Pool issuers, not servicers, buy loans out of an MBS pool. When they do, issuers must finance the purchase of the mortgages with their corporate assets. The bought-out loans are then held on the issuer’s balance sheet.
The interest rate an issuer can offer is directly tied to its funding costs. If an issuer has to buy the loan out of an MBS to modify its loan, the interest rate offered to the borrower will increase by the same amount the issuer’s funding costs increased.
If the issuer is Fannie Mae or Freddie Mac, the GSEs hold the securities on their balance sheet and fund them with their debt. The borrower is modified into a loan with the original interest rate (the rate on the modified loan is the lower of the original rate or the new rate). The original rate on the mortgage may be lower than the rate on the debt, but the GSEs can easily bear this cost.
If the organization is an issuer of Ginnie Mae–guaranteed MBS, a lower mortgage rate than debt rate is a problem for them and the borrower. When an issuer cannot afford to buy the loan, it doesn’t have an effective loss mitigation strategy to offer the borrower, and the borrower is faced with either foreclosure or sale of their home to meet their mortgage obligation.
What Higher Rates Mean For The MBS Market
In the latter scenario, when issuers buy a loan out of the pool, they lose the funding from the MBS and must fund the mortgage at their cost of funds—which in today’s market is probably substantially greater than the original note rate. After the modification, the mortgage can be repooled into a new MBS at a higher interest rate, which takes it off the issuer’s balance sheet. But the borrower will receive a modification in which they are paying a higher interest rate, and the higher mortgage payment will probably lead to the borrower losing their home.
The approximate doubling of interest rates in the MBS market has created a situation in which Ginnie Mae issuers cannot afford to buy loans out of MBS pools and lose their low-cost funding, and struggling borrowers cannot afford a proportionally higher interest rate.
The challenge the industry faces now is determining how a mortgage can be modified to a payment the borrower can afford without requiring the issuer to buy the loan out of the MBS and lose its attractive funding costs.