Mortgage-Backed Securities

Mortgage-backed securities (MBSs)

Securities backed by a pool of mortgage loans.

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Mortgage-Backed Security

A derivative whose value is derived from unpaid mortgages. This entitles the owner to a claim on the principal and interest payments on the particular mortgages backing the security. MBSs pay an interest rate that is usually related to the interest rates the homeowners are paying on their mortgages. The equivalent of the coupon on a mortgage-backed security is a percentage of the interest and principal paid on the mortgages backing the security. An obvious risk to an MBS is the possibility that interest rates may decline, causing homeowners to refinance their mortgages. This provides capital to MBS holders, but it comes at a time when purchasing more MBSs would yield less due to the decline in interest rates. More complicated versions of MBSs include the collateralized mortgage obligation and the mortgage derivative. These attempt to reduce the risk associated with declines in interest rates.

Another risk associated with mortgage-backed securities is the possibility that a substantial number of mortgages will default. A main proximate cause of the credit crunch, which began in 2006-2007, was the fact that many mortgage-backed securities backed by subprime mortgages began to default. See also: Credit risk, Liquidity risk, Credit crunch.

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Mortgage-Backed Securities (MBSs)

What Does Mortgage-Backed Securities (MBSs) Mean?

Refers to a type of asset-backed security secured by a mortgage or a collection of mortgages and grouped in one of the top two ratings as determined by a credit rating agency such as Moody's; usually make periodic payments that are similar to coupon payments. Furthermore, the mortgages must have originated from a regulated and authorized financial institution. Also known as a mortgage-related security or a mortgage pass-through. MBSs shift the loan risk from the originator to the agencies that bundle the mortgages into securities rather than to the investors who ultimately purchase the MBSs.

Investopedia explains Mortgage-Backed Securities (MBSs)

When one invests in a mortgage-backed security, one essentially is lending money to a home buyer or business. An MBS is a way for a smaller regional bank to lend mortgages to its customers without having to worry about whether the customers have the assets to cover the loans. Instead, the bank acts as a middleman between the home buyer and the investment markets. This type of security also is used commonly to redirect the interest and principal payments from the pool of mortgages to shareholders. These payments can be broken down further into different classes of securities, depending on the riskiness of different mortgages as they are classified under the MBS.

Related Terms:
• Collateralized Mortgage Obligation—CMO
• Credit Crunch
• Securitization
• Subprime Loan
• Subprime Meltdown