What is the ‘Pass-Through Rate’
The pass-through rate is the rate on a securitized asset pool — such as a mortgage-backed security (MBS) — that is “passed-through” to investors once management fees and guarantee fees have been paid to the securitizing corporation. The pass-through rate (also known as the coupon rate for the MBS) is lower than the interest rate on the individual securities within the offering. The largest issuers of securitized assets are the Sallie Mae, Fannie Mae and Freddie Mac corporations whose guarantees are backed by the U.S. government, giving them high credit ratings.
Explaining ‘Pass-Through Rate’
The pass-through rate is the net interest the issuer of a mortgage-backed security pays investors after all other costs and fees are settled. The amount forwarded to investors passes from the payments on the underlying mortgages, through the pay agent, and ultimately to the investor.
Pass-Through Rate and Interest Rate
The pass-through rate is always less than the average interest rate paid by the borrower on the mortgages backing the security. Various fees are deducted from the paid interest, including general management fees for conducting transactions and for guarantees associated with the securities involved. As defined in the terms and conditions governing the issuance of the securities, fees are set up as percentages of the interest generated or as flat rates.
Securitizing Mortgage-Backed Asset Pools
Many institutions underwriting mortgages prepare and issue financial instruments backed by those mortgages. During times of economic stability, the risk associated with investing in mortgage-backed securities is low compared to many other investment options. The return realized as the pass-through rate is typically considered equitable for the degree of risk involved.
Projecting a Pass-Through Rate
In many cases, an investor may project the amount of return realized from the pass-through rate. Of course, unanticipated factors may arise and influence the amount of net interest generated. For example, if the mortgages backing the security carry a variable or floating rate rather than a fixed rate, shifts in the average interest rate will impact the amount of return. For this reason, investors may attempt to anticipate interest rate fluctuations over the life of the security and factor them into the projected pass-through rate. This process helps the investor decide whether the return is worth the degree of risk associated with the underlying mortgages.
Fannie Mae and Freddie Mac
Congress created Fannie Mae and Freddie Mac for providing liquidity, stability and affordability in the mortgage market. The organizations provide liquidity for thousands of banks, savings and loans and mortgage companies making loans for financing homes.
Further Reading
- The Effect of RMB Exchange Rate Pass-through: An Empirical Analysis Based on VAR [J] – en.cnki.com.cn [PDF]
- Interest rate pass through and asymmetric adjustment: evidence from the federal funds rate operating target period – www.tandfonline.com [PDF]
- Pass-through of RMB Exchange Rate to Chinese Domestic Prices [J] – en.cnki.com.cn [PDF]
- Exchange rate pass-through into import prices – www.mitpressjournals.org [PDF]
- Interest rate pass-through in the Euro area during the financial crisis: A multivariate regime-switching approach – www.sciencedirect.com [PDF]
- Interest rate pass through and asymmetries in adjustable rate mortgages – www.tandfonline.com [PDF]
- Interest rate pass-through and financial crises: do switching regimes matter? The case of Argentina – www.tandfonline.com [PDF]
- Impact of bank competition on the interest rate pass-through in the euro area – www.tandfonline.com [PDF]
- Interest rate pass-through in Europe and the US: Monetary policy after the financial crisis – www.sciencedirect.com [PDF]
