Are you considering investing in mortgage backed securities, or perhaps you’re simply curious as to what they are? If so, you’ve come to the right article. We’ll explain what mortgage backed securities are, how you can invest in them, why they are important, and other key details.
For securities that were traditionally seen as relatively “ho-hum”, mortgage backed securities, or “MBS” for short, have gained a lot of attention over the past several years. These securities were at the center of the 2008 financial crisis, from which the world is still recovering. In fact, mortgage based securities have even been the topic of popular movies, like “The Big Short,” and others.
What are Mortgage Backed Securities?
So what is a mortgage backed security anyways? Let’s break down the terms so we can unravel what exactly these assets are. Often, it helps to analyze financial turns backwards to front. First, we know that a MBS is a security, which is a fungible, negotiable financial asset. In other words, it is something you can invest in and trade. The next part of the term is “mortgage backed”, which means that the security’s value is based on mortgages.
Mortgages, in turn, refer to loans given out for houses. The mortgage itself is backed by the house or property, and as such are generally regarded as quite safe. Loans that are backed by collateral are, in general, viewed as safer investments because if the loan goes bad, the lender still has the collateral.
A mortgage backed security is thus a type of asset in which the value of the investment vehicle is tied to mortgages. Basically, when you invest in a MBS, you are loaning money to people who are looking to buy houses. Normally, you will invest in a pool of mortgages. If you invested say $1,000 dollars into a mortgage backed security made up of 1,000 mortgages, you’d be loaning each person a dollar, more or less.
Usually, rating agencies give high ratings to mortgage backed securities. In fact, to qualify as a MBS they must secure one of the top two scores. The mortgages must also must have originated from an accredited bank. This helps ensure that the mortgages are of a high quality.
Mortgage bonds is another similar term used. With a mortgage bond, the bond itself is backed by the collateral of the houses under mortgage. These bonds are often viewed as safer than many other types of bonds due to the collateral tied to the bond.
What Role Did MBS’S Have in the Financial Crisis?
First, it’s important to acknowledge that this is a rather contentious argument. Some people believe that mortgage backed securities were the sole cause of the 2008 financial crisis. Others believe that they had very little to do with it. The actual role is thus somewhat debatable.
It does appear that mortgage backed securities did play an important role in the crisis. At the time, banks were not being very careful with how they designed MBS’s. In other words, they didn’t pay as much attention to the content of the security itself. As a result, many securities that investors thought were filled with high quality mortgages were, in fact, filled with junk mortgages.
These mortgages soured, people stopped making payments, and then the MBS’s themselves essentially became worthless. This set off a domino effect with cheap, abandoned homes suddenly flooding the market. Property values collapsed, more people stopped paying their mortgages, and the situation got worse and worse.
The debate still isn’t settled, however. If you’re curious about the role of MBS’s in the 2008 economic crisis we recommend you do a bit more research.
What Is A CMBS?
Another mortgage-based security is a CMBS. The last three letters stand for mortgage-backed-security, can you guess what the first letter stands for? If you guessed “commercial”, then you guessed right! These securities are very similar to traditional house-based MBS’s, but are tied to commercial properties instead.
How About a HELOC?
HELOC, meanwhile, refers to a home equity line of credit. This means a person can borrow money and use their house as equity. The money isn’t used to buy a house, but is instead invested elsewhere, such as in a small business. A HELOC is basically a second mortgage, allowing home owners to tap into the value of their homes.