the premium and the beneficiary is the BANK because if you default, they make a claim to NHA who then reimburses them against losses.

In any case, an NHA MBS is a Mortgage Backed Security that is NHA insured – and these are the bulk of MBS’s on the marketplace. This is effectively the same thing as having the Government of Canada guarantee the investment. So in that vein, many people treat NHA MBS’s on the same risk level as a Canada Savings Bond – but you’ll note that they generally have higher yields.

The moral of the story? If you like GIC’s you may want to look at NHA MBS’s since they offer the same guarantees and higher liquidity and yield than GIC’s on average. However, as The Canadian Capitalist points out: "However, the main problem with MBS is that distributions are in the form of interest and principal repayments. Since most mortgages come with pre-payment privileges, when interest rates are falling, homeowners are likely to repay principal faster and slower in a rising interest rate environment. Investors, on the other hand, end up with the losing side of the bargain in both a falling and rising rate environment." Click here to read the rest of his comment.

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Preet Banerjee
Preet Banerjee
...is an independent consultant to the financial services industry and a personal finance commentator. You can learn more about Preet at his personal website and you can click here to follow him on Twitter.
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