What Is the Origin of Mortgage Backed Securities?
A mortgage backed security is a type of investment, an instrument that investors can buy and use much like a bond. It channels the funds from mortgage payments into investment profit for the person who holds the security. Until the 2007-2008 housing market crash, mortgage backed securities had become a very popular investment tool, especially for large investment firms that could buy many at the same time. These securities developed as lenders sought to lower their risk and enter the investment market.
Other People Are Reading
-
Basic Mortgage Profit
-
Before mortgage backed securities began to develop, lenders would profit off the payments that borrowers paid monthly on their mortgages. These payments were split into two parts, a principal payment and an interest payment. The interest portion was controlled by the interest rate the lender set -- interest is the primary form of payment that all lenders receive from loans, so choosing rates was one of the most important decisions a lender could make when creating a mortgage.
Managing Risk
-
Lenders that wanted to manage their risk carefully made sure to raise interest rates for borrowers who had a bad credit history, or sometimes refused borrowers altogether. But as interest rates continued to fall in the housing market and more people were interested in getting mortgages, lenders created more and more risky loans. Eventually, the lending organizations realized that they were not balancing risk well in accepting so many risky borrowers, and sought to lower their chances of loss.
-
Securitization
-
The method lenders created to both make risky mortgages and ensure their profits was known as securitization. Lenders bound up mortgages in pools and sold them to large mortgage companies as investment instruments. The amount the lenders were paid for these instruments varied based on the mortgage, but the lender could receive all the money for the loan immediately rather than waiting for the monthly payments made by the borrower.
Investment
-
The mortgage companies in turn sold the mortgage backed securities to investors, who made them part of their portfolios. The securities were seen as a useful addition to options like bonds. The payments that the borrowers made would eventually flow through and become payments to the investors. However, while bonds depended on the solvency of a single company, mortgaged backed securities depended on the ability of many borrowers to pay off their loans.
-
