What Are Pass-Through Certificates?
Pass-Through Certificates, also known as Pass-Through Securities, represent interests in a pooled collection of mortgages sold by mortgage bankers to investors. These instruments allow investors to receive portions of the monthly mortgages, which include both interest and principal payments, directly into their accounts.
The Mechanics Of Pass-Through Certificates
How It Works:
Let’s consider a practical example: A mortgage banker aggregates and sells $5,000,000 worth of pass-through certificates in $10,000 denominations. This bundle is supported by an equal sum of VA (Veterans Affairs) and FHA (Federal Housing Administration) mortgages. As homeowners make their monthly mortgage payments, those collections are funneled to the certificate holders.
Fees and Remittances:
While the bulk of the monthly collections goes to the certificate holders, the mortgage banker retains a portion for their services. Specifically, 0.44% of the annual principal is kept as a servicing fee to manage the mortgages efficiently.
Benefits of Investing in Pass-Through Certificates
- Steady Income: Receive monthly payments directly from the mortgage pool.
- Diverse Mortgage Types: Typically backed by reliable mortgage sources like VA and FHA loans.
- Government Guarantee: Often, these certificates gain an added layer of security by entities such as Ginnie Mae.
Risks to Consider
- Prepayment Risk: Homeowners may pay off their mortgages faster, impacting the expected returns.
- Market Risk: Fluctuations in interest rates can affect the value of the certificates.
- Default Risk: In the case where pooled mortgages default, this could affect the investor’s returns.
Frequently Asked Questions
What Are the Differences Between Pass-Through Certificates and CMOs?
Collateralized Mortgage Obligations (CMOs) piece out the mortgage collections into varied tranches, offering flexibility in risk and reward, while pass-through certificates typically represent a portion of every payment received.
Are Pass-Through Certificates Sound Investments?
Yes, especially those guaranteed by trusted entities like Ginnie Mae. They offer a stable income stream and are generally considered low-risk compared to other investment forms.
How Are Servicing Fees Calculated?
Servicing fees are often a small percentage of the annual principal of the mortgages in the pool. For example, in our scenario, it is 0.44% per year.
Related Terms: Collateralized Mortgage Obligations (CMOs), Mortgage-backed securities (MBS), Ginnie Mae, VA mortgages, FHA mortgages.
