Mortgage revenue bonds are bond issues that are backed by revenue generated by the collection of payments on currently active mortgages. This particular class of bonds is often issued by housing authorities and similar institutions in many cities, or even by state level housing agencies. Often, it is the funds collected from the sale of the mortgage revenue bond that are used to finance the mortgages associated with the project, a strategy that effectively allows the issuing entity to finance the project without committing its other resources.
One example of how a mortgage revenue bond issue may function can be found in the establishment of a business park by a city or town. The municipality issues the bond to cover the expense of buying the land where the park will reside. The land is divided into tracts or lots, then sold to businesses who build on the property and establish business operations. The municipality holds mortgages on those sales, and uses the monthly payments received from the businesses to pay the bondholders both their original investment, plus the amount of interest specified within the terms of the bond issue. Once the bond issue is fully settled, the city is free to use any remaining funds from the project to fund various public services, or to launch a new project.
While it is possible to structure the mortgages that back the mortgage revenue bond in any of the same ways that a conventional mortgage can be structured, the normal course of action is to make use of fixed-rate mortgage deals. Choosing to go with a fixed-rate approach rather than a floating rate for the backing mortgages makes it possible for investors to have a better idea of what type of return to expects, since that return is not subject to shifts in the average rate of interest over the life of the bond issue. At the same time, working with mortgages that are set up with a fixed interest rate makes the accounting process much simpler for the bond issuer.
Like most bond issues, a mortgage revenue bond can be structured to provide interest payments at specific points during the life of the bond, or pay all interest due to the bondholder at the point of maturity. There is some degree of risk associated with this type of bond issue, since the repayment of this debt instrument does depend on the repayment of the underlying mortgages. However, that risk is somewhat limited when compared to the volatility of other forms of investment. In addition, it is not unusual for the entity that issues the government or municipal bond to also have backup plans for covering any shortfalls associated with the issue of a mortgage revenue bond.
