Meaning: A mortgage-backed security (MBS) is an investment similar to a bond that is made up of a bundle of home loans bought from the banks that issued them. Investors in MBS receive periodic payments similar to bond coupon payments. An MBS may also be called a mortgage-related security or a mortgage pass-through.
How a MBS Works?: The mortgage-backed security turns the bank into a middleman between the homebuyer and the investment industry. A bank can grant mortgages to its customers and then sell them on at a discount for inclusion in an MBS. The bank records the sale as a plus on its balance sheet and loses nothing if the homebuyer defaults sometime down the road. The investor who buys a mortgage-backed security is essentially lending money to home buyers. An MBS can be bought and sold through a broker.
What are the types of MBS?:
1- Pass-Throughs : The pass-through mortgage-backed security is the simplest MBS, structured as a trust, so that principal and interests payments are passed through to the investors. It comes with a specific maturity date of 15 or 30 years, but the average life may be less than the stated maturity age.
2- Collateralized Mortgage Obligations: CMOs consist of multiple pools of securities which are known as slices, or tranches. The tranches are given credit ratings which determine the rates that are returned to investors. The least risky tranches offer the lowest interest rates while the riskier tranches come with higher interest rates and, thus, are generally more preferred by investors.
Mortgage-backed securities played a central role in the financial crisis that began in 2007 and went on to wipe out trillions of dollars in wealth, bring down Lehman Brothers, and roil the world financial markets.
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