What is a mortgage-backed security?
If you took out a mortgage loan to pay for your home, the odds are high that your mortgage is backing up a publicly traded security. This sounds complicated. But mortgage-backed securities are actually a common and important investment type today.
Here’s how the process usually works:
First, a homeowner takes out a mortgage from a lender.
The lender sells that mortgage loan. Often, lenders will sell the loan to what is known as a government-sponsored enterprise. Usually, this will be Fannie Mae or Freddie Mac. The lender might also sell the loan to a private institution such as a bank. Homeowners themselves might not know that their loan has been sold if their lender continues to service it. (Your lender is still servicing your loan if you are still sending mortgage payments to it each month.)
The government agency or private institution takes several of the mortgage loans it has bought and bundles them into a pool of loans. There is no set number of
loans that is required to make up a pool; the actual number is left to the discretion of the bank, financial institution or agency. These pools of loans generate regular income as homeowners continue to send in their monthly mortgage payments.
The owners of these pools then sell claims on the cash flow that they are generating to investors. These claims come in the form of securities, or, as you might call them, bonds.
If you want to invest in a mortgage-backed security, you’ll have to do so through a government agency or private institution. Ginnie Mae, Freddie Mac and Fannie Mae account for the majority of mortgage-backed security investment opportunities today. Plenty of people want to invest in these securities. Mortgage-backed securities are the largest sector of the U.S. bond market today.
If you’re interested in investing your dollars in a mortgage-backed security, we suggest contacting your financial planner. This professional can help you navigate the fundamentals of this investment opportunity.
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