Mortgage-backed security

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A mortgage-backed security (MBS) is a type of asset-backed security (an "instrument") which is secured by a mortgage or collection of mortgages. The mortgages are aggregated and sold to a group of individuals (a government agency or investment bank) that securitizes, or packages, the loans together into a security that investors can buy. Bonds securitizing mortgages are usually treated as a separate class, termed residential;^[1] another class is commercial, depending on whether the underlying asset is mortgages owned by borrowers or assets for commercial purposes ranging from office space to multi-dwelling buildings.

The structure of the MBS may be known as "pass-through", where the interest and principal payments from the borrower or homebuyer pass through it to the MBS holder, or it may be more complex, made up of a pool of other MBSs. Other types of MBS include collateralized mortgage obligations (CMOs, often structured as real estate mortgage investment conduits) and collateralized debt obligations (CDOs).^[2]

In the U.S. the MBS market has more than $11 trillion in outstanding securities and almost $300 billion in average daily trading volume.^[3]

A mortgage bond is a bond backed by a pool of mortgages on a real estate asset such as a house. More generally, bonds which are secured by the pledge of specific assets are called mortgage bonds. Mortgage bonds can pay interest in either monthly, quarterly or semiannual periods. The prevalence of mortgage bonds is commonly credited to Mike Vranos.

The shares of subprime MBSs issued by various structures, such as CMOs, are not identical but rather issued as tranches (French for "slices"), each with a different level of priority in the debt repayment stream, giving them different levels of risk and reward. Tranches of an MBS—especially the lower-priority, higher-interest tranches—are/were often further repackaged and resold as collateralized debt obligations.^[4] These subprime MBSs issued by investment banks were a major issue in the subprime mortgage crisis of 2006–2008.

The total face value of an MBS decreases over time, because like mortgages, and unlike bonds, and most other fixed-income securities, the principal in an MBS is not paid back as a single payment to the bond holder at maturity but rather is paid along with the interest in each periodic payment (monthly, quarterly, etc.). This decrease in face value is measured by the MBS's "factor", the percentage of the original "face" that remains to be repaid.

In the United States, MBSs may be issued by structures set up by government-sponsored enterprises like Fannie Mae or Freddie Mac, or they can be "private-label", issued by structures set up by investment banks.