Mortgage-backed Security
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Building on the definition of a bond, 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.
A bond is an obligation on behalf of the bond issuer to make interest payments to the bond holder until, at the bond matures (or comes due). At that time, the bond issuer pays the face value of the bond to the bond holder and the bond is termed matured or redeemed. The 'face' value of the bond usually remains the same throughout the life of the bond. In the case of MBSs, the bond issuer is a collection of mortgages. The interest payments to the bond holder are the interest payments being made on those mortgages. The process of securitization determines which mortgages are brought together.
There is one concept, central to MBSs, that needs to be understood. In the case of bonds, the principal is usually paid back as a single payment to the bond holder at maturity. Since in the case of mortgages, each periodic payment consists of principal and interest, this principal is paid back to the MBS holder along with the interest payment. Thus the total face value of the MBS is constantly reducing. We have a new term to help determine the principal outstanding - factor. The factor tells us what percentage of the original 'face' of the MBS remains to be repaid.
Thus, the MBS's structure is also known as a pass-through. Both interest payments and principal payments are passed through to the MBS holder.
Read more about Mortgage-backed Security: Securitization, Types, Uses, Criticisms, Market Size and Liquidity, Recording and MERS
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