Is Your Mortgage a Dwarf?

by Investing School on September 26, 2011

Considered a slang term, a dwarf is used to describe a pool of mortgage backed securities which have a maturity period of only 15 years and have been issued by the Federal National Mortgage Association – Fannie Mae for short.

The advantage to purchasing MBSs backed by Fannie Mae is that these securities are backed by the U.S. government or by independent governing bodies in the secondary market. Ginnie Mae is another official body which has the authority to guarantee MBS issues which have met a strict set of criteria.

To understand how mortgage based securities work, here is a simple explanation. When you, or anyone, purchase a house the bank offering you the mortgage loan gives you the money in exchange for your note. They can later decide to either keep the loan in their portfolio, collecting your payment monthly, or they can sell the loan to increase their available cash.

The purchasing company, let’s call it XYZ, will pool your loan with other loans which have similar characteristics. Then XYZ sells securities in the loan pool to investors. These funds are used to purchase more mortgages, etc. For those investors the security is similar to a bond purchase and they get regular payments from XYZ.

From the perspective of the home buyer it makes very little difference what slang is used by brokers to describe a particular kind of mortgage. A shorter mortgage means fewer interest charges and a faster track to equity. From the investor’s standpoint, prepayment of mortgages, refinancing of mortgages in the pool and other factors can reduce the expected income significantly.

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