Mortgage-Backed Securities (MBS) are financial instruments that are the result of pooling together a group of individual mortgage loans. These loans are typically residential mortgages, for example, for purchasing homes or other real estate properties.
When a borrower takes out a mortgage loan to purchase a home, they make regular payments of principal and interest over a specified period of time. Then these payments go to the investors who hold the mortgage-backed securities representing ownership in that pool of loans.
Government-sponsored enterprises (GSEs) are the ones who typically issue and sell mortgage-backed securities. Examples of such enterprises are Fannie Mae and Freddie Mac in the United States. Private financial institutions can also issue and sell MBS. These securities can often have different risk levels or tranches which depends on the credit quality of the underlying loans.
Investors in MBS receive a share of the interest and principal payments by the borrowers in the pool. The cash flows from the mortgage loans are distributed to the investors in accordance with the terms of the MBS. These payments can provide a steady income stream for investors.
The value and performance of mortgage-backed securities depend on several factors, including changes in interest rates, prepayment rates (when borrowers pay off their mortgages early), and default rates on the underlying mortgage loans.
The complexity and risks of MBS were highlighted during the 2008 financial crisis when certain types of mortgage-backed securities experienced significant losses in value.
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