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What Are Mortgage-Backed Securities?
May 11, 2022

What Are Mortgage-Backed Securities?

by The CE Shop Team

What Is a Mortgage-Backed Security and How Do They Work? 

The journey a mortgage goes through after its closing is a key piece to the liquidity of the mortgage industry. As a homeowner you go through the mortgage pre-approval process, the loan acceptance, and the closing. After that you’ll begin making mortgage payments, but what’s your mortgage going through behind the scenes? That’s where the secondary mortgage market and mortgage-backed securities come in. 

Let’s dive in to talk about mortgage-backed securities and why we utilize them. 

What Is a Mortgage-Backed Security? 

A mortgage-backed security, also known as an MBS, is an investment comparable to a bond secured by home and other real estate loans. More specifically, they’re asset-backed securities that are created by the interest and principal from residential mortgages.  

Mortgage-backed securities are made up of bundles of home loans (with similar characteristics) that are pooled together, then bought from the banks that issued them. These bundles of mortgages are sold at a discount to government-sponsored enterprises (GSE) like Fannie Mae or Freddie Mac, federal institutions like Ginnie Mae, or sometimes to securities firms that use them as a sort of collateralized bond. The buying and selling of mortgage-backed securities happens completely within the secondary mortgage market

Real Life Example: Say you obtain a mortgage through a mortgage lending service like Rocket Mortgage. Initially your mortgage is owned, serviced, and securitized by Rocket Mortgage. Often around one month after your mortgage has begun, you will receive a notice informing you that your mortgage has been sold to an enterprise like Fannie Mae. Rocket Mortgage will still be your servicer, but your mortgage is now backed and funded by Fannie Mae. 

Check out this video by Khan Academy for more insights on mortgage-backed securities: 


What Is an Investor's Role in Mortgage-Backed Securities? 

Investors play a large role in the purchase of mortgage-backed securities. They buy these bundles of mortgages from banks and in turn, receive payments like bond coupon payments. 

Because mortgage-backed securities are as safe as the mortgage loans they back, investors tend to see this as a trusted investment. 

What Are Mortgage-Backed Securities?

A Brief History of Mortgage-Backed Securities 

Let’s take a look at the timeline that led to mortgage-backed securities and their journey over the years. 

  • 1933: The Glass-Steagal Act separates commercial and investment banking 
  • 1934: The National Housing Act of 1934 creates the Federal Housing Administration 
  • 1938: Fannie Mae is created to form a liquid secondary market for mortgages 
  • 1968: Ginnie Mae is created and issues the very first mortgage-backed security 
  • 1970: Fannie Mae is allowed to purchase private mortgages 
  • 2008: The subprime mortgage crisis sees low-quality mortgage-backed securities backed by subprime mortgages 
  • 2012: The mortgage industry recovers and high-quality mortgage-backed securities become a profit center for U.S. banks 

Today, mortgage-backed securities are sold continuously within the secondary mortgage market. As of 4/1/2022, financial institutions have issued just over $990 billion in mortgage-backed securities. 

Although your main goal as a mortgage holder is to make your monthly payments, it’s important to learn what happens to your mortgage throughout its lifespan. Mortgage-backed securities help keep the secondary mortgage market liquid, funding loans that wouldn’t otherwise be funded, giving homeowners a better chance at not only finding a lender but finding the right mortgage. 

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