Posted in Finance, Accounting and Economics Terms, Total Reads: 314
Definition: Pass-Through Rate
The pass-through rate is the interest amount, normally known as net interest, which the issuer of a loan-backed security shall pay to investors, once all costs and fees related to servicing the investment have been paid for. This rate is typically the return that investors get by choosing to invest in the securities.
This rate of interest is known as a pass-through because of the fact that the amount forwarded to the investors passes from the payments on the underlying loans, through the paying agent, and finally to the investor.
One thing important to note here is that the pass-through rate is always less than the average interest rate that is given by the borrower on the loans which are used to back the security. This is because many types of fees are subtracted from the interest paid. These fees involve general management fees for conducting transactions in relation to the securities involved, as well as any type of charge for guarantees linked with the investment itself. Generally, these fees are brought up as percentage of the interest coming in, although in sometimes the fees are flat rates that are explained in the terms and conditions covering the issuance of the securities.
For example, if an agency takes $1 million worth of loans, each of which pays 5% interest, and turns them into a 4.6% mortgage-backed security. The 4.5% shows the pass-through rate, and the agency makes the remaining 0.4% as a commission of the proceeds.