What Are Mortgage-backed Securities?
Mortgaged-backed securities offer investors the opportunity to purchase a share of the revenue and income flow that mortgage pools generate. Government institutions and, in some cases, private trusts called Real Estate Investment Trusts (REITs) purchase mortgages from banks and lenders, combine them, and offer investors the option of buying a security on the resulting cash flow. Since most of these pools are run by government institutions like Freddie Mac and Fannie Mae, they often come with a government guarantee. This guarantee further minimizes the risk for investors, which is a significant contributing factor to the favorability of mortgage-backed securities.
How Do Mortgage-backed Securities Work?
When a bank or lender agrees to lend money to a mortgage borrower, or homeowner, the borrower begins to make monthly payments. Traditionally, those monthly payments go to the lender or bank, and the process ends there. However, it’s standard practice for banks or lenders to turn around and sell those mortgages to government entities like Ginnie Mae, Fannie Mae, and Freddie Mac or REITs.
At that point, the original lender is still able to facilitate the loan, but the money they’re getting each month for that loan passes through them to the entity that purchased the loan. That is why the process is often called a “pass-through.” The entity that purchased the loan isn’t just buying the one loan, though.
They go to various lenders and banks and obtain loans of a similar type with similar characteristics. They then pool those mortgages together, creating what can sometimes be a massive pool of monthly income. Then, these entities sell a portion of this pool, or security, to investors. Hence, the investor winds up owning a part of this massive monthly income stream and is paid out each month for both the principal and the interest payments funneled into the pool. Essentially, you as the investor are paying to be on the receiving end of a portion of the mortgage payments funneled into the pool.
Are Mortgage-backed Securities Right For You?
Mortgage-backed securities are an attractive investment option for many reasons. First, they offer monthly income, whereas many other investment opportunities make you wait for quarterly payments. Second, your payment includes both the principal and the interest, which increases the amount of money coming your way. Third, they’re backed by government guarantees if you go through one of the governmental organizations. Finally, they offer high yields and low risk. Based on long-term debt, when paired with the high cash flow, these securities put many investors at ease.
It’s true that there are many benefits to investing in mortgage-backed securities. However, no investment opportunity is perfect, and you should consult with a reputable investment professional who can look at your particular situation and portfolio and advise you accordingly.