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Sat, Mar 15, 2025, 1:44 PM 6 min read
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Mortgage-backed securities (MBS) are investments made up of bundled residential or commercial mortgages sold to investors. As homeowners make their monthly payments, investors receive returns. These securities help lenders continue issuing new loans, keeping the housing market active. Some MBS are backed by government agencies, while others carry more risk depending on borrower repayment. A financial advisor can help assess MBS investment risks, compare options and determine if they fit your overall portfolio strategy.
Mortgage-backed securities (MBS) transform individual home loans into tradable financial assets. The process works like this:
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Banks and mortgage lenders originate home loans.
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Individual loans are combined into pools of similar loans.
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Pools are packaged as securities.
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These securities are sold to government-sponsored enterprises or private investors.
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Investors who buy these securities receive the interest and principal payments made by borrowers who took out the loans.
While MBS provide opportunities for steady income, their value fluctuates with the housing market and credit conditions, making them sensitive to economic cycles. Prepayment risk is a key consideration for MBS investors. If homeowners refinance or pay off mortgages early, it can affect cash flows to investors.
Mortgage-backed securities come in several forms, each with distinct structures and risk profiles. The primary types are pass-through securities and collateralized mortgage obligations (CMOs). Additional variations exist within these broad categories. The performance of MBS of any variety depends on factors like interest rates, borrower repayment behavior and broader economic trends.
Pass-through securities are the simplest form of MBS. These securities pool together mortgage loans and pass the principal and interest payments directly to investors. They often have fixed interest rates and predictable cash flows, but they remain susceptible to prepayment risk, which can impact the duration and returns of the investment. Since they are not actively managed, pass-through securities provide a cost-efficient and straightforward way for investors to gain exposure to the mortgage market.
CMOs break mortgage pools into tranches, or segments, that offer different levels of risk and return. Some tranches receive payments first and have lower risk, while others carry higher yields but face greater uncertainty in cash flows.
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