Learn more about mortgage pools, how they work, and what mortgage pooling means for you.
Definition and Examples of Mortgage Pools
Mortgage pools are common. Lenders need to have liquidity to continue offering loans; if all their credit is tied up in existing loans, they can’t create more loans. To resolve this problem, lenders often bundle several mortgages with similar attributes to sell them. Different entities will buy these groups, whether it’s the federal government agency Ginnie Mae, government-sponsored enterprises Fannie Mae or Freddie Mac, or a private firm. Once banks have recouped the funds they have lent out by selling those mortgage pools, they are able to continue lending.
How Mortgage Pools Work
The primary mortgage market consists of lenders directly lending money to borrowers. This is what you will have experienced if you’ve ever purchased a home. However, as mentioned, banks can’t lend money to borrowers indefinitely; they eventually would run out of cash and credit. To avoid having this happen, they round up and form groups of similar mortgages. These may be loans for the same type of property, such as single-family homes, or they may feature similar maturation dates. After the mortgage pool has been created, it will be purchased by either a governmental, a quasi-governmental, or a private entity. These agencies then securitize these pools—meaning they convert them to securities that represent claims on the principal and interest payments made by the borrowers within the mortgage pool. Once this has happened, the entities will begin issuing mortgage-backed securities (MBS), which are bonds that can be purchased on the secondary mortgage market. There are multiple types of mortgage-backed securities that feature different structures, including pass-through participation certificates. These securities simply entitle a holder to the pro rata portion of both interest and principal payments made on the mortgage pools.
What Mortgage Pooling Means for You
If you’re a homeowner, not much will change for you if your lender chooses to bundle your mortgage into a pool and sell it—which happens routinely. You’ll only see a difference if your lender also sells servicing rights to your mortgage to another company. If, instead, you want to invest in mortgage-backed securities, it’s possible to do so. There can be good reasons to invest in these instruments. For example, you can gauge risk by looking at the geographic locations of the mortgages in the pool. If one location, such as Alabama, is experiencing weakness in the housing market, others that are not suffering from the same soft market can help balance out the collateral underlying the MBS you’re considering. Mortgage-backed securities also offer a stable monthly income, which can be more attractive than other bonds offering only annual or semiannual payments. Risks associated with mortgage-backed securities include prepayment by borrowers. In this case, your return may be minimized as the principal is paid off before all possible interest has been accrued. Those who remember the 2008 housing crisis may be wary of mortgage-backed securities. The crisis had its roots in too little market regulation and predatory lending, as well as the rise of private-label mortgage-backed securities. As a result, the Dodd-Frank Act was created. The act led to a broad overhaul of financial regulation, including provisions against predatory lending. Section 941 of Dodd-Frank also includes a “skin-in-the-game” clause, which requires any entity that securitizes a mortgage pool to retain at least 5% of the credit risk of the assets underlying the security in the event that it sells or transfers it. This is a type of risk retention designed to ensure that the interests of these entities remain aligned with the investors in the mortgage-backed securities—meaning less risk overall.
