- Pre-payment risk;
- Contraction risk; and
- Extension risk.
Prepayment risk is the risk that declining interest rates or a strong housing market will cause the mortgage holders to refinance or otherwise repay their loans sooner than originally expected. This could then create an early return of principal to holders of these loans.
For mortgage-related securities, contraction risk is the risk that declining interest rates will accelerate the assumed prepayment speeds of mortgage loans, returning principal to investors sooner than originally expected and compelling them to reinvest at the
prevailing lower rates.
Conversely, extension risk is the risk that rising interest rates will slow the assumed prepayment speeds of mortgage loans. This will essentially delay the return of principal to investors and could actually cause them to miss an opportunity to reinvest their funds
at a higher yield.
The U.S. government offers several types of government debt:
- Treasury bills
- Treasury notes
- Treasury bonds
- Treasury Inflation Protected Securities (TIPS).
TIPS are unique in that the principal amount is adjusted according to the current formula used to calculate the Consumer Price index (CPI). The principal can be adjusted upward or downward as inflation or deflation is determined. The interest rate remains the same. TIPS are offered for sale in maturities of five, 10 and 30 years.
During the recent past (2009-2010), the U.S. government calculated that the Consumer Price Index should remain unchanged due to the lack of inflation. As we previously discussed, many criticize the current CPI of being an inaccurate measure of the true impact of the cost of food, fuel and housing.
You be the judge. Has your cost of food, fuel and housing remained the same since the beginning of 2009? If you answered “no,” then you can see that TIPS principal inflation adjustment may be a good idea, but will still significantly lag behind inflationary reality.
TIPS values are based on a government-manipulated formula that excludes the basic and inflation-sensitive commodities of food and fuel, meaning that you will not receive complete protection from inflation. As with so many things in life, the devil is in the fine print.
Too many families needlessly lose everything they have. Don’t let that be you. If you need help building a fortress around your estate to protect it from creditors, predators, and the cost of chronic disease, give our office a call at 800-310-3100. Your first consultation is absolutely free. We’ll let you know what steps you need to take, right now, to protect yourself and your family. Call now, because when you’re out of money, you’re out of options!
Rick L. Law, Attorney, Estate Planner for Retirees.
Rick was named the #1 Illinois elder law estate planning attorney by Leading Lawyer Magazine. He has been quoted in the Wall Street Journal, AARP Magazine, TheStreet.com, and numerous newspapers and articles. Rick is the lead attorney for Law Elder Law, LLP, focusing in Estate Planning, Guardianship, and Nursing Home Solutions. His goal is to give retirees an informed edge when it comes to dealing with an uncertain future. Get flexible retirement strategies that work during good times and bad, plus information on how you can save your home and assets from being used to pay for long term care. Appointments available in Chicago, Aurora, Oak Brook, Schaumburg, and Joliet. Call 800-310-3100 for your free consultation now!
By Rick Law, Elder Law Attorney in Illinois.
Today let’s talk about a common investment that many seniors have in their investment portfolio. Mortgage backed securities (bonds) while “safe” may not provide the “ROI” (return on investment) that you’re looking for in today’s economy.
Some risks associated specifically with mortgage-backed securities include