Bonds: The Unbeaten Path to Secure Investment Growth

Chapter 9. U.S. AGENCY and Other MORTGAGE-BACKED SECURITIES

THIS CHAPTER DESCRIBES two types of mortgage securities. We first start with mortgage pass-through securities that are guaranteed by an agency. They're called "agency mortgage securities." We then describe the more complex "collateralized mortgage securities" that may or may not have an agency guarantee.

In its basic form, a mortgage pass-through security (generally known as a mortgage-backed security) represents an ownership interest in a number of similar mortgage loans made by financial institutions such as savings and loans, commercial banks, and mortgage companies. When these mortgage loans are combined or pooled, they become mortgage-backed securities. U.S. government agencies issue and/or guarantee many of these mortgage-backed securities. For simplicity's sake we'll refer to mortgage-backed securities as mortgage securities. The cash flow, consisting of both principal and interest payments, from the pool of mortgage loans, reduced by fees, is passed through to holders of the mortgage securities.

A Complex Structure

Although there's a lot of money to be made from these financial instruments, their complex structure makes them more difficult to understand than other investments. It helps first to understand how a mortgage security's underlying asset, a simple mortgage loan, is created. Mortgages came into being because most people have only enough money for a down payment when purchasing a house. They require help in ...