There are two types of mortgage-backed securities: non-agency and agency.
Investing your money is one of the smartest moves you can make. Real estate continues to be one of the most lucrative investment options available. If you want to make your money work for you, it’s essential to know about mortgage-backed securities. For example, what is a non-agency loan?
Mortgage-Backed Securities: Agency vs. Non-Agency
It’s important for prospective investors to understand the various types of investments they can make. It’s vital to increase your financial literacy in order to make the best economic choice using your hard-earned money. If you want to invest, you should know more about mortgage-backed securities and collateralized mortgage obligations.
A mortgage-backed security (MBS) is a debt obligation representing claims to cash flows generated from mortgage pools. Financial institutions purchase multiple mortgage loans, and then private or governmental entities group them to form mortgage pools. A mortgage pool is a group of mortgage loans held as collateral for a mortgage-backed security.
Securitization is a financial process that creates a new financial instrument from groupings of debt, such as mortgage loans. For example, securitization is when a private entity issues securities that represent claims on the principal and interest payments made by mortgage loan borrowers. Suppose you invest your money in mortgage-backed securities. In that case, you are lending money to homeowners and receiving a return when they make mortgage payments.
Private entities create non-agency mortgage-backed securities. A few examples of private institutions include banks, brokerage firms, and home builders. Non-agency mortgage loans are also known as private-label mortgage-backed securities. The non-agency MBS market offers mortgage financing to individuals who have trouble meeting agency MBS standards.
Governmental or quasi-governmental entities create agency mortgage-backed securities.
These are the three agencies that create and provide agency mortgage-backed securities:
- The Government National Mortgage Association (Ginnie Mae)
- The Federal National Mortgage Association (Fannie Mae)
- The Federal Home Loan Mortgage Corporation (Freddie Mac)
Ginnie Mae is the only agency MBS that is backed by the full faith and credit of the U.S. government. If you invest in Ginnie Mae bonds, you are guaranteed to receive timely payments because these bonds are free from default risk. Suppose you are interested in investing in the housing market. In that case, it’s easy to think agency MBS loans are an example of no-risk investments. However, keep in mind that zero-risk investments are not possible.
On the other hand, Fannie Mae and Freddie Mac bonds only provide certain guarantees since they are not backed by the full faith and credit of the U.S. government. However, Fannie Mae and Freddie Mac have special authority to borrow funds from the United States Treasury.
What Are Collateralized Mortgage Obligations?
Collateralized mortgage obligations (CMOs) are complicated mortgage-backed securities. CMOs have different investment goals and risk tolerances to better appeal to investors.
When you invest in a CMO, the principal and interest payments made through mortgage pools get distributed to tranches according to the priority of payments. Tranches are different classes of securities that each have different balances, prepayment risks, coupon rates, and maturity dates. CMOs are risky because homeowners often refinance when interest rates fall. Refinancing means investors get returns at a time when reinvesting those funds is not ideal.
Should I Invest in Mortgage-Backed Securities?
Investing is an excellent way for consumers to grow their money. Investing your money is an effective way to make your hard-earned money work for you. Of course, there is always risk involved when it comes to investing your money. The good news is that some options offer more financial security than others.
Investors should know about three major asset classes: bonds, stocks, and cash equivalents. Although direct investment in non-agency MBS is limited to institutional investors, many everyday people consider investing in the MBS market a safe investment option. According to financial experts, mortgage-backed securities are a fixed-income asset class that delivers various benefits to investors. Mortgage-backed securities are liquid assets with historically attractive yields similar to U.S. Treasury bonds.
Mortgage-backed securities have not always been a safe investment option. Non-agency securities are typically composed of Alt-A and subprime loans, which contributed to the 2008 market crash. But since the mortgage crisis, stricter lending standards have made the MBS market safer. That said, residential mortgage-backed securities and collateralized mortgage obligations remain risky investment options for first-time investors. Why? Because non-agency loans lack government backing. Without guarantees, there is a higher risk of default on bonds.
Additional Investment Options
Investing in mortgage-backed securities requires some economic knowledge due to the complex market. There are plenty of alternative investment opportunities to consider. The most common investment types are general investment accounts like stocks and bonds.1 Continue reading to learn more about different investment options:
High Yield Savings Accounts
There are a lot of pros with savings accounts. If you do not yet have one, consider getting a high-yield savings account. High-yield accounts are similar to traditional savings accounts, except investors can earn a higher return on investment. The Federal Deposit Insurance Corporation (FDIC) insures high-yield savings accounts to protect investors against bank failure or theft on a federal level. Any amount up to $250,000 is FDIC-insured. In addition, this type of savings account is also safe against market fluctuations.
If you don’t have a lot of money to invest, know that most financial institutions do not have minimum balance requirements. Consumers can also legally withdraw their cash from high-yield savings accounts up to six times a month without penalty fees.
Certificates of Deposit
A certificate of deposit (CD) is a savings account option for investors who can spare money. Certificates of deposit are FDIC-insured, just like high-yield savings accounts. However, borrowers cannot withdraw their money for a specified period. Suppose you need access to your invested funds before the maturity date. In that case, you must pay a penalty fine to the financial institution. Terms for certificates of deposit typically range from three months to five years. The longer you leave your money alone, the more you can earn.
If you are considering this investment option, know that financial institutions that offer CDs enforce minimum balance requirements. The minimum amount required can range from a few hundred dollars to a few thousand.
U.S. Treasury Bonds
Many financial experts advise first-time investors to consider U.S. Treasury bonds. U.S. Treasury bonds are one of the safest investment opportunities because the government has not yet defaulted on its debt. While U.S. Treasury bonds have lower yields than other investment options, investors receive greater inflation protection. You can purchase a government bond directly from the U.S. Treasury or use an online brokerage platform. However, you may have to pay additional fees if you buy government bonds from a secondary market.
Series I Savings Bonds
Series I Savings bonds are government bonds that offer decent interest rates for investors and are safe from inflation. And unlike Treasury Inflation-Protected Securities (TIPS), the yield of I Bonds cannot dip below zero! This type of government bond can earn interest for up to thirty years. However, you must hold I Bonds for at least five years or forfeit three months of interest payments.
Investing your money in gold is a relatively low-risk choice because your investment is safe from inflation. Although, the price of gold can fluctuate similarly to stocks. But according to research, gold is a monetary asset that tends to hold its value. Investing in gold can also help you diversify your financial portfolio.
Should I Use Loans To Get Investment Money?
If you want to invest but currently lack the money to do so, you may consider using a loan to obtain fast cash. However, this may not be a financially wise decision. Taking on additional debt, such as personal loan options or payday loans, with the hope of growing your money can easily backfire and leave you struggling to escape a debt spiral.
In addition, many lenders strictly prohibit borrowers from using loan money for investment opportunities because there is a risk of unsupportable debt. So, unfortunately, you cannot use quick cash loans to buy mortgage-backed securities.
The Bottom Line With CreditNinja
Investing can be a smart financial move as long as you can afford to lose the amount you invest. Letting your money grow for you can help you obtain wealth over time. While there are safer investment options, such as high-yield savings accounts, no investment is truly free of risk.
If you want to buy mortgage-backed securities, knowing how they work is essential. There are two types of mortgage-backed securities: agency and non-agency. The safest option of the two is to invest in agency MBS because the government or quasi-government agencies create these loans. The risk of default is low with agency MBS. In addition, it would be best to have a clear financial goal before purchasing loans. Once you feel confident in your investment decision, you can buy mortgage-backed securities from brokerage firms.
To learn more about different types of loans and answer questions like “What is a bond loan?” check out the rest of the CreditNinja Dojo!