What is a Mortgage Backed Security?

The phrase “mortgage backed security”, also known as an “MBS”, makes reference to debt obligations that represent claims to the cash flows from aggregated mortgage loans, which are most commonly loans on residences. These mortgage loans are bought from the banks and/or mortgage companies and combined into pools. This grouping is managed by a governmental, government-affiliated, or private entity. That entity then offers securities for sale on claims for the principal and interest payments owed from the borrowers on all of the loans in the pool. This process is called “securitization.”

The vast majority of Mortgage Backed Securities are issued through a United States agency known as the Government National Mortgage Association or “Ginnie Mae”, or else through government affiliated organizations such as the Federal National Mortgage Association also known as “Fannie Mae” and the Federal Home Loan Mortgage Corporation more commonly called “Freddie Mac”.

In addition to these government-supported MBSs, there are also private institutions such as brokerage firms, banks, and other institutions that are able to securitize mortgages. These types of products are known as “private-label” mortgage securities.

The federal agency Ginnie Mae, because it is fully backed by the US government, guarantees that investors will receive the appropriate payments from their MBS. In addition, Fannie Mae and Freddie Mac are able to offer specific guarantees despite not being actual government agencies. In fact, despite not wielding the credit of the federal government, these two organizations do enjoy the authorization to borrow funds directly from the US Treasury Department.

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