Mortgage Securitization Explained
Mortgage securitization is yet another term in the mortgage market that can confuse mortgage shoppers no end. While some financial experts refer to mortgage securitization as an excellent financial innovation, others allege that mortgage securitization was party responsible for the economic crisis that recently shook the world. Irrespective of its advantages or disadvantages, mortgage securitization is here to stay and is an aspect of the mortgage market that cannot be eliminated.
Mortgage Securitization Explained
Mortgage securitization is a process in which a number of similar mortgages are pooled together and used as collaterals to sell securities that receive interest from monthly mortgage payments made by borrowers. Mortgage lenders can use the funds so generated for re-investment. Mortgage securitization diversifies the risk faced by mortgage lenders by enabling them to liquefy their mortgage loan assets into securities that can be traded.
The Process
As previously mentioned, a number of mortgage loans with similar characteristics are pooled together and moved into a Special Purpose Vehicle (SPV), which issues securities using this mortgage loan pool as collateral. The income generated by this mortgage loan pool in the form of monthly mortgage payments is then used to pay principal and interest on the securities issued.
Usually, the SPV gives the right to service this mortgage pool either to a third party or to the original mortgage lender. These rights can be further transferred to another company, owing to which the borrower has to make monthly payments to a company that has not lent him/her the loan. The right to service mortgage loans is considered to be an asset in itself, which can be sold, securitized, and assigned just like mortgage loans.
Advantages
Mortgage lenders use the concept of securitization to sell mortgage loans they had originated and then use this money to originate more mortgage loans. For instance, if a mortgage lender provides a mortgage of £300,000 at 6 percent interest and retains it, the lender will earn 6 percent on the loan plus the origination fee. If, on the other hand, the mortgage lender sells this loan to a mortgage pool, it can originate another loan at 6 percent and earn more.
Mortgage securitization, therefore, enables mortgage lenders to originate the same mortgage loan over and over again without retaining it as an asset on the books.
Types of Securities
Loan companies can sell two varieties of securities backed by mortgage loan pools—pass through securities and collateralized mortgage obligations (CMO). The owners of pass through securities get a share of the income generated by the mortgage pool.
In case of CMOs, the entire mortgage loan pool is divided into sections with credit rating, rate of interest, and maturity date. While pass through securities are issued only by mortgage companies run by the government, CMOs are offered by private companies.
Mortgage securitization simply means that a home mortgage loan taken by a particular homeowner does not belong to any particular mortgage lender, but belongs to a number of investors, with the mortgage service company collecting monthly mortgage payments.