Three Main Uses Provide Income Capital Appreciation Tax-deferred Savings

What is it?
Mortgage Backed Securities (MBS), sometimes referred to as pass through certificates, are an investment instrument that represents ownership of an undivided interest in a group of mortgages. Principal and interest from the individual mortgages are used to pay principal and interest on the MBS.


When you invest in a Mortgage Backed S ecurity you are lending money to a home buyer or business. MBS are a way for small regional banks to give mortgages to their customers without having to worry if they have the assets to cover the loan. Instead they act as a middleman between the home buyer and the investment markets.

Who pools these mortgages together? The majority of MBS are issued and backed by government sponsored corporations like the Government National Mortgage Association (Ginnie Mae), Federal Home Loan Mortgage Corporation (Freddie Mac), Federal National Mortgage Association (Fannie Mae). Each entity offers a slightly different variation in the securities they issue. Ginnie Mae MBS are typically the most popular and widely held because they are backed by the U.S. Government, whereas Fannie Mae is government sponsored but also trades as a public company.

Objectives and Risks:
Mortgage Backed Securities are an undiscovered gem. While these securities are primarily used to provide safe income there is also the opportunity to get some capital appreciation as interest rates fall. Another advantage to MBS is that they are very suitable for most tax-deferred savings accounts.

Generally pass-throughs are traded actively similar to the way that bonds are, so there is very little liquidity risk. Furthermore pass-throughs are considered to be an extremely safe investment, often said to have the same credit worthiness as treasuries but offering a 1-2% greater return. Monthly income from MBS can vary as interest rates change because mortgages can be prepaid, and when interest rates are falling prepayments tend to rise. Prepayments only shorten the life of the MBS and are passed directly to the investors.

How to Buy or Sell it:
Mortgage Backed Securities can be purchased at almost any full service broker. More and more discount brokers are offering MBS as well. These securities don't come cheap, most are sold in chunks of $25,000. There are some variations of MBS (called CMOs) that can sell for under $5,000.

Strengths:

very low risk investments that offers a 1-2% higher return than comparable low risk securities. most MBS are either fully backed or sponsored by the U.S. government.

Weaknesses:

minimum investment can be fairly high, upwards of $25,000. outside of a retirement account there are virtually no tax advantages of owning an MBS. The income from an MBS is taxed as regular income.

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