Have you ever considered investing in residential mortgage-backed securities (RMBS)? If not, you’re missing out on a lucrative opportunity.
What is residential mortgage-backed security?
Investopedia explains that RMBS investments are debt-based securities backed by loan interest paid by homeowners. The interest can come from loans like mortgages, home equity loans, and subprime mortgages. These loans tend to have fewer defaults and higher interest, which eliminates substantial risk.
Here’s how it works. Either a government agency or an investment banking firm packages together a large number of residential loans they own. Then, bonds are sold and backed by the designated pool of loans.
When homeowners make their loan payments, investors get high-interest rates and the issuing institution collects a fee for managing the loan pool. Since investors are investing in a pool of loans, if one homeowner defaults, the other loans in good standing will mitigate the damage.
There are some risks to consider
Before jumping into the RMBS investment game, there are several risks to consider. Aside from a massive default due to economic collapse, the next largest risk is a prepayment. As an investor, you’ll get paid less when homeowners pay back the principal of their mortgages before the loan’s maturity date.
Short on capital? Invest in RMBS indirectly
The good news is, if you don’t have enough capital to invest in the RMBS market directly, you can invest indirectly through investment fund programs. To learn more about this kind of opportunity, check out Firstmac’s High Livez investment fund backed by Australian home loans.
6 Reasons RMBS investments are a good idea
If you’ve never considered mortgage-backed securities, this article will explain 5 reasons the RMBS market is a good investment for both novice and experienced investors.
1. RMBS investments can yield up to 10%
RMBS investments can produce an attractively high yield of up to 10%. This high yield comes from the relatively low risk of investment. Today, there aren’t as many delinquent borrowers and consumer credit remains decent. Home values have also been appreciating, which contributes to the high yield.
Any investment that has a potential yield of 10% should be seriously considered. Even the best interest rate for a CD won’t yield anywhere near 10%.
2. A loan default won’t always stop payouts
Under normal circumstances, when a homeowner defaults on their loan, your RMBS investment will stop paying out. However, some agency-backed securities provide a payout guarantee for principal and interest in the case of loan default. This is great news, as it significantly lowers the risk involved in RMBS securities.
As Noobpreneur explains, government-authorized securities are safer. For example, the SEC explains that Ginnie Mae’s payouts are guaranteed by the government’s Federal Housing Administration (FHA). (As with the case of reverse mortgages – go here to learn more). In case of a default, federal tax revenues will be used to pay investors. Freddie Mac and Fannie Mae aren’t guaranteed by the U.S. government, but they both have the authority to borrow funds from the U.S. Treasury.
Although agency-backed securities are generally safer, non-agency securities are safer today than they have been in the past.
3. Non-agency-backed securities are safer than in 2008
During the 2008 financial crisis, many investors sought specific mortgage securities for their high yields. These securities produced high yields because of the extremely high-interest rates high-risk buyers were paying. When homeowners defaulted on their loans, everything came crashing down, and that strategy backfired.
Today’s borrowers are held to higher standards and high-risk buyers are not approved for the loans they were in the past. The 2008 market was flooded with RMBS securities from high-risk borrowers and short of a total economic collapse, that level of devastation won’t happen again anytime soon.
4. Lower transaction costs
The cost of buying and selling assets can be significant. RMBS transactions, however, tend to be lower. This is a simple point, but important because every dollar saved is another dollar you can invest.
5. RMBS will diversify your portfolio and lower risk
If you’re an experienced investor, RMBS investments will help you diversify your portfolio with less risk.
The price of agency-backed MBS investments generally rises with interest rates and with low prepayment levels. When interest rates drop and prepayments rise, MBS investments cost less.
If you want to reduce your risk as much as possible, opt for agency-backed securities from Ginnie Mae first and then look to Freddie Mac and Fannie Mae.
6. The RMBS market is liquid
Agency-backed RMBS investments have high liquidity and average a daily trading volume of $270 billion. This high trading volume makes it easier for buyers and sellers to connect, which is the primary reason RMBS transaction costs are lower.
How to get started investing in RMBS securities
There are a few different ways to get started investing in RMBS securities and you should choose your method based on your level of experience and the amount of time you can dedicate to research.
You can buy individual securities through a broker if you have the time and experience required to research the demographics for each security. For example, you’ll need to research the age, location, and credit profile for each mortgage before investing.
The easier way to invest is through funds dedicated to MBSs like exchange-traded funds. Five popular ETFs dedicated to residential mortgage-backed securities include:
- iShares Barclays MBS Fixed-Rate Bond Fund (MBB)
- iShares Barclays GNMA Bond Fund (GNMA)
- Barclays Agency Bond Fund (AGZ)
- SPDR Barclays Capital Mortgage Backend Bond ETF (MBG)
- Mortgage-Backed Securities ETF (VMBS)
RMBS investments require effort – it’s worth your time
Investing in residential mortgage-backed securities isn’t a passive strategy. However, it’s a strategy worth the time and effort required to get results. As with any investment, the risk is involved, but that’s part of playing the investment game. If you’re serious about creating passive income from your investments, consider adding RMBS securities to your portfolio.