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Residential Mortgage Backed Securities: Have They Reached The Bottom Yet?
Residential mortgage backed securities have seen a big fall during the financial crisis and the economic meltdown that is still occurring. But what exactly are these securities, and have they reached the bottom yet? Residential mortgage based securities originate with residential debt, which includes home equity loans and mortgages including subprime mortgages. These securities are backed by residential mortgages and debt instead of commercial mortgages and debt. The financial crisis caused all mortgage based debt to lose value and fall. Residential mortgage backed securities are also called a mortgage related pass through and a mortgage related security. A residential mortgage backed security pays interest plus the principal, and this security is backed by at least one mortgage, usually a pool of mortgages that have been placed together.
The financial crisis has scared many investors off of investing in residential mortgage backed securities, because these investments have gone significantly down in value. The real estate and mortgage sector has been unstable and lost value substantially. Many new home buyers are facing difficulty getting approved for a mortgage, because banks and other financial firms are not lending money. In addition, home foreclosures are on the rise because many owners have mortgages that are larger than the value of their home, due to the fact that home prices have dropped as well. This means that many people do not have equity left in the home, so they allow it to be foreclosed on. Residential mortgage backed securities are rated in one of the top two groups of ratings, which is determined by a credit agency, and the origination of the mortgage must be from a regulated and authorized financial institution. These steps were intended to make the market for these securities more stable, but when the housing market busted it did not work as intended. As a result almost all residential mortgage backed securities went down in value.
If help comes in the form of a government program which helps homeowners keep their homes instead of losing them to foreclosure, the residential mortgage backed securities market would stabilize and become less volatile. Residential mortgage backed securities come in two basic types, and these are known as pass through and Collateralized Mortgage Obligations, or CMOs. A pass through residential mortgage based security is one that offers a direct ownership share in a mortgage pool, while CMOs are pools of pass through residential mortgage backed securities. Investing in CMOs can help minimize prepayment risks, and this is done in different ways. There are sequential pay CMOs and stripped CMOs. Stripped CMOs pay either interest only, called IO, or principal only, termed PO. In the current financial climate, prepayment risks are not as important as foreclosure risks.
If a mortgage is foreclosed on, there are no interest or principal payments, because the lender takes possession of the home and the mortgage holder does not usually make payments. This can leave many residential mortgage backed security investors with a financial loss. These securities offer different classes and levels of risk. Until this market stabilizes, these investments should be considered risky.
The information supplied in this article is not to be considered as medical advice and is for educational purposes only.