What are mortgage-backed securities?
Mortgage-backed securities, also known as mortgage-backed bonds, are collateralized by mortgages, which are often residential mortgages. They’re created by pooling mortgages purchased from the original lenders. Investors receive monthly interest and principal payments from the underlying mortgages. Since the principal amount is generally paid down monthly, mortgage-backed securities differ from traditional bonds in that there isn’t necessarily a predetermined amount that gets redeemed at a scheduled maturity date.
Why would Schwab recommend mortgage-backed securities?
Investors who are looking for monthly income might want to explore the benefits of mortgage-backed securities, as they pay both interest and a portion of principal on a monthly basis. This return of principal can then be spent or reinvested in the current interest rate environment.
What does Schwab charge to trade mortgage-backed securities?
These are specialty products. Please call us at 800-626-4600 for complete pricing information.
What are the different types of mortgage-backed securities?
Schwab offers three types of mortgage-backed securities, each of which are guaranteed by three government-sponsored enterprises (GSEs): Ginnie Mae, Fannie Mae, and Freddie Mac. The three different types are:
Government National Mortgage Association (GNMA)
Bonds guaranteed by Ginnie Mae are backed by the full faith and credit of the U.S. government. Unlike the other GSEs referenced below, GNMA does not purchase, package, or sell mortgages, but does guarantee their principal and interest payments.
Federal National Mortgage Association (FNMA)
Fannie Mae purchases mortgages from lenders, then packages them into bonds and resells them to investors. These bonds are guaranteed solely by Fannie Mae, are not direct obligations of the U.S. government, and do carry credit risk.
Federal Home Loan Mortgage Corporation (FHLMC)
Freddie Mac purchases mortgages from lenders, then packages them into bonds and resells them to investors. These bonds are guaranteed solely by Freddie Mac, are not direct obligations of the U.S. government, and do carry credit risk.
Take a closer look at the benefits.
Monthly cash flow
Investors receive a monthly payment, but the amount received each month consists of both interest and principal and may vary from month to month. The amount of interest paid each month is dependent on the amount of principal left in the underlying mortgage pool.
Historically, mortgage-backed securities have provided yields that are higher than those for Treasuries of comparable maturities. This is mainly due to the uncertain nature of their cash flows and lower liquidity than Treasuries. Mortgage-backed securities issued by Fannie Mae and Freddie Mac are not explicitly guaranteed by the U.S. government and therefore carry more credit risk.
Mortgage-backed securities may be collateralized by mortgages from different parts of the country, so weakness experienced in the housing industry in one part of the U.S. may potentially be offset within the pool of mortgages.
High credit quality
Most mortgage-backed securities are considered to have high credit quality. Ginnie Mae mortgage-backed securities are backed by the full faith and credit of the U.S. government and carry the same implied rating as U.S. Treasuries. Senior debt mortgage-backed securities issued by Fannie Mae or Freddie Mac are also highly rated, though they have no federal guarantee. In addition, agency mortgage-backed securities generally have higher credit quality when compared with other individual bond types, such as corporate bonds, because they are collateralized by an underlying pool of mortgages.
Review the risks.
Mortgage-backed securities are subject to many of the same risks as those of most fixed income securities, such as interest rate, credit, liquidity, reinvestment, inflation (or purchasing power), default, and market and event risk. In addition, investors face two unique risks—prepayment risk and extension risk.
When mortgage rates fall, homeowners typically refinance more frequently and mortgage-backed securities tend to repay principal more quickly than originally anticipated. This can result in a shorter average life and a lower-than-expected return since investors receive the higher fixed coupon for a shorter period of time.
When mortgage rates rise, homeowners typically refinance less frequently and mortgage-backed securities tend to repay principal more slowly than originally anticipated. This can result in a longer average life and a lower-than-expected return since investors receive the lower fixed coupon for a longer period of time.
Find mortgage-backed securities.
Schwab offers a variety of mortgage-backed securities. Please call 800-626-4600 to find the choice that’s right for your portfolio.
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1. As of January 2016.
Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications, and other factors.
This information is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner, or investment manager.