Key Takeaways
- MBS provide lenders funds to offer more mortgages to buyers.
- High demand for MBS can lower mortgage interest rates.
- MBS are sold to investors, creating liquidity in the market.
- Low MBS demand may result in higher mortgage rates.
Article Summary
Mortgage-backed securities (MBS) are investment products based on groups of mortgage loans, which play a significant role in determining mortgage rates.
Mortgage-Backed Securities: Explained in Plain English
Mortgage-backed securities (MBS) are investment products created by bundling mortgages from homeowners and then selling shares of the bundle to investors worldwide. Also known as mortgage-backed bonds, mortgage-backed securities directly influence current mortgage rates through their relationship with the supply and demand of mortgage funds.
When lenders make mortgages for home buyers and refinancing homeowners, they often sell them to government-backed agencies like Fannie Mae and Freddie Mac, who pay cash to the lenders for the loans. When lenders get paid, it re-supplies their reserves, which allows them to make more mortgages to first-time home buyers and others.
Meanwhile, Fannie Mae, Freddie Mac, and other buyers of mortgages group the loans they buy into bonds that are backed by the mortgages and sold to institutional investors, including pension funds, large companies, and parts of governments.
MBS investors are buying bonds. A given bond's interest rate is the average of the mortgage rates inside them. In this way, mortgage-backed securities affect U.S. mortgage rates.
Interest rates may increase when demand for mortgage-backed bonds is low, or investors might stop investing in mortgage-backed bonds. Conversely, interest rates can drop when demand for mortgage-backed bonds is high.
This is part of how the Federal Reserve and mortgage rates are linked, if only indirectly.
Mortgage-Backed Securities: A Real World Example
Imagine a scenario where inflation pressures are falling, spurring high demand for mortgage bonds from worldwide investors, including pension funds and insurance companies. As demand for mortgage bonds rises, the price of mortgage-backed bonds rises because demand is growing faster than supply.
Bond prices and bond yields move in opposite directions, so as prices rise, mortgage rates fall, which makes homeownership more affordable for first-time home buyers and others.
Frequently Asked Questions About Mortgage-Backed Securities
Get answers to frequently asked questions about mortgage-backed securities, including how they affect rates, their role in the housing market, and their economic impact.
