A bond is a promise to repay a fixed amount of money with interest. Mortgage companies issue loans and sell them to financial institutions as mortgage bonds. If the borrower defaults, the financial institution may suffer a loss if the bond is worth more than the house.
A bond is similar to a promissory note. An investor buys a bond from a financial institution for a fixed amount of money. The financial institution then promises to pay the money back years from that day with a small percentage of interest added to the original value.
When a person buys a house, they usually have to borrow money from a bank or mortgage company. To borrow this money, the person must sign a promissory note stating that they will repay the amount of the loan, plus a percentage of interest, which accrues each month. Typically, a mortgage payment spans between fifteen and thirty years and is repaid in monthly installments.
To issue these loans, the mortgage company may need to “borrow” a large sum of cash from a larger financial institution. The mortgage lender offers several mortgage agreements in a lump sum package to a financial institution, which in exchange issues a mortgage bond. In this situation, the larger financial institution “buys” the mortgage agreement from the mortgage lender and receives the borrower’s monthly payment in return. The mortgage surety process helps the mortgage lender get the money he needs, while the larger financial institution earns extra money by receiving the borrower’s monthly payment.
In most cases, a mortgage bond is a win-win situation for both financial institutions. However, the recent increase in home values has caused some difficulties with this deal. Because home values were rising, mortgage lenders made loans to people who weren’t ideal candidates. As such homeowners do not repay any more loans and the home’s value levels off, the bond may be worth more than the home’s value.
If the borrower defaults on the mortgage loan, the loss is transferred to the financial institution that issued the mortgage bond. To recover the money, the financial institution that issued the mortgage bond can resell the house. This can still result in a loss of money if the bond is worth more than the house.
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