Pool issuers, not managers, buy loans from a pool of MBS. When they do, issuers must finance the purchase of the mortgages with their corporate assets. The repurchased loans are then recorded on the issuer’s balance sheet.
The interest rate an issuer can offer is directly related to its funding costs. If an issuer must redeem the loan from an MBS to modify their loan, the interest rate offered to the borrower will increase by the same amount as the issuer’s funding costs have increased.
If the issuer is Fannie Mae or Freddie Mac, the GSEs hold the securities on their balance sheet and finance them with their debt. The borrower is changed to a loan with the original interest rate (the changed loan rate is the lower of the original rate or the new rate). The initial mortgage rate may be lower than the debt rate, but GSEs can easily bear this cost.
If the organization is an issuer of Ginnie Mae-guaranteed MBS, a mortgage rate below the debt ratio is a problem for it and for the borrower. When an issuer cannot afford to purchase the loan, they have no effective loss mitigation strategy to offer the borrower, and the borrower is faced with foreclosing or selling their house to meet his mortgage obligation.
What higher rates mean for the MBS market
In the latter scenario, when issuers purchase a loan out of the pool, they lose the MBS funding and must fund the mortgage at their cost of funds – which in today’s market is likely significantly higher than the original interest rate. . After the modification, the mortgage can be bundled into a new MBS at a higher interest rate, removing it from the issuer’s balance sheet. But the borrower will receive a modification in which he pays a higher interest rate, and the higher mortgage payment will likely result in the borrower losing his home.
The approximate doubling of interest rates in the MBS market has created a situation where Ginnie Mae issuers cannot afford to buy loans from MBS pools and lose their low-cost funding, and Distressed borrowers cannot afford a proportionately higher interest rate.
The challenge the industry now faces is how a mortgage can be changed to a payment the borrower can afford without forcing the issuer to redeem the MBS loan and lose its attractive funding costs.