Dozens of investment vehicles are on the market these days, each with their own pros and cons. It’s no secret that not every investment product is the same, but how can you pick the right investment platform when trends and the 24-hour news cycle may skew your perspective? After all, just because some people make money off of cryptocurrencies such as Bitcoin, that doesn’t mean it’s the right investment option for your everyday investor. Residential mortgage-backed securities are another alternative investment option, although they aren’t considered as often as they should be. Here’s what you need to know before you decide to invest in RMBS.
What is a residential mortgage-backed security?
A residential mortgage-backed security, also known as an RMBS, is similar in some ways to the investment product known as a bond. For example, payments are made out regularly from a variety of mortgages, rather than one singular stock. This means that if you’re investing in residential mortgage-backed securities in North Carolina, you may have some mortgages from Ashe County Real Estate and others from counties like New Hanover County, Bladen County, and Buncombe County. Having multiple mortgages bundled together can help you increase your profits as an investor. It also can mitigate risk, although it’s important to consider how each RMBS is structured to ensure that there’s an even distribution of mortgages. Don’t forget that too many poorly structured residential mortgage-backed securities was a contributing factor in America’s financial crisis during 2008.
How do residential mortgage-backed securities function?
There are two primary providers of residential mortgage-backed securities: firms specializing in investment banking and government agencies. Regardless of who is selling you the securities, both providers structure their RMBS similarly. A residential mortgage-backed security is built from a collection of loans held by the government or a banking firm. These loans are sold for cash and then bonds are essentially issued to investors, backed by the money made from the loans. While these kinds of securities offer some of the stability of bonds, they also offer higher interest rates than typical bonds. Even at their lowest historic rate in years, the interest rate of a mortgage is far more favorable than the rates attached to government bonds, which pay about 3 percent on average.
The advantages of investing in residential mortgage-backed securities
Because, as an investor, you’re buying into a collection of loans instead of one singular loan, you run less of a risk of losing money in a situation where a mortgage borrower winds up defaulting on their loan. This helps to protect your investment, and may make for a much more stable investment vehicle than other types of residential investment. For example, consider a situation when you own your own real estate and treat this as an investment. If property values rapidly decrease because of increasing mortgage rates, the discovery of harmful environmental conditions, or the sudden closure of a major employer, you’re out the money you spent on a more expensive property. Not investing in one single property, and instead focusing on a collection of mortgages can help you avoid this loss in value as an investor.
It’s vital that you understand what you’re investing in, as having a clear knowledge of the ins and outs of any investment vehicle can be the difference between making money and losing money. While some risk is associated with residential mortgage-backed securities, that risk is no larger than the risk of a company losing a large amount of market share, assuming that you’re picking your RMBS carefully. Keep the above information in mind, and you’ll be able to make money investing in residential mortgage-backed securities.