Mortgages Made More Available by Covered Bonds

By Dream Town · June 18, 2008 · Mortgage

The U.S. government is looking to European financing models in hopes of finding a way to make home loans more attainable for American home buyers. The new approach to mortgage loans would use a money lending practice called “covered bonds,” which is popular in Europe and has been used there for centuries.

Covered bonds are much less risky for banks and lenders than the types of dealings going on during the subprime mortgage crisis. They are basically debt securities supported by a pool of mortgages. But because the bonds stay on the bank’s books, the purchaser of the bond is safeguarded against loosing money due to borrowers defaulting. Here’s how it works: The bank acts as a secondary net for bondholders, the main backing is provided by a group of “high-quality mortgages” with good standing. These mortgages supply a healthy flow of cash to the bank which is used to fund additional loans.

The two layers of protection are hoped to encourage lenders to participate in covered bonds. A more secure system of shielding lenders and investors will increase the number of mortgages available and, in turn, make it easier for home buyers to acquire loans.