Hedging a mortgage

A CTA?

I think it's relatively common, but maybe not so much in the US, given the structure of most mortgages?

IMHO, it's hard to see how any institution but a bank could offer a mtge service that would satisfy customers' needs.
 
It's done institutionally all the time for mortgage investors; Hedging mortgage is one of those Fixed Income 102 kind of problem. It's been worked on since the 80's when these things were first securitized.

Providing a hedging service for retail customers would be a lot like selling them an interest rate swap. So the same kind of problems apply - it's huge regulatory and counterparty risk headache. So no one is going to do it. (not to mention, political risk - think about some guy who gets burned hedging away his interest rate risk and interest falls; he's now going to bitch to the media about evil wallstreet robbing him of his money. Hell, municipals have filed exactly this kind of suit against their bankers on the matter of rates hedges for their own lending. They claimed they were either duped or didn't understand...)

Quote from Martinghoul:

A CTA?

I think it's relatively common, but maybe not so much in the US, given the structure of most mortgages?

IMHO, it's hard to see how any institution but a bank could offer a mtge service that would satisfy customers' needs.
More...
 
Quote from Martinghoul:

A CTA?

I think it's relatively common, but maybe not so much in the US, given the structure of most mortgages?

IMHO, it's hard to see how any institution but a bank could offer a mtge service that would satisfy customers' needs.
More...


Yeah I guess it could be anybody, not just limited to a CTA. You are right though, if it was that great of a service it would be offered and advertised much much more.
 
Quote from sjfan:

It's done institutionally all the time for mortgage investors; Hedging mortgage is one of those Fixed Income 102 kind of problem. It's been worked on since the 80's when these things were first securitized.

Providing a hedging service for retail customers would be a lot like selling them an interest rate swap. So the same kind of problems apply - it's huge regulatory and counterparty risk headache. So no one is going to do it. (not to mention, political risk - think about some guy who gets burned hedging away his interest rate risk and interest falls; he's now going to bitch to the media about evil wallstreet robbing him of his money. Hell, municipals have filed exactly this kind of suit against their bankers on the matter of rates hedges for their own lending. They claimed they were either duped or didn't understand...)
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I was referring to retail specifically, of course... The institutional side of the equation is well-known and unloved. And yes, the books are definitely being re-written about the things you can and can't sell to even semi-sophisticated investors.

However, I just don't see the regulatory aspect as that big of a deal. The hedge doesn't have to be structured as an outright swap, but rather as a cap, to avoid the problems you're describing. European banks do offer such products (occasionally called mtge insurance) but they do it in a half-assed sort of way.

That's what I don't understand. If you're a retail customer and you have a floating-rate mtge (indexed to LIBOR, PRIME or whatever), it's a no-brainer that you might want to hedge. Given that and given that you're probably willing to overpay (people don't like defaulting), on top of paying bid/offer, shouldn't the banks/servicers be falling all over themselves to offer these caps? Maybe, 'cause there will be a fixed/floating imbalance that the mkt wouldn't be able to absorb... Don't know...
 
Quote from chromosome:

Greetings:

I am in the process of obtaining financing for a home purchase. The breakdown is as follows:

Cash down payment (no rate): $15,000
Cash down payment (floating 3% rate - follows PRIME, floats monthly): $47,500
Loan from bank (30-year fixed, 5%): $187,500

I am interested in setting up a hedging stragetgy to protect myself against the upward movement of PRIME. I am wondering if anyone has experience with this on a retail level.

The specific question is whether or not there is an ETF product that follows the PRIME rate I may short or if a futures account would be a better idea. Any thoughts are appreciated, thanks!
More...

I think in this type of situation you are not necessarily looking for a perfect hedge, just something to protect you if ST rates spike. Since the amount you are hedging, $47.5k, is relatively small compared to the notional value of interest rate futures, you can easily overhedge. Personally, I would look up the correlation between prime and LIBOR, then use eurodollar futures, the GE contract. I wouldn't try to be hedged all the time, but would just look to short them when or if rates turned up.
 
Quote from chromosome:

Greetings:

I am in the process of obtaining financing for a home purchase. The breakdown is as follows:

Cash down payment (no rate): $15,000
Cash down payment (floating 3% rate - follows PRIME, floats monthly): $47,500
Loan from bank (30-year fixed, 5%): $187,500

I am interested in setting up a hedging stragetgy to protect myself against the upward movement of PRIME. I am wondering if anyone has experience with this on a retail level.

The specific question is whether or not there is an ETF product that follows the PRIME rate I may short or if a futures account would be a better idea. Any thoughts are appreciated, thanks!
More...
OK chromosome, you've gotten a lot of good answers from <strike>some of</strike> most of the professionals on the Board, but I have a question for you.

Given the complexity of analysis, additional risk, and the money involved with hedging away a strong move in the Prime Rate, why not just focus on paying down the $47.5k instead?

Considering the fact that this is a retail purchase (your home), and not an investment property, that is exactly the approach I would take.
 
Good point regarding the Cap structure. It's simple, straightfoward, involves no counterparty risk (from the seller's perspective, anyway) and relatively easy to understand.

Wonder why it isn't done more.


Quote from Martinghoul:



That's what I don't understand. If you're a retail customer and you have a floating-rate mtge (indexed to LIBOR, PRIME or whatever), it's a no-brainer that you might want to hedge. Given that and given that you're probably willing to overpay (people don't like defaulting), on top of paying bid/offer, shouldn't the banks/servicers be falling all over themselves to offer these caps? Maybe, 'cause there will be a fixed/floating imbalance that the mkt wouldn't be able to absorb... Don't know...
More...
 
Why absurd? Given the 30-year swap rate is 4.48% right now, a 40-year fixed at 5% is really no different from 30-years worth of 3M reset floating loans.... it's only absurd if you don't under how the fixed income market works.

Quote from quin8670:

the fact that banks can make 30-year fixed at 5% is absurd
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Quote from MandelbrotSet:

OK chromosome, you've gotten a lot of good answers from <strike>some of</strike> most of the professionals on the Board, but I have a question for you.

Given the complexity of analysis, additional risk, and the money involved with hedging away a strong move in the Prime Rate, why not just focus on paying down the $47.5k instead?

Considering the fact that this is a retail purchase (your home), and not an investment property, that is exactly the approach I would take.
More...
I think we might have a winner here...

Given that your max loss on the PRIME piece doesn't appear life-threatening and transaction costs on whatever hedges you do will bite, sitting on your hands might just be the wisest course here, chromo...
 
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