Which one is right for you depends entirely on your personal situation. In seven easy-to-understand steps we examine how to go about purchasing your first condominium. When you buy or build your dream home, you want to protect it. While a residential mortgage-backed security RMBS is secured by single-family or two- to four-family real estate, a commercial mortgage-backed security CMBS is secured by commercial and multi-family properties, such as apartment buildings, retail or office properties, hotels, schools, industrial properties, and other commercial sites.
Low-quality mortgage-backed securities backed by subprime mortgages in the United States caused a crisis that played a major role in the —12 global financial crisis.
Most bonds backed by mortgages are classified as an MBS. To distinguish the basic MBS bond from other mortgage-backed instruments, the qualifier pass-through is used, in the same way that "vanilla" designates an option with no special features. These types are not limited to Mortgage Backed Securities.
Bonds backed by mortgages but that are not MBSs can also have these subtypes. The secondary mortgage market is the market where a network of lenders sell, and investors buy, existing mortgages or MBS.
A large percentage of newly originated mortgages are sold by their originators into this large and liquid market where they are packaged into MBS and sold to public and private investors, including Fannie Mae, Freddie Mac, pension funds, insurance companies, mutual funds and hedge funds. Because of the long-term nature of mortgages, the secondary market is an essential factor in maintaining lender liquidity. In addition to providing liquidity and increasing overall efficiency, the secondary market can smooth out geographic credit disparities.
However, in some respects, particularly where subprime and other riskier mortgages are involved, the secondary mortgage market may exacerbate certain risks and volatility. TBAs —short for "to-be-announced" securities—involve a special type of trading of mortgage-backed securities. TBAs are the most liquid and important secondary mortgage market, with volume in the trillions of dollars annually. There are settlement days when the traders have to make good on their trades.
At that time, they choose fractions from various pools to make up their TBA. Only agency mortgage-backed securities trade in the TBA market.
Instead, the parties to the trade agree on only five general parameters of the securities to be delivered: TBAs are critical in determining the ultimate interest rates that mortgage borrowers pay, since mortgage originators can "lock in" rates and use TBAs to hedge their exposure. In Europe there exists a type of asset-backed bond called a covered bond , commonly known by the German term Pfandbriefe.
Covered bonds were first created in 19th-century Germany when Frankfurter Hypo began issuing mortgage covered bonds. The market has been regulated since the creation of a law governing the securities in Germany in The key difference between covered bonds and mortgage-backed or asset-backed securities is that banks that make loans and package them into covered bonds keep those loans on their books.
This means that when a company with mortgage assets on its books issues the covered bond, its balance sheet grows, which would not occur if it issued an MBS, although it may still guarantee the securities payments. There are many reasons for mortgage originators to finance their activities by issuing mortgage-backed securities. Reasons other than investment or speculation for entering the market include the desire to hedge against a drop in prepayment rates a critical business risk for any company specializing in refinancing.
Critics have suggested that the complexity inherent in securitization can limit investors' ability to monitor risks, and that competitive securitization markets with multiple securitizers may be particularly prone to sharp declines in underwriting standards. Private, competitive mortgage securitization is believed to have played an important role in the US subprime mortgage crisis. Off—balance sheet securitizations are believed to have played a large role in the high leverage ratio of US financial institutions before the financial crisis.
The weighted-average maturity WAM and weighted average coupon WAC are used for valuation of a pass-through MBS, and they form the basis for computing cash flows from that mortgage pass-through. The difference goes to servicing costs i. To illustrate these concepts, consider a mortgage pool with just three mortgage loans that have the following outstanding mortgage balances, mortgage rates, and months remaining to maturity:.
The weighted-average maturity WAM of a pass-through MBS is the average of the maturities of the mortgages in the pool, weighted by their balances at the issue of the MBS. Note that this is an average across mortgages, as distinct from concepts such as weighted-average life and duration , which are averages across payments of a single loan. The weightings are computed by dividing each outstanding loan amount by total amount outstanding in the mortgage pool i.
These amounts are the outstanding amounts at the issuance or initiation of the MBS. The WAM for the above example is computed as follows:. Another measure often used is the Weighted-average loan age. The weighted-average coupon WAC of a pass-through MBS is the average of the coupons of the mortgages in the pool, weighted by their original balances at the issuance of the MBS. For the above example this is:. Pricing a "vanilla" corporate bond is based on two sources of uncertainty: The number of homeowners in residential MBS securitizations who prepay increases when interest rates decrease.
One reason for this phenomenon is that homeowners can refinance at a lower fixed interest rate. Commercial MBS often mitigate this risk using call protection. Since these two sources of risk IR and prepayment are linked, solving mathematical models of MBS value is a difficult problem in finance. The level of difficulty rises with the complexity of the IR model and the sophistication of the prepayment IR dependence, to the point that no closed-form solution i.
In models of this type, numerical methods provide approximate theoretical prices. These are also required in most models that specify the credit risk as a stochastic function with an IR correlation. Practitioners typically use specialised Monte Carlo methods or modified Binomial Tree numerical solutions.
Theoretical pricing models must take into account the link between interest rates and loan prepayment speed. Mortgage prepayments are usually made because a home is sold or because the homeowner is refinancing to a new mortgage, presumably with a lower rate or shorter term.
Prepayment is classified as a risk for the MBS investor despite the fact that they receive the money, because it tends to occur when floating rates drop and the fixed income of the bond would be more valuable negative convexity.
In other words, the proceeds received would need to be reinvested at a lower interest rate. Professional investors generally use arbitrage-pricing models to value MBS. These models deploy interest rate scenarios consistent with the current yield curve as drivers of the econometric prepayment models that models homeowner behavior as a function of projected mortgage rates. Given the market price, the model produces an option-adjusted spread , a valuation metric that takes into account the risks inherent in these complex securities.
There are other drivers of the prepayment function or prepayment risk , independent of the interest rate , such as:.
The credit risk of mortgage-backed securities depends on the likelihood of the borrower paying the promised cash flows principal and interest on time. The credit rating of MBS is fairly high because:. If the MBS was not underwritten by the original real estate and the issuer's guarantee, the rating of the bonds would be much lower. Part of the reason is the expected adverse selection against borrowers with improving credit from MBSs pooled by initial credit quality who would have an incentive to refinance ultimately joining an MBS pool with a higher credit rating.
Because of the diversity in MBS types, there is wide variety of pricing sources. In general, the more uniform or liquid the MBS, the greater the transparency or availability of prices.
Some institutions have also developed their own proprietary software. Complex structured products tend to trade less frequently and involve more negotiation. This is due to the actual pools not being shown. These are forward prices for the next 3 delivery months since pools have not been cut; only the issuing agency, coupon, and dollar amount are revealed. When a mortgage refinances or the borrower prepays during the month, the prepayment measurement increases. If the purchase price was , the investor loses 5 cents for every dollar prepaid, which may significantly decrease the yield.
This is likely to happen as holders of higher-coupon MBSs have a good incentive to refinance. This is due to the fact that when the borrower pays back the mortgage, he does so at "par". So if the investor bought a bond at 95 cents on the dollar, as the borrower prepays he or she gets the full dollar back and his or her yield increases.
However, this is unlikely to happen, as borrowers with low-coupon mortgages have very little incentive to refinance. Our assessment of the rise in mortgage interest rates. In purely financial terms, therefore, a fixed-rate mortgage is very rarely worthwhile. Even so, fixed-rate mortgages can be justified — particularly in situations in which interest rates rise abruptly, as happened at the end of the s.
Home owners with an adjustable-rate mortgage — the most frequently chosen product at the time — had to pay massively higher interest rates of almost 8 percent within a very short space of time.
Not all property owners are willing to accept such a rapid, sharp rise in interest rates. From that point of view, fixed-rate mortgages can be regarded as an insurance product. They offer protection, but at a premium. Replacing a LIBOR mortgage with a fixed-rate mortgage can make sense, particularly in the current situation with its historically low premium for a ten-year fixed-rate mortgage.
But home owners should not delay switching, because interest rates on fixed-rate mortgages are likely to rise further. The choice of mortgage is not just down to financial aspects — personal requirements and preferences are equally important. A rapid rise in adjustable mortgage interest rates can prove stressful. Individual expectations for the development of interest rates are also key to personal strategy.
It often makes sense to combine different mortgages and terms to achieve an optimum mix between flexibility and security. A consultation with a Financing Expert can help clarify your personal needs and mortgage requirements. Continue to the site you have selected. Main navigation Credit Suisse Home. Client Login Private Clients. Interest rates for fixed mortgages are rising The Swiss economy is running smoothly again, with Credit Suisse economists expecting it to grow by 2.
LIBOR mortgages usually more affordable than fixed-rate mortgages Although interest rates for fixed-rate mortgages have started to rise, they remain low by historical standards. Switching from a LIBOR to a fixed-rate mortgage In purely financial terms, therefore, a fixed-rate mortgage is very rarely worthwhile. Personal requirements are crucial in the choice of product The choice of mortgage is not just down to financial aspects — personal requirements and preferences are equally important.
LIBOR or fixed-rate mortgage? Schedule an appointment This link target opens in a new window Download real estate monitor This link target opens in a new window Are you unsure which is the right mortgage solution for you?
We would be happy to help. Mortgages , 1 x 1 of Home Ownership. The demand for residential property is high in the city of Bern and the surrounding area, says Nadja Müller, Head of Credit Suisse's mortgage center for southeastern Bern.