What is a Gross Coupon
Gross coupon is a term that is used to describe the coupon received from a mortgage pool security such as a mortgage-backed security (MBS). A mortgage-backed security is an investment that contains a pool of mortgages which generally have similar characteristics. A coupon is the annual interest rate paid on a bond, expressed as a percentage of the face value, also referred to as the coupon rate. The term coupon originally refers to actual detachable coupons affixed to bond certificates.
BREAKING DOWN Gross Coupon
Gross coupon refers to the average of all the interest rates in the pool paid by the owners of the mortgages, before any administration or service fees are deducted. A net coupon is lower than the gross coupon by an amount equal to the servicing, guarantee and other applicable fees related to the mortgage pool.
A lender, such as a mortgage company or bank, pools together many mortgage bonds that typically have similar coupons and original and remaining terms. The borrower pays a gross coupon to the lender, which in turn keeps some of the proceeds of the coupon for servicing, and then pays the net coupon to the buyer. Meanwhile, all of the principal payments are passed along to the bondholders.
The gross coupon paid to the investor is the monthly payment that homeowners pay on their mortgages in this pool. Any prepayments are passed along to the investor as well. Unlike most types of bonds that pay semiannual coupons, investors in mortgage-backed securities receive monthly payments of interest and principal.
Difference Between Gross and Weighted Average Coupon
The gross coupon of a mortgage-backed security is the average of all the interest rates in the MBS pool. The weighted average coupon of the MBS pool is the outstanding weighted face value gross coupon that borrowers pay the mortgage lender. In other words, the weighted average maturity represents the average interest rate of different pools of mortgages with varying interest rates. As defined by FINRA, weighted average coupon is calculated by weighting the interest rate of each mortgage loan in the pool by the amount of the mortgage outstanding.
Once set at the issuance date, a bond's coupon rate remains unchanged, and holders of the bond receive fixed interest payments at a predetermined time frequency. A bond issuer decides on the coupon rate based on prevalent market interest rates, among others, at the time of the issuance. Because different mortgage holders pay down their mortgages with different rates and different tenures, the weighted average coupon rate may change over the life of the MBS.