About MBS/ABS
Mortgage Securities: An Overview
A mortgage security represents an ownership interest in mortgage loans made by financial institutions to finance the borrower’s purchase of a home or other real estate. They are created when these mortgage loans are packaged, or “pooled,” by issuers or servicers, and securities are issued for sale to investors. As the underlying mortgage loans are paid off by the borrowers, the investors in the securities receive payments of interest and principal. In this on-line guide, the generic term “mortgage pass-through securities” will be used to refer to these types of securities, while the term “mortgage securities” will be used to refer to both mortgage pass-through securities and CMOs.
Mortgage securities play a crucial role in the availability and cost of housing in the United States. The ability to securitize mortgage loans enables mortgage lenders and mortgage bankers to access a larger reservoir of capital, to make financing available to home buyers at lower costs and to spread the flow of funds to areas of the country where capital may be scarce.
Before the 1970’s, banks were essentially portfolio lenders – they would hold loans made in their portfolios until they either matured or were paid off. These loans were financed by bank deposits and occasionally debt obligations of the bank itself. However, after World War II, depository institutions were unable to keep pace with the rising demand for household credit.
Asset securitization began when the first mortgage pass-through security was issued in 1970, with a guarantee by the Government National Mortgage Association (GNMA or Ginnie Mae). The most basic mortgage securities, known as pass-throughs or participation certificates (PCs), represent a direct ownership interest in a pool of mortgage loans. Shortly after this issuance, both the Federal Home Loan Mortgage Corporation (FHMLC or Freddie Mac) and Federal National Mortgage Association (FNMA or Fannie Mae) began issuing mortgage securities.
Mortgage pass-through securities may be pooled again to create collateral for a more complex type of mortgage security known as collateralized mortgage obligations (CMOs). CMOs may also be referred to as a Real Estate Mortgage Investment Conduit (REMIC). CMOs and REMICs (terms which are often used interchangeably) are multiclass securities which allow cash flows to be directed so that different classes of securities with different maturities and coupons can be created. They may be collateralized by raw mortgage loans as well as already-securitized pools of loans. The first CMO was issued in 1983. Three years later the Tax Reform Act of 1986 was passed, allowing mortgage securities to be issued in the form of a Real Estate Mortgage Investment Conduit (REMIC), which passes certain tax advantages to both issuers and investors. Since then, most CMOs have been issued in REMIC form.
All information and opinions contained in this publication were produced by the Securities Industry and Financial Markets Association from our membership and other sources believed by the Association to be accurate and reliable. By providing this general information, the Securities Industry and Financial Markets Association makes neither a recommendation as to the appropriateness of investing in fixed-income securities nor is it providing any specific investment advice for any particular investor. Due to rapidly changing market conditions and the complexity of investment decisions, supplemental information and sources may be required to make informed investment decisions.