Mortgage Bond

Definition

A mortgage bond is a type of bond that is secured by a mortgage or collection of mortgages. The holder of the bond has a claim to the underlying property if the debtor fails to keep up with their payments. It is a type of secured debt, offering lower risk to the investor compared to unsecured bonds.

Phonetic

The phonetic pronunciation of “Mortgage Bond” is: Mortgage – /ˈmɔːrgɪdʒ/Bond – /bɒnd/

Key Takeaways

1. Debt Instrument: Mortgage Bonds are a debt instrument – Mortgage bonds are a debt instrument secured by an interest in real estate owned by the borrower. They provide investors a claim on a property or properties in the event of default by the borrower.
2. Risk and Return: Risk and potential for high return – Although mortgage bonds are generally considered safe investments due to their ties with physical properties, they carry some risk. This risk is associated with the possibility of the borrower defaulting on their property payments. However, this very risk level provides the potential for higher returns compared to other types of bonds.
3. Interest Rates: Interest rates and property market influence – The value and yield of mortgage bonds are highly influenced by the interest rates and the status of the property market. Thus, an understanding of these aspects is important for prospective investors.

Importance

A Mortgage Bond is a significant business/finance term as it serves as an essential investing tool and a critical means for businesses to raise funds. Mortgage bonds are secured by the pledge of certain assets, usually real estate property. They play a paramount role in minimizing investment risk by providing a safety measure for bondholders. In the event of default, bondholders have a claim to these pledged assets. Their high-security feature often results in lower yields than unsecured debt due to reduced risk, making them appealing for conservative investors. Furthermore, issuing mortgage bonds usually allows companies to secure a comparatively lower interest rate, thus reducing their cost of capital, and providing them more financial flexibility.

Explanation

A mortgage bond serves as a way for businesses and financial institutions to raise capital. These bonds act as a secured debt obligation, allowing an entity, such as a corporation, to acquire needed funding for various corporate operations, expansion, or capital projects. With a mortgage bond, the issuing company essentially takes out a loan and uses its physical assets, typically real-estate, as collateral. Should the issuer default on the debt payments, bondholders have a legal claim over the collateral property, which can be sold off in order to recoup the investment.For investors, mortgage bonds provide an attractive option because the risk is arguably lower. Mortgage bonds carry less chance of default compared to unsecured bonds as they’re backed by real-estate assets. Therefore, investors who buy mortgage bonds are effectively lending money in return for interest payments and ultimate principal repayment upon bond maturity or sale of the collateral if the issuer defaults. In essence, the purpose of a mortgage bond is to provide a secure way for companies to raise funds, while offering investors a low-risk investment option.

Examples

1. Residential Home Purchase: One of the most common examples of a mortgage bond is a residential home purchase. When a person borrows money from a bank to buy a house, the bank will create a bond using the house as collateral. If the borrower defaults on their payment, the bank has the right to take over the home to recoup its losses.2. Commercial Real Estate Investment: Another example is the use of mortgage bonds in commercial real estate investment. A real estate investment trust (REIT) may issue mortgage bonds backed by a lock of properties they own. Investors who buy these bonds receive regular interest payments funded by the rental income from these properties.3. Mortgage-Backed Securities: Lastly, financial institutions like banks and mortgage companies often conglomerate mortgage loans into pools and issue bonds known as mortgage-backed securities (MBS). These are backed by the mortgage loan, and investors earn their returns from the interest payments made by borrowers on their home loans. An infamous example of this is the subprime mortgage bonds which were part of the 2008 financial crisis.

Frequently Asked Questions(FAQ)

Related Finance Terms

• Collateral: This refers to the assets that are pledged as security for repayment in the event of default on the loan. In the case of a mortgage bond, the property being purchased usually serve as collateral.
• Principal: This is the original sum of money borrowed in a loan, or put into an investment. In terms of a mortgage bond, it is the original amount of the loan that the issuer borrows.
• Interest: It is the cost of borrowing money, generally expressed as a percentage of the principal amount. In a mortgage bond, this is the money paid regularly at a particular rate for the use of money lent, or for delaying the repayment of a debt.
• Default: This is the failure to repay a debt including interest or principal on a loan or security. In terms of a mortgage bond, it refers to the failure of the bond issuer to make the scheduled payments.
• Maturity Date: This is the date on which the principal amount of a note, draft, acceptance bond or other debt instrument becomes due. In the context of a mortgage bond, it is the date by which the borrower must have paid back the entire loan amount to the bondholder.

Sources for More Information

• Investopedia
• The Balance
• Corporate Finance Institute
• AAII: The American Association of Individual Investors