How Does Mortgage Bond Trading Affect Rates?

What Is Mortgage Bond Trading?

While most individuals don't get the opportunity to participate in the mortgage bond trading market, prospective homeowners should understand what it is. Home mortgages made by larger lenders "pool" (put together) multiple loans to create mortgage-backed securities and bonds. They then offer these securities and bonds for sale in the open investment market. The earnings rate is determined by the interest rates of the mortgages making up the security or bond. Investors buy these bonds and pay cash that mortgage lenders use to make more mortgages to you and your neighbors.

Mortgage Bonds Are a Major Part of the Global Investment Market

Mortgage bonds are a major investment option in the global market. They are usually particularly attractive to large investors, like pension funds, insurance companies and other entities that concentrate on secure investments with reasonable earnings. Mortgage backed securities and bonds typically "compete" with company and municipal bonds for investment dollars. Pension funds and insurance companies are often large buyers because their investment needs are more directed to safety, security, and steady rate of return. The volatility of common stocks and more "exotic" investments are often simply too risky and undependable for these investors.

How Mortgage Bond Trading Affects Consumer Interest Rates

Most home mortgages in the U.S. are approved, documented and closed with the purpose of "pooling" and "packaging" them for sale into the secondary market. Instead of trading these loans directly for cash, many larger lenders take groups of mortgages and issue bonds for sale into the investment community. Lenders project what interest rates they must offer to investors in the future and typically price new mortgage loans accordingly. As the price of mortgage bonds decreases, so shall the current mortgage rates. Should the price of mortgage bonds increase, borrowers will see current mortgage rates increase, also. Lenders must "hedge" (reduce the risk) of losing money on the sale of mortgage bonds by raising the interest rate on new loans.

How Mortgage Bond Trading Affects Consumers in a Down Economy

During a down economy or recession, mortgage bond trading typically affects consumers negatively. The good news: Mortgage bond trading affects interest rates similarly--for better or worse--as it does in a growing, strong economy. Unfortunately, there are more serious consequences. The typical massive job losses and layoffs combined with the depressed fair market values (FMVs) of homes often causes the mortgage bond market to grind to a halt. The safety and security factor desired by mortgage bond investors disappears as foreclosures rise. This means there is less mortgage money available to home buyers and home owners.

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