What Are Mortgage Backed Securities?
Mortgage backed securities were first issued in the late 1960s, but they weren’t widely used until the mid-1970s. The concept began with a bond traded by Lewis Ranieri, a bond trader at Salomon Brothers. Ranieri was looking for an alternative to the local savings and loan banks, which were unable to offer high interest rates due to long payoff periods. Freddie Mac and Fannie Mae eventually made a deal to be backed by the Federal Housing Finance Agency. Since then, the market has grown and diversified, with financial institutions issuing more than $290 billion in mortgage backed securities.
Pass-through mortgage securities, also known as CMBS, are a common type of MBS. In this case, the underlying mortgages are pooled and the issuer collects the principal and interest payments and distributes them to the investors. Pass-through securities are usually structured to mature in five to thirty years, and the payment schedule depends on the method of mortgage payments. Mortgage pass-through securities are the most popular type of MBS.
These securities are not as risky as they sound, and investors can buy them from a government-sponsored entity, which is the safest way to buy them. While government-sponsored entities do have some backing from the Treasury, they don’t offer as much protection as they can for private investors. In return, investors receive monthly interest payments and a percentage of principal that is paid to the homeowners. The money is generated by homebuying and refinancing, which keep the money flowing in the market for MBS.
Another common type of MBS is structured through securitization trusts, which are governed by the federal government and private entities. Investors must be aware of the relationship between interest rate and prepayment risk. As a result, the theoretical pricing models of these securities must account for this relationship. Moreover, the varying liquidity premiums of related instruments make it difficult to calculate the value of an MBS. However, some practitioners try to improve these models by adding a factor called pool factor to express the price of an MBS.
A good mortgage backed security is backed by a large amount of mortgages. The investment requires substantial amounts of money and careful research. It is advisable to get professional advice before purchasing MBS. As with any investment, the investment is not suitable for the inexperienced. There are many risks involved in investing in this type of securities and a broker is required to place orders for you. Therefore, if you don’t have the time and expertise, it’s a good idea to hire a financial expert to help you navigate the process.
In recent years, mortgage backed securities have gained popularity. The MBS market was one of the catalysts for the financial crisis. As borrowers’ defaulted and the housing market collapsed, MBSs have fallen in value. A lack of liquidity has also affected other capital markets. However, borrowers need to remember that the interest rates on mortgage backed securities will fluctuate over time. This is why they should check their rates regularly and get the best deal.