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Related to Mortgage-backed security: Collateralized debt obligation, Credit Default Swaps, Residential Mortgage Backed Security
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.
Mortgage-backed securities are created when the sponsor buys up mortgages from lenders, pools them, and packages them for sale to the public, a process known as securitization.
The securities are available through publicly held corporations such as Fannie Mae and Freddie Mac or other financial institutions. Some of the securities are guaranteed by the Government National Mortgage Association, or Ginnie Mae.
The money raised by selling the bonds is used to buy additional mortgages, making more money available to lend.
The most common mortgage-backed securities, also known as pass-through securities, are self-amortizing, and pay interest and repay principal over the term of the security.
Mortgage-backed securities known as collateralized mortgage obligations (CMOs) or real estate mortgage investment conduits (REMICs) are structured differently. While a CMO or REMIC pays interest on a regular basis, the principal payments are structured in what are known as tranches and mature in sequence.
The principal is repaid to bondholders in the order in which the tranches are stacked, so the holders of the shortest-term tranche are paid principal first, the next shortest second, and so on.
You can buy individual mortgage-backed securities or select mutual funds, such as Ginnie Mae funds, that invest in mortgage-backed securities.