The pass-through rate is the rate on a securitized asset pool, such as a mortgage-backed security (MBS), that is "passed-through" to investors once management fees and guarantee fees have been paid to the securitizing corporation. The pass-through rate (also known as the coupon rate for an MBS) is lower than the interest rate on the individual securities within the offering. The largest issuers of securitized assets are the Sallie Mae, Fannie Mae, and Freddie Mac corporations, whose guarantees are backed by the U.S. government, giving them high credit ratings.
Breaking Down Pass-Through Rate
The pass-through rate is the net interest the issuer pays investors after all other costs and fees are settled. In an MBS, for example, the amount forwarded to investors passes from the payments on the underlying mortgages, through the pay agent and ultimately to the investor.
Pass-Through Rate and Interest Rate
The pass-through rate is always less than the average interest rate paid by the borrower on the mortgages backing the security. Various fees are deducted from the paid interest, including general management fees for conducting transactions and for guarantees associated with the securities involved. As defined in the terms and conditions governing the issuance of the securities, fees are set up as percentages of the interest generated or as flat rates.
Securitizing Mortgage-Backed Asset Pools
Many institutions underwriting mortgages prepare and issue financial instruments backed by those mortgages. During times of economic stability, the risk associated with investing in mortgage-backed securities is low compared to many other investment options. The return realized as the pass-through rate is typically considered equitable for the degree of risk involved.
Projecting a Pass-Through Rate
In many cases, an investor may project the amount of return realized from the pass-through rate. Of course, unanticipated factors may arise and influence the amount of net interest generated. For example, if the mortgages backing the security carry a variable or floating rate rather than a fixed rate, shifts in the average interest rate will impact the amount of return. For this reason, investors may attempt to anticipate interest rate fluctuations over the life of the security and factor them into the projected pass-through rate. This process helps the investor decide whether the return is worth the degree of risk associated with the underlying mortgages.
Fannie Mae and Freddie Mac
Congress created Fannie Mae and Freddie Mac to provide liquidity, stability, and affordability in the mortgage market. The organizations provide liquidity for thousands of banks, savings and loans, and mortgage companies making loans for financing homes.
Fannie Mae and Freddie Mac purchase mortgages from lenders and hold the mortgages in their portfolios or package the loans into mortgage-backed securities that may be sold. Lenders use the cash raised by selling mortgages for engaging in additional lending. The organizations’ purchases help ensure that people buying homes and investors purchasing apartment buildings or other multifamily dwellings have a continuous supply of mortgage money.