The Theory and Practice of Investment Management: Asset Allocation, Valuation, Portfolio Construction, and Strategies, Second Edition

RESIDENTIAL MORTGAGE-BACKED SECURITIES

Real estate-backed securities are securities backed by a pool (collection) of mortgage loans. Residential or commercial properties can be used as collateral for such securities. Real estate-backed securities backed by residential mortgage loans include mortgage passthrough securities, stripped mortgage-backed securities, and collateralized mortgage obligations. In this section, we describe residential mortgage-backed securities (RMBS) and in the next section we focus on commercial mortgage-backed securities (CMBS).

Mortgages

The raw material for a mortgage-backed security (MBS) is the mortgage loan. A mortgage loan, or simply mortgage, is a loan secured by the collateral of some specified real estate property, which obliges the borrower to make a predetermined series of payments. The mortgage gives the lender the right if the borrower defaults (i.e., fails to make the contracted payments) to “foreclose” on the loan and seize the property in order to ensure that the debt is paid off. The interest rate on the mortgage loan is called the mortgage rate or contract rate. Here our focus is on residential mortgage loans.

When the lender makes the loan based on the credit of the borrower and on the collateral for the mortgage, the mortgage is said to be a conventional mortgage. The lender also may take out mortgage insurance to guarantee the fulfillment of the borrower’s obligation. Some borrowers can qualify for mortgage insurance guaranteed ...