A mortgage bond is a bond just like any other. There is a fixed rate of return that the investor knows about prior to making a purchase. Compare a bond to an individual stock or mutual fund and you’ll soon discover a wide disparity between yields, or profit. Stocks can provide a greater return on an investment compared to an individual bond, but the stock still carries with it some degree of risk. Investors can purchase stocks knowing their investment can provide profits in the future as well as understanding the investment could falter, even to the point of becoming worthless should the company go into bankruptcy or conservatorship. The attraction with a bond isn’t the rate of return but the safety of the asset.
A mortgage bond is one where the bond is collateralized by real estate. When someone buys and finances a home with a mortgage, it’s relatively rare the creditor keeps the loan on its books and collects the interest each month. Instead, the mortgage bond is ultimately sold in the secondary markets, primarily to mortgage giants Fannie Mae and Freddie Mac. Individual bonds are packaged together to create a security, referred to as a mortgage backed security, or MBS. It is these mortgage backed securities that are traded amongst investors.
Just like any other bond, the price of a mortgage bond can go up or down depending upon investor sentiment. Historically, bonds are a safe haven for investors. Even though the yield is relatively low, it’s a yield, nonetheless. In volatile or otherwise uncertain times, investors can opt to pull out of stocks into the safety of bonds. When investors feel the economy is a bit on shaky ground, money is transferred to bonds. When there is a greater demand for this safety in the form of bonds, the price goes up as more investors are seeking the same degree of security. When the price of a bond goes up due to this demand, the yield inversely falls. This is one of the primary reasons we’ve seen such low rates over the past couple of months due to this uncertainty.
The demand for mortgage bonds will translate into lower mortgage rates for consumers. When lenders set their interest rates for the day each morning, they refer to the proper index. If a lender primarily sells loans to Fannie Mae, they’ll refer to the price of the prevailing Uniform Mortgage Backed Security, or UMBS. This security moves up and down based upon current markets and demand. As the demand for safety increases this drives up demand for the UMBS which results in lower rates. Conversely, if investors feel the economy is soon to be on an upswing, bonds will be sold off and funds transferred to stocks.
It’s important to note that even though lenders follow the same suite of indices, many times interest rates among lenders can be slightly different. One lender can set a rate for a 30 year fixed conforming loan while another can set a different rate using the very same index. The reasons can vary based upon lenders competing for your business to managing flow. That’s why as a mortgage broker I’m able to compare rates from different lenders to help identify the ideal loan program, rate and fees ideal to your situation.
One final note about mortgage bonds, because they’re traded all day in the secondary markets, it’s possible a rally in bonds mid-day can trigger a price adjustment. Let’s say a lender sets a rate in the morning at 3.00%. An unfavorable economic report is released during the day which causes investors to pull money out of stocks and mutual funds and into mortgage bonds. Due to the sudden demand of bonds, the price will go up and yields fall. The fall could be to the degree lenders will issue a “reprice” which would lower available mortgage rates. Lenders refer to this as a “intra-day” rate adjustment. This doesn’t happen very often because investors don’t like to be surprised. Lately however, economic projections have missed the mark, attributing to adjustments during the course of a business day.