Mortgage-Backed Securities (MBS) are types of investment securities that are backed by mortgages. These securities allow investors to profit from the mortgage business without having to buy or sell actual home loans. MBS are created when a number of mortgages are bundled together and sold to an investment bank, which then packages them into a single security.
When homebuyers take out mortgages, lenders often sell these loans to investment banks. The banks then bundle these loans into MBS and sell them to investors. The monthly mortgage payments made by homebuyers are passed through to MBS investors, providing them with regular income.
There are two main types of MBS: pass-through securities and collateralized mortgage obligations (CMOs). Pass-through securities involve pooling mortgages with similar characteristics and passing the monthly payments directly to investors. CMOs, on the other hand, are more complex and structured, dividing the mortgage pool into different classes, or tranches, each with varying degrees of risk and return.
Investing in MBS can offer regular income and diversification, but they also come with risks. These include prepayment risk (where homeowners pay off their mortgages early), interest rate risk, and default risk. The level of risk varies based on the type of MBS and the quality of the underlying mortgages.
MBS played a significant role in the financial crisis of 2007-2008. Many MBS were backed by subprime mortgages, which had a higher risk of default. When the housing market collapsed, the value of these MBS plummeted, contributing to the financial crisis.
Mortgage-Backed Securities are an essential component of the financial market, offering opportunities and risks to investors. They have a significant impact on the mortgage and housing markets and can influence economic conditions.