Mortgage-backed bonds

A friend told me that when one gets a mortgage from the bank, the bank does not hold the deed.  I found this hard to believe, but after closer inspection, I realized that this is more complicated than I first thought.

The stock market is known as the place where people can buy and/or sell stocks and/or bonds.  When one buys a stock, one buys a piece of the company.  When one buys a bond, one lends the company money.  Furthermore, bonds comes in two main types.  Asset-backed (secured) and unsecured bonds.

When one purchases a bond that is asset-backed (secured), it has collateral attached to it in case of default.  This collateral can be anything that has value.  Therefore, in the case of mortgage-backed bonds, the bonds are backed by the mortgages taken out by the people who taken out a mortgage to purchase a home.  Therefore, the bank, who uses the mortgages as collateral, sells the mortgage-backed bonds in the market to raise capital (cash) with the promise of paying the principal borrowed plus interest on the mortgage-backed bonds.

In Canada, banks have been selling mortgage-backed bonds.  Therefore, bonds sold by institutions that offer mortgages that have a maturity date of 10, 15, 20, 25, 30 years are most likely mortgage-backed bonds.  Although, as of February 5, 2012, the risk of the CHMC collapsing is low.

In any case, if Canada’s housing market collapses, I am sure you know who will be left footing the bill.

The Canadian government owned CHMC, that insures Canadian mortgages, is reaching the $600 billion mark at http://www.cbc.ca/news/business/story/2012/02/02/flaherty-mortgage-cmhc.html

CMHC’s, Canadian Mortgage and Housing Corporation, article about the mortgage-backed bonds can be read at http://www.cmhc-schl.gc.ca/en/hoficlincl/in/camobo/loader.cfm?url=/commonspot/security/getfile.cfm&PageID=54142

After the sub-prime mortgage crisis in the US, I am pretty sure many investors are thinking twice before buying mortgage-backed bonds.

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