Mortgage-Backed Security (MBS)
Quick Definition
A bond-like investment created by pooling mortgage loans and selling shares of the cash flows to investors.
Key Takeaways
- Created by pooling mortgage loans and securitizing the cash flows
- Agency MBS (Fannie, Freddie, Ginnie) carry government guarantees
- Prepayment risk is the primary risk — borrowers refinance when rates drop
- The U.S. MBS market exceeds $11 trillion in outstanding securities
What Is Mortgage-Backed Security (MBS)?
A mortgage-backed security (MBS) is a type of asset-backed security formed by pooling thousands of individual mortgage loans and issuing bonds backed by the principal and interest payments from those mortgages. Agency MBS, guaranteed by government-sponsored enterprises like Fannie Mae, Freddie Mac, or Ginnie Mae, are among the safest and most liquid fixed-income securities after Treasuries. Non-agency (private-label) MBS carry credit risk and were at the center of the 2008 financial crisis. MBS investors face prepayment risk — when homeowners refinance or sell, principal is returned earlier than expected, typically when rates fall and reinvestment opportunities are less attractive. The MBS market is enormous, exceeding $11 trillion in the U.S.
Mortgage-Backed Security (MBS) Example
- 1Fannie Mae pools 5,000 individual 30-year mortgages into a single MBS that investors can buy and trade
- 2When mortgage rates drop from 6% to 4%, MBS holders face heavy prepayments as homeowners refinance
Related Terms
Asset-Backed Security (ABS)
A financial security collateralized by a pool of assets such as loans, leases, credit card debt, or receivables.
Collateralized Debt Obligation (CDO)
A complex structured finance product that pools various debt instruments and repackages them into tranches with different risk levels and returns.
Reinvestment Risk
The risk that cash flows from a bond (coupons or principal) will be reinvested at lower interest rates than the original investment.
Agency Bond
A bond issued by a government-sponsored enterprise (GSE) or federal agency, offering higher yields than Treasuries with near-government credit quality.
Bond
A fixed-income debt security where investors loan money to an issuer in exchange for regular interest payments and return of principal at maturity.
Treasury Bond (T-Bond)
A long-term U.S. government debt security with a maturity of 20 or 30 years, paying semiannual coupon interest.
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