What is 'Mortgage-Backed Note'
A mortgage-backed note is a type of security backed by a mortgage. These notes serve as a type of investment vehicle for the holder. The investor receives a return on their investment through the monthly payments associated with the mortgage that secures the note. These notes also obligate the borrower to make the agreed upon payments.
Mortgage-backed notes come with a specified date of maturity, interest rate and face value. When the note reaches maturity, the note becomes payable to its holder. A common type of mortgage-backed note is a GNMA bond. These bonds are issued by Ginnie Mae (the Government National Mortgage Association). Because Ginnie Mae is a corporation owned by the U.S. government, these bonds are backed by the full faith and credit of the United States government. This means that if the the borrower defaults, payment is guaranteed through the U.S. Treasury.
BREAKING DOWN 'Mortgage-Backed Note'
Mortgage-backed notes determine the type of mortgage that they can back. If a note has a fixed schedule of principal and interest payments, then the mortgage is a fixed-rate mortgage. If the note has a flexible interest rate, then the mortgage is an adjustable-rate mortgage.
Beginning in 2015, China began expanding mortgage-backed notes in order to help buoy its housing market and economy. This expansion included allowing banks to sell commercial mortgage-backed notes for the first time.
How Mortgage-Backed Notes Work
Mortgage-backed notes can be an appealing way for investors to profit from the real estate market without having to directly purchase real estate. For example, an investor may wish to invest a portion of the funds in their IRA in mortgage-backed notes. If they decide to invest $10,000 in a mortgage-backed note, their IRA will then receive deed of trust and a note stating the amount that they’ve invested, along with a specified interest rate and the date of the note’s maturity.
Meanwhile, that $10,000 goes toward a loan that allows someone else to purchase a home. That person may be purchasing a home for $100,000. A mortgage company will then combine the invested $10,000 with financing from other sources to provide a homebuyer with a $100,000 mortgage. Each month, when the borrower makes their monthly payments, a portion of that payment, which includes interest, will go toward the investor’s IRA. When the mortgage has been paid off, the note matures. At this point, the borrower is no longer in debt and owns their home outright; and the complete yield of the note has been paid into the investor’s IRA.