Origins
The origins of modern residential mortgage-backed securities can be traced back to the Government National Mortgage Association (Ginnie Mae), although variations on mortgage securitization existed in the U.S. in the late 1800s and early 1900s. In 1968, Ginnie Mae was the first to issue a new type of government-backed bond, known as the residential mortgage-backed security. This bond took a number of home loans, pooled the monthly principal and interest payments and then used the monthly cash flows as backing for the bond(s). The principal of these mortgages was guaranteed by Ginnie Mae, but not the risk that borrowers pay off the principal balance early or opt to refinance the loan, a set of possible future outcomes known as "prepayment risk." Selling pools of mortgages in this way allowed Ginnie Mae to acquire new funds with which to buy additional home loans from mortgage brokers which furthered the agency's Congressionally mandated mission to "expand affordable housing".
Because these bonds had the full faith and backing of the United States government, they received high credit ratings and "paid an interest rate that was only slightly higher than Treasury bonds." Following the success of Ginnie Mae's offerings, the other two government-sponsored housing agencies, Fannie Mae and Freddie Mac, began offering their own versions of RMBS. The government's guarantee of the mortgage loans assured investors that if the borrower defaulted, they would be repaid in full. But in return for that guarantee, borrowers were held to strict underwriting standards. For example, with Fannie Mae, homebuyers had to make a minimum down payment of 10 percent of the home value, and the buyer's income had to be well documented and preferably from a periodic salary.
Read more about this topic: Residential Mortgage-backed Security
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