Mortgage securitization is connected with financial technology, where monetary institutions convert mortgages into resources for investors to purchase. The securitization process is designed to handle financial risks while adding liquidity to the housing market. Meanwhile, traders are worried about making competitive rates of return that maintain and construct purchasing power above the rate of inflation. Despite all these advantages, mortgage securitization was associated with housing bubbles and real estate speculation.
Identification
Securitized mortgages may be referred to as collateralized mortgage obligations (CMO), or mortgage-backed securities. Investors who purchase into CMOs receive interest and principal payments from a larger pool of interest rates. CMOs perform well when the housing market is strong and homeowners are able to make regular mortgage payments. Conversely, CMO investments can get rid of cash during downturn, where desperate homeowners are susceptible to foreclosure and short sales.
Features
CMOs are further divided into tranches, which prioritize the purchase price of interest and principal payments. Tranches effectively provide alternatives for investors to consider risks versus benefit. As an instance, the last tranche to receive payments includes the most risk. This tranche, nevertheless, should market for the lowest cost and offer more growth potential. Banks that securitize mortgages earn fees and commissions for servicing these goods. The government-sponsored businesses of Fannie Mae and Freddie Mac are traditionally the largest players in the marketplace for securitized mortgages.
Benefits
Securitized mortgages permit entry into the real estate market for smaller investors. Investors can invest $1,000 in a CMO mutual fund. From there, the investment stake can easily be sold for cash through a broker. Smaller investors will see this process to be more effective and cost-effective than making big down payments to secure mortgages of their own to purchase real property. Further, real property investments may call for several months, if not years, to market for cash. The securitization of residential mortgages increases the quantity of money available to give real estate funding. The extra money supply effectively reduces interest rates for potential home buyers.
Considerations
Prevailing interest rates affect the investment performance of securitized mortgages. Volatile interest rate fluctuations introduce monetary dangers to CMO investors. When interest rates decline, refinancing action accelerates as homeowners change their existing mortgages with newer loans that charge lower interest rates. Now, present CMO pools lose the ability to earn future interest payments connected with the elderly mortgages. Securitized mortgages can also get rid of money when interest rates shift higher. Investment funds then flows from existing mortgage investments and costs drop, as newer fixed-income assets offer higher rates of interest.
Warning
Lower interest rates associated with securitized mortgages can drive housing costs up to unrealistic levels. Housing bubbles happen when speculators use access to cheap mortgage financing to put competitive bids on real estate deals. Middle-income individuals are then closed out of the current market, and housing requirement eventually falls. A housing crash often ensues, where property values decline considerably and spark economic downturn.
