Mortgage backed securities:

A mortgage-backed security (MBS) is an asset-backed security that represents a claim on the

cash flows from mortgage loans through a process known as securitization.

In finance, a mortgage-backed security (MBS) is an asset-backed security whose cash flows

are backed by the principal and interest payments of a set of mortgage loans. Payments are
typically made monthly over the lifetime of the underlying loans.

Securitization:

The process of securitization is complicated, and is highly dependent on the jurisdiction upon
which the process is conducted. The basics are:

1. Mortgage loans (mortgage notes) are purchased from banks and other lenders and
assigned to a trust
2. These loans are assembled into collections, or "pools"
3. These trusts securitize the pool and issue mortgage-backed securities, with
documentation that identifies the underlying loans.

Types:

The mortgage backed securities can be divided into various kinds, but the most prominent
mortgage backed securities are:

 Residential mortgage backed securities

 Commercial mortgage backed securities
 Collateralized mortgage obligation
 Stripped mortgage backed securities

Residential mortgage backed securities:

The residential mortgage backed securities (RMBS) are special bonds found in the security market in
the US and are the kind of securities which are supported by private property especially the house of
the mortgagor, this private property here serves as the collateral

A type of security whose cash flows come from residential debt such as mortgages, home-equity loans
and subprime mortgages. This is a type of mortgage-backed securities that focuses on residential
instead of commercial debt.

Holders of an RMBS receive interest and principal payments that come from the holders of the
residential debt. The RMBS comprises a large amount of pooled residential mortgages.
Commercial mortgage backed securities:

Commercial mortgage-backed securities (CMBS) are a type of mortgage-backed security backed by

mortgages on commercial rather than residential real estate.

A type of mortgage-backed security that is secured by the loan on a commercial property. A CMBS
can provide liquidity to real estate investors and to commercial lenders. As with other types of MBS,
the increased use of CMBS can be attributable to the rapid rise in real estate prices over the years.

Commercial Mortgage-Backed Securities [CMBS] are major financing options that the individual
investor can consider while making his choice of investments. They are Mortgage-Backed Securities
that are mortgage loans offered on commercial properties such as multifamily properties like
apartments, office properties, industrial properties, hotels, restaurants, shops, malls, and other
commercial sites.

Collateralized mortgage obligation:

A type of mortgage-backed security that creates separate pools of pass-through rates for different
classes of bondholders with varying maturities, called tranches. The repayments from the pool of
pass-through securities are used to retire the bonds in the order specified by the bonds' prospectus.

Here is an example how a very simple CMO works: The investors in the CMO are divided up into
three classes. They are called either class A, B or C investors. Each class differs in the order they
receive principal payments, but receives interest payments as long as it is not completely paid
off. Class A investors are paid out first with prepayments and repayments until they are paid off.
Then class B investors are paid off, followed by class C investors. In a situation like this, class A
investors bear most of the prepayment risk, while class C investors bear the least.

Stripped mortgage backed securities:

A stripped mortgage-backed security (SMBS) where each mortgage payment is partly used to
pay down the loan's principal and partly used to pay the interest on it. These two components
can be separated to create SMBS's, of which there are two subtypes:

 An interest-only stripped mortgage-backed security (IO) is a bond with cash flows

backed by the interest component of property owner's mortgage payments.
 A principal-only stripped mortgage-backed security (PO) is a bond with cash flows
backed by the principal repayment component of property owner's mortgage
payments.
Term of Mortgage

It depends on the kind of mortgage applied for, like the fixed rate mortgage is spread over a
period of 10 to15 years and the adjustable rate mortgage is spread over a comparatively short
time span like 2 years, 5 years or 7 years.

The Indian mortgage financing rates are of the following types -

Fixed Mortgage Rate - in this case the rate of interest remains fixed throughout the loan term. The
mortgage rates does not varies according to market conditions. In other words, the rate of interest is
pre-fixed during the process of borrowing and it generally varies between between 12.5 % to 25 %.

Flexible Mortgage Rate - is one in which the interest rate varies according to market movements. This
type of interest rate is called 'adjusting' or 'floating' rates. The risk factor is high in this type of interest
rates.

Advantages of Mortgage Backed Securities:

The need of mortgage backed securities has been felt in the past few years by the mortgage originators
to refill their investments. The mortgage backed securities aid in the development of new instruments
to collect funds from the market, as the mortgage backed securities are usually very economic and
more effective than the other financing instruments offered by the banks and the other forms of
financing issued by the central government. The mortgage backed securities mainly aid the companies
dealing in these securities, to posses a better alternative than the assets owned by them. The financing
companies will now be relieved of the costs of maintenance of the assets and other costs related to
assets, which will reduce their overheads immensely and increase the profit ratio.

Special Feature of Mortgage Backed Securities:

The commercial mortgage-backed securities are bought in exchange of offices, manufacturing units,
land, multi-story buildings, and hotels, which means that they are gained against the personal or
commercial holdings. The loans provided in lieu of the above mentioned collaterals can be extended
beyond 5 years at fixed interest rates and may not provide the facility of paying off the loans before
the specified tenure. These loans are also stretched over shorter periods like a maximum of 3 years
with the facility of payment before time and are mostly accompanied by adjustable interest rates.

Exceptions to Mortgage Backed Securities:

The mortgage-backed securities can, however, prove problematic in case of the home mortgage
lenders of the United States of America, as home loan applicants there are provided with the facility
to make the loan payment before time to cover up a part of the next month's interest amount. Such
activities have a deep impact on the loan amount and the inconsistencies in payment make it difficult
to have an idea about the exact amount of funds to be obtained at every month from the mortgage-
backed securities.

Uses:

There are many reasons for mortgage originators to finance their activities by issuing mortgage-
backed securities:

MBS  transform relatively illiquid, individual financial assets into liquid and tradeable capital market
instruments.

 It allow mortgage originators to replenish their funds, which can then be used for additional
origination activities.

They are frequently a more efficient and lower cost source of financing in comparison with other bank
and capital markets financing alternatives.

It allow issuers to diversify their financing sources, by offering alternatives to more traditional forms
of debt and equity financing.

It allow issuers to remove assets from their balance sheet, which can help to improve various
financial ratios, utilize capital more efficiently and achieve compliance with risk-based capital
standards.