What Is a Mortgage-Backed Security (MBS)?

A mortgage-backed security (MBS) is a bond backed by a pool of home loans. Investors who buy it receive a share of the principal and interest that the borrowers in the pool pay each month. Most MBS are issued or guaranteed by Ginnie Mae, Fannie Mae, or Freddie Mac, which promise investors their payments even when borrowers fall behind. If your own mortgage ends up in a pool, your rate, payment, and loan terms stay the same.

What does it mean to bundle mortgages?

Bundling mortgages means grouping many home loans into a pool and selling securities that pay investors from that pool's payments. The SEC calls this securitization. It works in four steps:

1. A lender makes the loans. Banks, credit unions, and mortgage companies lend to homebuyers and homeowners who refinance.
2. The loans are pooled. Loans with similar features, such as a 30-year fixed rate, are grouped together. Fannie Mae holds each of its pools in a separate trust.
3. Securities are issued. Each security entitles its holder to a share of the pool's payments. In the simplest type, a pass-through, every holder gets the same proportional share of all principal and interest.
4. Investors buy them. Ginnie Mae lists banks, hedge funds, pension funds, insurance companies, and international investors among the buyers. The lender gets cash back to make new loans.

A bundle is not a single loan sold whole. One security is backed by many loans, and an investor owns a fraction of the whole pool, not any particular house's mortgage.

Who creates MBS, and who guarantees them?

Ginnie Mae's guarantee sits behind several layers. The FHA, VA, or USDA insurance covers losses on the loans. The lender that issued the pool, which also services the loans, must advance missed payments from its own funds. Ginnie Mae pays investors only if that lender fails.

Fannie Mae and Freddie Mac are government-sponsored enterprises (GSEs). They have been in federal conservatorship, run by the Federal Housing Finance Agency (FHFA), since September 2008, and the U.S. Treasury provides them a financial backstop. A UMBS from either company can be delivered to settle the same trade, so investors treat the two as interchangeable. What Fannie Mae and Freddie Mac are covers their role for homebuyers.

Private-label MBS carry no agency guarantee, so investors take the losses when borrowers default. Most of them, like most agency MBS, are backed by home loans; residential mortgage-backed securities (RMBS) covers that market. CDOs compared with MBS explains how securities built from other debt differ.

How does your monthly payment reach investors?

1. You pay your servicer, the company that sends your statements. If you have an escrow account, it pays your property taxes and insurance from it.
2. The servicer keeps its servicing fee and sends the principal and interest onward. For Fannie Mae pools, the servicer must send the scheduled principal and interest even if you did not pay that month.
3. The guarantor takes its guaranty fee for promising investors their payments.
4. Investors receive the remaining principal and interest payments, with interest calculated at the pass-through rate.

That means the rate on your loan, called the note rate, equals the investors' pass-through rate plus the guaranty fee plus the servicing fee. Fannie Mae sets a minimum servicing fee of 0.25% a year on fixed-rate loans. Example: on a 6.50% loan in a pool paying investors 6.00%, the other 0.50% is split between the servicer, which gets at least 0.25%, and Fannie Mae's guaranty fee.

When borrowers stop paying: the servicer or guarantor keeps advancing payments to investors. Fannie Mae and Freddie Mac use a 24-month delinquency trigger for pool buyouts, with earlier removal for events such as permanent modification or foreclosure referral. Ginnie Mae lenders may buy out loans that have been in default for 90 days or more. Investors then get that loan's remaining principal back early. The loan's owner changes, but the borrower still deals with the servicer about catching up or a modification. How MBS work as an investment explains what these buyouts and early payoffs mean for investors.

What changes for you if your loan is in an MBS pool?

Your note does not change. The rate, monthly payment, balance, and remaining term stay exactly as you signed them. What can change:

• Who owns the loan. When ownership changes, the new owner generally must send you a notice by the 30th day after the transfer with its name, address, and phone number. Ginnie Mae is not the owner of loans in its pools, only the guarantor of the securities.
• Who services the loan. A lender that pools your loan can keep servicing it, as Ginnie Mae issuers do. If servicing moves, the old servicer must tell you at least 15 days before the transfer and the new servicer within 15 days after. For 60 days after the transfer, a payment the old servicer receives on time cannot be treated as late.
• Whose rules apply if you fall behind. Your servicer still handles collections and help, but the options come from the loan's program: FHA, VA, or USDA rules for loans in Ginnie Mae pools, and Fannie Mae or Freddie Mac rules for theirs.

To find out who owns your loan, send your servicer a written request, using its designated address for information requests if it has one. It must identify the owner within 10 business days after receiving your request. Freddie Mac also offers a free online Loan Look-Up Tool. The difference between a servicer and a mortgage holder explains which company to contact for what.