Define Mortgage Backed Securities

Mortgage Backed Securities

An individual borrows loan from a bank or other lender for purchase of property (house). The borrower mortgages the property title deeds as collateral with the banker for getting the loan and he has to pay monthly installment (EMI) for the repayment of the loan in the agreed period (5years, 10 years, 20 years etc., as the case may be).

These originated mortgages are sold off by the lender in a secondary market. Investment bankers or a federal agency known as the Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac) are the buyers of these mortgages. By grouping together numerous mortgages, the investment banker or FHLMC will issue securities known as mortgage backed securities. Mortgage backed securities are sold as bonds. Their coupon payments and par value are derived from the original mortgages from which they are created.

For example, Mr. X takes housing loan from a local bank for the amount ` 10, 00,000 by mortaring his house. His bank sells his mortgage in the navigate market to an investment banking firm that groups together mortgages in order to sell mortgage backed securities to buyers such as a pension fund. In return X’s bank receives the value of the mortgage, 10,00,000, which it can again lend out to a different borrower although he still make his monthly payment to the bank that originated mortgage, the interest and principal payment is passed-through to the buyer of the mortgage backed security. X’s bank will receive a small processing fee, the investment banker takes a cut by offering a coupon on the bonds that is slightly less than the interest payments on the mortgage, and the buyer gains a slightly higher return that a corresponding 10-year Treasury note. The risk of default is in actual fact zero because home mortgages are guar-anteed by the Federal Housing Administration (FHA), Mortgage backed securities are a class of derivatives since the owner of these bonds derives the return from the payments on mortgages, but does not actually own the mortgage itself.

Reverse Mortgage Loan

A reverse mortgage is a loan that enables senior home owners, aged 62 and above, to convert part of their home equity into tax-free* income-without having to sell their home, give up title to it, or make monthly mortgage payments. The loan only becomes due when the last borrower(s) permanently leaves the home.

Reverse Mortgage Loan is a scheme for senior citizens. It was introduced by National Housing Bank. The announcement of this scheme was made by Govt. in the Union Budget of 2007-08.