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Mortgage Backed Securities
When mortgage rates sky-rocketed in the 1980s, the Canada Mortgage and Housing Corporation began looking to the securitization market in the United States for answers on how to get financing costs back down to manageable levels. The CMHC looked at Fannie Mae (the Federal National Mortgage Association), Freddie Mac (the Federal Home Loan Mortgage Corporation) and Ginnie Mae (the Government National Mortgage Association) in the U.S., the latter of which the Canadian mortgage-backed securities model most closely resembles.
The CMHC announced the introduction of the National Housing Act Mortgage-Backed Securities Program in 1985. Prior to this year, the securitization market in Canada was relatively non-existent. The creation of this Mortgage-Backed Securities (MBS) program opened up the market to a broad array of Canadian investors. An amendment made to the National Housing Act meant that the CMHC could now unconditionally guarantee the timely payment of returns on pools of insured mortgages.
Mortgage Backed Securities
Mortgage Backed Securities – Definition
A mortgage-backed security is a fixed-rate investment representing an ownership of a pool of many mortgages. The Canadian government backs these investments, which are then sold to investors through the CMHC. Such investments free more funds to be loaned as insured mortgages. Mortgage insurance is required in Canada on all high-ratio loans; that is, loans wherein 80 per cent or greater of the loan to value is financed.
Thus, while mortgage insurance assures the lender that their funds are covered should the borrower default on their insured loan, the Government of Canada, via the CMHC, assures the investor that their investment in mortgage-backed securities is guaranteed to generate returns upon maturity.
Mortgage-backed securities tend to provide the investor with a four to six per cent return over the life of the investment. In addition, MBS offer two major assets: investment income paid monthly, and the ability to sell prior to maturity. The former benefit means mortgage-backed securities can generate an excellent source of retirement income, while the former means that MBS can be sold at market value whenever the investor should decide.
Because mortgage-backed securities are guaranteed through a government agency, there is essentially no risk associated with this form of investment. There is, however, a minimum investment requirement, which usually equates $5,000. Terms can be selected from one to ten years.
Proponents of mortgage-backed securities stand by two chief achievements the creation of such a program in Canada has afforded:
1. Investors provide increased financing with which to fund insured mortgages, which in turn generates more revenue for the CMHC and means more housing opportunities for a wider range of Canadians at lower mortgage rates. With more people qualifying for mortgages, and those mortgages being insured, lenders face little risk by making available these funds. Thus lenders face no need to up borrowing rates – they’re pool of borrowers has increased, and the loans they’re asking for have grown in size too.
2. A wide range of Canadian investors now have access to a competitive, guaranteed investment, which fits well into a retirement portfolio.
Critics of mortgage-backed securities, however, see this increase of flowing financing dollars a devil in disguise. They fear that financing has become too easy to attain, and that the widening of the qualified home and property buyer margin has artificially increased the value of Canadian properties. Upping the amount of eligible borrowers has meant that sellers can afford to ask for more. While rates hold low, borrowers can still be approved, even on loans that are in risk of overtaking them should rates spike. Some economists fear that the housing bubble and crash seen in the U.S., and some parts of Europe, could still occur here.