Mortgage Pass Through Security

A Mortgage Pass Through (MPT) Security is a type of specialty bond . It is a pool for several loans, all of which have the option of prepayment . Prepayment refers to an individual right to cancel a debt. Termination is either due to interest rates or for private reasons (e.g. move or divorce).

However, it can also happen that no termination takes place, although this is induced by the interest. As a consequence, only partial repayments of MPT Securities take place, which depend on the individual termination behavior.

A "Mortgage Pass Through" bond secures loan claims against homeowners and thus makes them tradable (see: Loan trading).

Individual loans can be sold to the Federal National Mortgage Association (Fannie Mae) by the Mortgage Originator. This bundles the loans and sells them to investors.

Interest, repayment and prepayment by the borrower are passed on to the investors.

Comparison with callable bond

In the case of a callable bond, the issuer or the investor can have a right of termination. With a mortgage pass through, the prepayment risk lies with the investor.

The future interest and repayment payments are therefore uncertain for the investor and can assume any value. In the case of a termination bond, either a full repayment takes place on termination or the bond continues to exist in full. This makes the callable bond a special case of prepayments. In the event of termination with 100% prepayment rate and without termination, 0% prepayment rate.

Specialty

The problem with mortage pass-through securities is that the interest and principal payments are uncertain. This arises from the uncertainty of prepayment payments.

Structure of a mortgage pass through

                           Hausbesitzer
 Darlehen                      |  |            Zinsen, Tilgung, Prepayment
                       Mortgage Originator
 Verkauf der Mortgage          |  |            Zinsen, Tilgung, Prepayment
                            Fannie Mae    
 Mortgage Pass Through         |  |            Zinsen, Tilgung, Prepayment
                            Investoren

Solution approaches for determining a fictitious effective interest rate

The following solutions are available:

fixed average maturities
constant prepayment rates
historical statistical prepayment rate
A single borrower of the pool pays a fixed mortgage rate, which is the annuity loan view.

Time series observation with prepayment:

The prepayment rate starts at a low level and levels off at one value.

Cash flow of a coupon bond

Constant prepayment rate.