Mortgage-Backed Securities

When mortgage rates were on the rise in the 1980s, the Canada Mortgage and Housing Corporation needed answers. Specifically, they began looking to the United States for answers on how to get financing costs down to a manageable level, primarily through mortgage-backed securities.

The CMHC looked to entities in the U.S. Fannie Mae (Federal National Mortgage Association), Freddie Mac (Federal Home Loan Mortgage Corporation), and Ginnie Mae (Government National Mortgage Association) were the model. The latter is what Canadian mortgage-backed securities models look the most like.

The CMHC announced the National Housing Act Mortgage-Backed Securities Program in 1985. Before this, the securitization market in Canada almost didn’t exist. The creation of the Mortgage-Backed Securities (MBS) program opened up the market to a huge range of investors. A change made to the National Housing Act made it so that the CMHC could unconditionally guarantee payment of returns on pools of insured mortgages.

Definition of Mortgage-Backed Securities

A mortgage-backed security is a fixed-rate investments. They represent ownership of a pool of many different mortgages. Investors can get these investments, backed by the Canadian government, through the CMHC.

This kind of investment results in more funds to be loaned as insured mortgages. Mortgage insurance is mandatory in Canada on all high-ration loans. A high-ratio loan is one where 80 percent or more of the loan-to-value is financed.

Mortgage insurance provides protection for the lender. This is because the money is covered if the borrower defaults on their loan. The Government of Canada (through the CMHC) provides the investor with protection. This guarantees that their mortgage-backed securities will provide returns at maturity.

Mortgage-backed securities generally provide the investor with four to six percent return over the life of the investment. MBS also offers two major investments. Firstly, investment income is paid monthly. Secondly, it provides the ability to sell prior to maturity.

This means that mortgage-backed securities can provide reliable retirement income. It also means that MBS can be sold at market value when the investor decides.

Mortgage-Backed Securities at a Glance

• One of the safest investments available in Canada – offers almost risk-free guaranteed returns if held to maturity
• Maintain a high degree of liquidity; can re-sell at market value at any time
• Can provide monthly income, ideal for retirement; or lump-sum payouts
• RRSP and RIF eligible
• Low amount needed to invest
• Competitive yields

Additional Information

Because mortgage-backed securities are guaranteed through a government agency, there is little to no risk in this type of investment.

There is a minimum requirement, usually equating to around $5,000 or so. You can select your term, from one to ten years.

Controversy

Those in favor of mortgage-backed securities stand by two things that creation of such a program in Canada has created:

1. Investors provided increased financing for insured mortgages. This creates more revenue for the CMHC and means more housing for a wider range of Canadians. It also means lower mortgage rates. Lenders face little risk by providing these funds since more people need mortgages and mortgage insurance will be required. This means lenders don’t need to increase borrowing rates – the pool of borrowers has increased, and the loans they’re asking for have grown in size too.
2. Canadian investors have access to a guaranteed investment. This fits well into a retirement portfolio.

There are critics of mortgage-backed securities. They think that this increase of financing dollars will make it too easy to get a loan. There is also a fear that the qualified home and property buyer margin will widen.

More borrowers has meant that sellers can afford to ask for more. While rates hold low, borrowers can still be approved. Moreover, they can be approved on loans that are at risk of overtaking them if rates go up. Some economists fear a housing crash. The U.S. and some parts of Europe have had this happen, and there is fear that it could happen in Canada.