1
$\begingroup$

What would happen to an MBS (mortgage-backed security) if hypothetically speaking all the underlying mortgages were fully paid back by the mortgagees (borrowers), much before the maturity date?

I request the repliers of this question to follow this pattern:

  • If the answer is w.r.t. a global context, please start it with "In a global context..." .
  • If the answer is w.r.t. only a country(XYZ)'s context, please start it with "In XYZ , ....".

Thank you in advance!!!

$\endgroup$
2
$\begingroup$

Depends on the structure.

  • In the US, most residential MBS are pass-through, so the MBS is prepaid.
  • In Canada, MBS are (or at least were) mostly packaged into non-passthrough structures, so MBS cash flows follow fixed coupon schedule. There are prepayment penalties which are used to absorb the cash flows.
  • My understanding is that European pfandebriefe markets use a collateral pool, which absorbs prepayments.
$\endgroup$
3
  • $\begingroup$ What is a logical reason(s) behind placing a penalty for pre-closure on the borrower? I can only see a greed-fuelled motive from the perspective of the investment bank, so as to keep a mortgage alive for ultimately being able to put it into an MBS. $\endgroup$ – Akshay Prabhakant Feb 14 at 18:04
  • 2
    $\begingroup$ If banks absorb prepayment risk, it is extremely difficult for them to duration match their portfolio. The lack of duration matching was a severe issue for banking systems in the 1970s. The US MBS market is somewhat unique in that the bond market absorbs prepayment risk. $\endgroup$ – Brian Romanchuk Feb 14 at 19:27
  • 1
    $\begingroup$ And the Danish system is amazingly straightforward— borrowers can buy their own loan back out at the current market price. $\endgroup$ – dismalscience Feb 14 at 20:05

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.