Mortgage-Backed Securities (MBS) - Overview

Securities play a crucial role in the housing finance market and broader financial systems, shaping investment opportunities and risk management strategies.
Loan Against Property
APPLY
5 min
25 May 2024

What is Mortgage Backed Securities?

Mortgage Backed Securities (MBS) are financial instruments that are created by pooling together various mortgage loans and selling the consolidated debt as bonds to investors. These securities allow investors to receive regular payments derived from the underlying mortgages' principal and interest payments. MBS are structured to provide liquidity in the mortgage market and offer investors a way to invest in real estate without directly owning property. They come in various forms, such as pass-throughs and collateralised mortgage obligations (CMOs), each with different risk and return profiles. The performance of MBS is closely tied to the real estate market and borrowers' ability to repay their loans.

In the context of a loan against property (LAP), similar securitisation practices can be applied where loans secured by properties are bundled together to create investment products. This helps financial institutions manage risk and provide additional liquidity for further lending activities.

Mortgage Backed Securities are created when banks and other mortgage lenders bundle together individual mortgage loans and sell them as a single security to investors. These securities are backed by the cash flows from the underlying mortgage loans, including both principal and interest payments made by homeowners.

How do mortgage-backed securities work?

When a homeowner makes a mortgage payment, a portion of that payment goes towards paying off the principal amount borrowed, while the rest covers the interest on the loan. Mortgage-backed securities distribute these cash flows to investors in the form of periodic payments, typically every month. Investors receive a share of the principal and interest payments based on the proportion of the MBS that they own.

Types of mortgage backed securities

There are several types of mortgage-backed securities, including:

  1. Pass-through securities: These securities pass through the principal and interest payments from the underlying mortgage loans directly to the investors.
  2. Collateralised mortgage obligations (CMOs): CMOs divide the cash flows from the underlying mortgage loans into multiple tranches, each with different risk and return characteristics.
  3. Stripped mortgage-backed securities: These securities separate the principal and interest payments of the underlying mortgage loans into different securities, catering to investors with specific preferences for cash flow timing.

Advantages of investing in mortgage-backed securities

Investing in mortgage-backed securities (MBS) offers several advantages:

  1. Stable cash flows: MBS provides a steady stream of income through the interest and principal payments from mortgage loans.
  2. Diversification: MBS allows investors to diversify their portfolios by gaining exposure to the real estate market without directly owning property.
  3. Relative safety: MBS issued by government-sponsored entities or reputable financial institutions are often considered relatively safe investments due to their backing.

Risks associated with mortgage-backed securities

Despite their advantages, mortgage-backed securities carry certain risks:

  1. Interest rate risk: Fluctuations in interest rates can affect the prepayment behaviour of homeowners, impacting the cash flows and returns of MBS.
  2. Credit risk: There is a risk of default on the underlying mortgage loans, especially in the case of subprime or non-conforming mortgages.
  3. Prepayment risk: Homeowners have the option to refinance their mortgages or pay them off early, which can disrupt the expected cash flows to MBS investors.

Key players in the mortgage-backed securities market

The mortgage-backed securities market involves various participants, including:

  1. Mortgage originators: These are financial institutions that originate and underwrite mortgage loans.
  2. Government-backed entities: In India, entities like the National Housing Bank (NHB) play a significant role in the MBS market by purchasing, guaranteeing, and securitising mortgage loans.
  3. Investors: Institutional investors, such as pension funds, mutual funds, and insurance companies, are major participants in the MBS market, seeking to earn returns on their investments.

How to invest in mortgage-backed securities?

Investors can access the mortgage-backed securities market through various channels, including:

  1. Direct purchase: Investors can buy MBS directly from issuers or through brokerage firms.
  2. Exchange-traded funds (ETFs): ETFs provide a convenient way to invest in a diversified portfolio of MBS, offering liquidity and transparency.
  3. Mutual funds: Mutual funds specialising in MBS offer investors professional management and diversification across a range of mortgage-backed securities.

Consider Bajaj Finserv Loan Against Property

Loans against property (LAP) serve as a crucial component within the realm of mortgage-backed securities, contributing to the pool of underlying assets that back these securities. Institutions like Bajaj Finance offer LAP facilities, providing borrowers with the opportunity to unlock the value of their property assets for various financial needs. Bajaj Finserv Loan Against Property provides several benefits to its customers, including competitive interest rates, flexible repayment options, and quick approval processes. Here is why one should apply for a loan against property with Bajaj Finance:

  • Our loan application process for loans against property is streamlined for efficiency and clarity, ensuring a seamless experience. Simply apply online, and upon document verification, expect approval within 72 hrs.
  • Tailored to your needs, our loans against property offer personalised solutions, allowing flexibility in adjusting features such as loan amount and repayment period according to your unique requirements.
  • Benefit from competitive interest rates starting as low as 8% to 14%, giving you an advantage in managing your finances effectively.

In conclusion, mortgage-backed securities (MBS) serve as a vital link between real estate and financial markets, facilitating efficient capital allocation and risk management. Through the securitisation of mortgage loans, MBS offers investors opportunities for income and portfolio diversification while providing borrowers with access to capital. Despite the benefits, it is crucial to acknowledge the associated risks such as interest rate fluctuations and credit risks. However, with careful consideration, investors can navigate these complexities and capitalise on MBS investments.

Moreover, with products like Bajaj Finserv Loan Against Property, borrowers can leverage their property assets efficiently. With streamlined processes, tailored solutions, competitive interest rates, and convenient top-up loan facilities, Bajaj Finance enhances the accessibility and appeal of mortgage-backed securities.

Bajaj Finserv app for all your financial needs and goals

Trusted by 50 million+ customers in India, Bajaj Finserv App is a one-stop solution for all your financial needs and goals.

You can use the Bajaj Finserv App to:

  • Apply for loans online, such as Instant Personal Loan, Home Loan, Business Loan, Gold Loan, and more.
  • Invest in fixed deposits and mutual funds on the app.
  • Choose from multiple insurance for your health, motor and even pocket insurance, from various insurance providers.
  • Pay and manage your bills and recharges using the BBPS platform. Use Bajaj Pay and Bajaj Wallet for quick and simple money transfers and transactions.
  • Apply for Insta EMI Card and get a pre-approved limit on the app. Explore over 1 million products on the app that can be purchased from a partner store on Easy EMIs.
  • Shop from over 100+ brand partners that offer a diverse range of products and services.
  • Use specialised tools like EMI calculators, SIP Calculators
  • Check your credit score, download loan statements and even get quick customer support—all on the app.

Download the Bajaj Finserv App today and experience the convenience of managing your finances on one app.

Do more with the Bajaj Finserv App!

UPI, Wallet, Loans, Investments, Cards, Shopping and more

GET THE APP

Disclaimer

1. Bajaj Finance Limited (“BFL”) is a Non-Banking Finance Company (NBFC) and Prepaid Payment Instrument Issuer offering financial services viz., loans, deposits, Bajaj Pay Wallet, Bajaj Pay UPI, bill payments and third-party wealth management products. The details mentioned in the respective product/ service document shall prevail in case of any inconsistency with respect to the information referring to BFL products and services on this page.

2. All other information, such as, the images, facts, statistics etc. (“information”) that are in addition to the details mentioned in the BFL’s product/ service document and which are being displayed on this page only depicts the summary of the information sourced from the public domain. The said information is neither owned by BFL nor it is to the exclusive knowledge of BFL. There may be inadvertent inaccuracies or typographical errors or delays in updating the said information. Hence, users are advised to independently exercise diligence by verifying complete information, including by consulting experts, if any. Users shall be the sole owner of the decision taken, if any, about suitability of the same.

Frequently asked questions

What is an example of a mortgage-backed security?
An example of a mortgage-backed security is a pass-through security, where investors receive payments consisting of principal and interest from a pool of underlying mortgage loans.
What are securities backed by mortgages?
Securities backed by mortgages are financial instruments representing ownership interests in pools of mortgage loans. These securities derive their value and cash flows from the payments made by homeowners on their mortgages.
What is the difference between bonds and mortgage-backed securities?
While bonds represent debt obligations issued by corporations or governments, mortgage-backed securities are backed by pools of mortgage loans. Bonds typically offer fixed interest payments, while MBS offer variable payments based on the underlying mortgage cash flows.
What are mortgage-backed securities in India?
In India, mortgage-backed securities (MBS) represent securities backed by pools of mortgage loans. These instruments allow investors to participate in the real estate market by receiving cash flows from the underlying mortgage payments made by homeowners.
What are the risks associated with investing in mortgage-backed securities?

Investing in mortgage-backed securities involves multiple risks. The primary risk is prepayment risk, where borrowers may repay their mortgage early, affecting the overall return on investment. Extension risk is another risk factor where if interest rates rise, homeowners could delay refinancing, extending the duration of the mortgage-backed security. Other risks include market risk, where the value of the mortgage-backed security could fluctuate due to changes in the financial market, and credit risk, where borrowers could default on their mortgage, impacting your investment.

How do interest rate changes affect mortgage-backed securities?

Changes in interest rates considerably impact mortgage-backed securities. If interest rates fall, the likelihood of homeowners refinancing their mortgages to receive a lower rate increases, leading to an acceleration in the rate of repayment - this is known as prepayment risk. On the other hand, if interest rates rise, the refinancing rates decrease, extending the duration of the mortgage and leading to extension risk. Thus, the investment return could vary depending on the interest rate environment.

How is the performance of a mortgage-backed security evaluated?

The performance of a mortgage-backed security is evaluated through various methods. The yield or return on investment is a primary metric, but it is more complex due to factors like homeowner's prepayments. Analysts also consider the average life of the security, which represents the average time it takes for principal payments to be received. Additionally, the security's price sensitivity to changes in interest rates, also known as its duration, is assessed. All these factors collectively help in evaluating the performance of a mortgage-backed security.

What is extension risk in mortgage-backed securities?

Extension risk in mortgage-backed securities is a situation that occurs when interest rates rise. As rates rise, homeowners are less likely to refinance their mortgages, meaning the investors receive their principal back more slowly than anticipated. This extends the average life of the security, exposing investors to a longer period of risk. The result is that the security's sensitivity to further interest changes increases, often causing the value of the mortgage-backed security to decline. It is therefore crucial for an investor to gauge the extension risk before investing.

Show More Show Less

Related videos