Explain Bond Money for Mortgages
Mortgages and bonds are closely related in the financial arena. Most consumers don't necessarily think of bonds when it comes to obtaining a mortgage to buy or refinance a home, but many financial institutions use bonds to obtain the money that it lends to the borrower in the first place.
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Significance
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A bond works similar to an IOU, so when an individual or an organization buys a bond, the issuer of the bond is saying that it promises to pay the buyer back the amount he purchased the bond for, plus interest.
Mortgage
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Most buyers don't usually have enough money on hand to simply pay cash for a house, so they'll typically go to a bank or mortgage lender to obtain the money to buy the home. To obtain financing from the bank or lender, the borrower signs a promissory note, which is a promise to repay the loan back to the bank or lender. Since mortgages tend to be long-term debts (e.g., 15 or 30 years), the lender receives its money back in monthly installments.
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Mortgage Bond Issuance
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To obtain the money that banks and lenders need to offer mortgages, some lenders borrow the money from a bank or financial institution that's bigger than its own organization. In return, the original mortgage lender or bank offers a bundle of mortgages as a package offering to the institution it's borrowing the money from. In return for this group of mortgages the bank offers the larger financial institution, the financial institution offers a mortgage bond. The mortgage bond is the larger financial institution's agreement to buy the bundle of mortgages and receive the monthly payment from the borrowers on the mortgages in the bundle.
Benefits
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Mortgage bonds are beneficial to both parties in a mortgage transaction---the bank borrowing the money and the financial institution lending the money. The bank borrowing money benefits because it obtains the money it needs to lend to its customers; the bank lending the money earns money from the principal and interest payments it receives from the mortgage borrowers.
Disadvantage
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The primary disadvantage of the mortgage bond process occurs when a borrower defaults on his mortgage. When such a default occurs, the loss of the mortgage goes back to the financial institution that issued the bond. This can translate to a financial loss, because even if the mortgage bond issuer sells the home to reclaim its money, the sale of the property may net less money than the amount that's due.
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References
- Photo Credit bond of the state loan, russia, 1951 year image by air from Fotolia.com
