While there continues to be debate about whether the worst of the housing crisis is ahead of us or behind us, and regardless of one’s opinion about what caused it, it’s important to understand various types of investments associated with real estate and mortgages. Real Estate Mortgage Investment Conduits (REMIC) are such investments.
The big picture is this: someone decided that family, second, corporate, and other mortgages could potentially be invested in. People everywhere were paying their mortgage to their local bank each month, and the bank was making all the money. An investor comes in and says they’ll buy the mortgage from the bank and the investor starts bringing in that revenue.
If that mortgage goes bad – if it defaults – then the investor is out a lot of money, so he decides to buy up lots of different mortgages in order to minimize the percentage of mortgages that go under. But even if a mortgage defaults, he’s still out all the money so he wants to spread out the risk of these mortgage investments. So, he takes it a step further by taking a sliver of each mortgage, bundling those slivers into one security, and then selling that security to other investors.
So far, none of this is a REMIC. The bundles that have been created are called mortgage-backed securities (a somewhat self-explanatory term). However, if a company wants to get involved in mortgage-backed securities, as well as increase their flexibility and decrease their risk, they will create a REMIC. A REMIC then is the actually trust, company, partnership, or other entity created for the specific purpose of investing in and bundling mortgages.
Here are some key advantages to a REMIC:
· There is no minimum equity requirement, meaning the REMIC can sell all of its assets.
· Investors can get paid monthly; other types of investments limit payouts to quarterly.
· The REMIC doesn’t have to pay federal taxes, although the investors do on income.
· Risk is spread out between each security, so if one mortgage defaults it will have a smaller overall effect.
Some disadvantages include:
· REMICs can’t easily switch out mortgages as they please; once the REMIC has been created and the mortgages have been bundled, they’re stuck with them.
· REMICs are subject to state taxes, depending on the state.
· If all the mortgages default, like what’s been happening the past few years, the bulk of the investment can be lost.