Mortgage Cash Flow Characteristics
- Simply put, a mortgage is a debt instrument that is backed by real estate as collateral.
- Fully Amortized Mortgage Loan: Borrower makes an equal monthly payment that includes an interest component and a principal repayment component.
- In the early years of the repayment schedule, interest makes the largest share of the monthly payment, as principal repayment takes over as the largest share in the later years.
With a TI BA2+ calculator, the monthly payment can be obtained by entering the following:
PV = Mortgage Amount
I/Y = Monthly interest rate (i.e. the annual interest rate / 12)
N = Number of months in mortgage (i.e. 12 * number of years)
CPT PMT: Will generate monthly mortgage payment
When a private investor purchases a mortgage from a financial institution as an investment, the financial institution will take out a service fee from the mortgage's coupon rate.
Investor's Net Interest/Net Coupon = Gross Coupon - Service Fee
- Commonly mortgages can be wholly or partially pre-paid at the borrower's discretion, without penalty.
- NOTE: when evaluating asset backed securities it is critical to know whether or not the borrower can prepay without penalty. This will impact the security valuation approach; more to come.
- Prepayment: Payment in excess of the required monthly minimum; commonly applied as a reduction of principal.
- Curtailment: Borrower prepays only a portion of the debt principal.
- Example: a borrower with an amortizing mortgage loan pays above the monthly minimum, but not so much that the payment covers the full remaining balance of the debt.
- In the event the mortgage market rates drop below the borrower's existing rate, then the borrower has an incentive to refinance.
- Refinancing: Taking out a new lower rate mortgage to repay the existing higher rate mortgage.
- Prepayment Risk: Risk to the lender (investor) that the borrower will repay the mortgage principal sooner than expected and the lender will be forced to reinvest (or relend) the funds at a lower interest rate.
- Collateralized Mortgage Obligations (CMO) and CMO Tranches
- Stripped MBS – Interest Only (IO) and Principal Only (PO)
- Residential Non-Agency MBS
- CMBS: Structure and Call Protection
- Amortizing Loans vs. Non-Amortizing Loans
- Overview of Asset Backed Securities (ABS)
- Internal and External Credit Enhancements
- Pay-through Structures: Prepayment Tranching vs. Credit Tranching
- Home Equity Loans (HEL) Backed Securities
- Manufactured Housing Backed Loans
- Auto Loans Backed Securities
- Student Loan Backed Securities (SLABS)
- SBA Loan Backed Securities
- Credit Card Receivable Backed Securities
- Collateralized Debt Obligations (CDOs) and Synthetic CDOs
- Cash Flow Yield, Nominal Spread, and Zero Volatility Spread for ABS/MBS
- Monte Carlo Simulation for ABS/MBS
- CFA Level 2: Fixed Income Part 2 – Introduction
- Duration and Convexity for ABS/MBS
- Mortgage Cash Flow Characteristics
- Choosing an Appropriate Spread for ABS/MBS
- Mortgage Pass-through Securities: Characteristics and Risks
- Cash Flows and Prepayment Risk
- Single Monthly Mortality (SMM) & Conditional Prepayment Rate (CPR)
- PSA Prepayment Benchmark