Mortgage-Backed Securities in Canada
Table of contents
Mortgage-backed securities (MBS) play a crucial role in Canada’s housing finance system. Whether you’re a borrower, investor, or simply curious about what happens after a mortgage is funded, understanding MBS can help you see the big picture of how lenders manage risk and how funds flow through the economy.
Unlike the US market, where risky MBS contributed to the 2008 financial crisis, Canada’s system is known for its stability, government backing, and stricter regulations. We’ll unpack what mortgage-backed securities are, how they differ in Canada, and what you need to know if you’re considering them as an investment or want to understand how they influence mortgage rates.
Key Takeaways
- Canadian mortgage-backed securities are considered safer than their US counterparts due to government guarantees.
- MBS provide lenders with funding to keep mortgage rates competitive.
- Investors gain predictable returns, but they must also understand the risks associated with prepayment and interest rate changes.
What Are Mortgage-Backed Securities?
Mortgage-backed securities (MBS) are financial products created by bundling together pools of individual mortgages and selling them as a single investment. When a homeowner makes their mortgage payment each month, part of that payment goes to investors holding pieces of the MBS.
This system allows banks and mortgage lenders to transfer the risk of the mortgages to investors. In return, investors receive a predictable stream of interest and principal from the monthly payments collected.
MBS can include thousands of mortgages, giving investors exposure to a diversified pool rather than relying on the performance of just one borrower.
How Do Mortgage-Backed Securities Work in Canada?
Canada’s approach to MBS is unique. The federal government insures the vast majority of mortgage-backed securities here through the Canada Mortgage and Housing Corporation (CMHC).
The National Housing Act Mortgage-Backed Securities (NHA MBS) program, launched in 1987, allows lenders to pool insured mortgages and sell them to investors. Because CMHC guarantees the timely payment of principal and interest, these investments are considered to be of very low risk.
The Government of Canada also issues Canada Mortgage Bonds (CMB). These bonds convert the monthly mortgage payments into semi-annual bond payments, making them more appealing to institutional investors.
This government-backed system provides a stable funding source for Canadian mortgages while protecting investors from defaults.
Types of Mortgage-Backed Securities
Mortgage-backed securities in Canada typically fall into three main categories, each offering a different way for investors to participate in the mortgage market. Understanding how these structures work is essential before considering an investment, as each type comes with its advantages, repayment expectations, and risk factors.
Pass-Through Securities
Pass-through securities are the simplest form of MBS and function much like a trust. When a lender pools a group of insured mortgages, the payments from those loans flow directly to investors every month. Each investor receives a proportionate share of the total principal and interest collected. This design makes cash flows predictable, though the actual timing can vary if homeowners pay off their loans early or refinance.
Collateralized Mortgage Obligations (CMO)
Collateralized Mortgage Obligations, or CMOs, are a more sophisticated structure designed to meet the needs of investors with different risk appetites. When a mortgage pool is split into CMOs, it is divided into multiple slices called tranches. Each tranche is prioritized differently for payment, so senior tranches receive their principal and interest first, while junior tranches absorb more risk in exchange for potentially higher returns. This tiered design allows investors to choose their preferred balance of risk and yield; however, it also means that CMOs can be harder to analyze without expert guidance.
Stripped Mortgage-Backed Securities (SMBS)
Stripped Mortgage-Backed Securities divide the mortgage payments into two distinct parts: principal-only (PO) strips and interest-only (IO) strips. Investors who purchase PO strips receive payments that reflect the repayment of the underlying loan balances, while IO investors collect only the interest portion. This separation creates unique investment profiles. For example, PO strips can gain value when interest rates fall and borrowers pay off mortgages early, while IO strips may lose value in the same scenario. This complexity means SMBS are often best suited to experienced investors or institutions that understand the nuances of interest rate sensitivity.
Advantages and Disadvantages of MBS
Mortgage-backed securities present both pros and cons to lenders and investors.
Benefits for Investors and Lenders
Mortgage-backed securities offer a range of benefits for both lenders and investors, influencing the way mortgage funding operates in Canada. For lenders, issuing MBS allows them to recycle capital more efficiently, which ultimately helps keep mortgage credit flowing to new borrowers. For investors, these securities offer three main advantages worth highlighting:
- Predictable income: Regular cash flows create steady returns, appealing to income-focused investors.
- Diversification: Instead of relying on a single mortgage, investors are exposed to a large pool of loans, reducing the impact of any individual default.
- Government backing: In Canada, the CMHC guarantees payments on most MBS, which significantly reduces the risk of capital loss due to borrower defaults.
Potential Risks and Drawbacks for Investors and Lenders
Although Canadian MBS are known for their stability, it’s essential to consider the potential drawbacks before making an investment decision. These risks may not be suitable for every portfolio, particularly if you prefer investments with more predictable time horizons or simpler structures. Some of the most common considerations include:
- Prepayment risk: Homeowners might repay their mortgages earlier than expected, reducing the total interest you would earn.
- Interest rate risk: When interest rates rise, the market value of existing MBS can fall, which may affect your returns if you need to sell before maturity.
- Complexity: Certain MBS structures, such as CMOs or SMBS, require a more in-depth analysis and may be more challenging to understand compared to simpler fixed-income investments.
Find a better rate, and we’ll match it, beat it, or give you $500*.
*Conditions Apply
With nesto, it’s stress-free
What Differentiates Canada’s MBS Market From the US?
Many people associate mortgage-backed securities with the 2008 Great Financial Crisis (GFC) in the US. However, the Canadian MBS market is structured very differently.
In the US, many MBS were built on subprime loans without strong mortgage underwriting standards or government guarantees. When borrowers defaulted in 2008, investors absorbed significant losses.
In contrast, nearly all Canadian MBS are backed by insured mortgages, and CMHC guarantees payments to investors. This framework has resulted in a more stable market that has not experienced the same level of systemic risk.
How MBS Affect Mortgage Rates and the Housing Market
Mortgage-backed securities play a direct role in determining mortgage rates.
When lenders package and sell mortgages as MBS, they receive fresh capital to issue new loans. This liquidity supports competitive mortgage rates for borrowers.
The yields investors demand for MBS also influence the cost of funds for lenders. If yields rise, lenders may need to increase mortgage rates to cover higher funding costs.
Overall, MBS helps ensure the smooth flow of mortgage credit (credit liquidity) across the Canadian housing market.
How to Invest in Mortgage-Backed Securities
Mortgage-backed securities (MBS) can be a stable addition to a diversified portfolio, especially for investors seeking predictable income and low credit risk; however, they aren’t suitable for everyone. The complexity of different tranches, sensitivity to interest rate movements, and the potential for principal prepayment can all impact returns, making it essential to evaluate these investments carefully.
Canadian investors can access mortgage-backed securities in two main ways:
- Buying NHA MBS from financial institutions like banks, trust companies, or credit unions, typically in denominations starting at $5,000.
- Purchasing Canada Mortgage Bonds (CMB), which offer semi-annual payments and fixed mortgage terms of up to 10 years.
Because CMHC guarantees payments, these products are often considered lower risk than many other fixed-income investments.
Before committing funds to mortgage-backed securities, take time to review the essential details with a qualified financial adviser who can help you understand how your investment performs over time. Some of the key aspects to consider include:
- The type of MBS: Whether it’s a pass-through security or a more complex structure like a CMO or SMBS, each has unique characteristics and risk profiles.
- Maturity dates and repayment schedules: These influence how long your money will be invested and when you’ll receive principal payments.
- Prepayment features: Understand whether homeowners can repay early and how that might affect your income.
- Expected yields: Compare yields to other fixed-income options and factor in the impact of interest rate changes.
We’re curious…
Frequently Asked Questions (FAQ) About Mortgage-Backed Securities (MBS) in Canada
What is a mortgage-backed security in Canada?
A mortgage-backed security is an investment created by pooling insured residential mortgages and selling the cash flows to investors. In Canada, most MBS are typically guaranteed by the CMHC, and hence the Government of Canada.
Are mortgage-backed securities safe investments?
Generally, Canadian MBS are considered low risk because they are bundled with high-ratio insured mortgages, backed by the federal government. However, they still carry prepayment and interest rate risks for investors.
How do MBS impact my mortgage rates as a borrower?
By creating credit liquidity and freeing up capital for lenders, MBS helps maintain the flow of mortgage credit, which supports competitive mortgage rates for consumers.
What is the difference between CMBs and NHA MBS?
NHA MBS pay monthly cash flows directly to investors, while Canada Mortgage Bonds (CMB) convert these flows into semi-annual payments, making them more like traditional bonds.
How can investors buy mortgage-backed securities in Canada?
You can purchase MBS through banks, credit unions, and other financial institutions in minimum denominations, or buy Canada Mortgage Bonds (CMB) issued by Canada Housing Trust.
Final Thoughts
Mortgage-backed securities form the foundation of Canada’s housing market, balancing the needs of lenders and investors while supporting home affordability. Thanks to strong regulation and government-backed CMHC guarantees, they remain a trusted option for those seeking predictable returns and a way to invest in the mortgage sector without owning property directly.
If you’re planning your next home purchase, mortgage renewal or refinance, remember that mortgage-backed securities help lenders like nesto offer more flexible financing and competitive rates. Connect with a nesto mortgage expert to discover how this stable funding system supports your options and simplifies the process of setting up a mortgage strategy that aligns with your long-term goals.
Why Choose nesto
At nesto, our commission-free mortgage experts, certified in multiple provinces, provide exceptional advice and service that exceeds industry standards. Our mortgage experts are non-commissioned, salaried employees who provide impartial guidance on mortgage options tailored to your needs and are evaluated based on client satisfaction and advice quality. nesto aims to transform the mortgage industry by providing honest advice and competitive rates using a 100% fully digital, transparent, seamless process.
nesto is on a mission to offer a positive, empowering and transparent property financing experience – simplified from start to finish.
Contact our licensed and knowledgeable mortgage experts to find your best mortgage rate in Canada.
Ready to get started?
In just a few clicks, you can see our current rates. Then apply for your mortgage online in minutes!
