Mortgage-backed securities (MBS) are financial instruments that are created by packaging together a group of individual home loans into a single security. These securities are then sold to investors who receive payments from the interest and principal payments made by the homeowners. As interest rates rise, the value of mortgage-backed securities can fluctuate.
Inverse Relationship
When interest rates rise, the value of existing mortgage-backed securities will generally fall. This is because as interest rates increase, the value of fixed-income securities, such as MBS, decreases. This is because new securities will offer higher yields, making the older securities less attractive to investors.
Longer Terms
The value of mortgage-backed securities can also be affected by changes in the prepayment rates of the underlying mortgages. As interest rates rise, fewer homeowners are likely to refinance their existing mortgages, which means that prepayment rates are likely to slow down. This can lead to an increase in the duration of the mortgage-backed securities, which can further reduce their value.
High Sensitivity to Changes
One of the reasons that mortgage-backed securities are particularly sensitive to interest rate changes is that they are based on long-term loans, such as 15 or 30-year mortgages. The payments made on these loans are spread out over a long period of time, which means that the value of the security is particularly sensitive to changes in interest rates.
Housing Market Downturn
The performance of mortgage-backed securities can be affected by changes in the housing market. If the housing market experiences a downturn, homeowners may be more likely to default on their mortgages, which can lead to lower payments to investors in the MBS. This can lead to a decrease in the value of the security.
Interest Rate Rises, MBS Falls
As interest rates rise, the value of mortgage-backed securities generally falls. This is because new securities will offer higher yields, making the older securities less attractive to investors. The value of mortgage-backed securities can also be affected by changes in prepayment rates and the performance of the housing market.