A mortgage-backed security (MBS) is an asset-backed security that represents a claim on the cash flows from mortgage loans through a process known as securitization.

Securitization

The process of securitization is complicated, and is highly dependent on the jurisdiction within which the process is conducted. The basics are:

  1. Mortgage loans (mortgage notes) are purchased from banks and other lenders and assigned to a trust
  2. The trust assembles these loans into collections, or "pools"
  3. The trust securitizes the pools by issuing mortgage-backed securities

While a residential mortgage-backed security (RMBS) is secured by single-family or two to four family real estate, a commercial mortgage-backed security (CMBS) is secured by commercial and multifamily properties, such as apartment buildings, retail or office properties, hotels, schools, industrial properties and other commercial sites. A CMBS is usually structured as a different type of security than an RMBS.
These securitization trusts include government-sponsored enterprises and private entities which may offer credit enhancement features to mitigate the risk of prepayment and default associated with these mortgages. Since residential mortgages in the United States have the option to pay more than the required monthly payment (curtailment) or to pay off the loan in its entirety (prepayment), the monthly cash flow of an MBS is not known in advance, and therefore presents risk to MBS investors.
In the United States, the most common securitization trusts are Fannie Mae and Freddie Mac, U.S. government-sponsored enterprises. Ginnie Mae, a U.S. government-sponsored enterprise backed by the full faith and credit of the U.S. government, guarantees its investors receive timely payments, but buys limited numbers of mortgage notes. Some private institutions, such as Investment Banks, Real Estate Mortgage Investment Conduits (REMICs) and the Real Estate Investment Trusts (REITs), also securitize mortgages, known as "private-label" mortgage securities.Issuances of private-label mortgage-backed securities increased dramatically from 2001 to 2007, and then ended abruptly in 2008 when real estate markets began to falter.


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