Mortgage-backed securities (MBSs) are investment products that have been around for decades, but they gained notoriety after the 2008 financial crisis. Today, MBSs remain a popular choice among investors looking for stable income streams. However, many people still wonder, “Can I buy a mortgage-backed security?” The answer is yes, and in this comprehensive guide, we’ll explore everything you need to know about buying MBSs.
Can I Buy a Mortgage-Backed Security?
Yes, anyone can buy mortgage-backed securities as long as they have access to the financial markets through a brokerage account. MBSs are a type of bond backed by a pool of mortgages. When an individual or institution buys an MBS, they essentially purchase a slice of the underlying mortgage pool’s cash flow. As homeowners make their monthly mortgage payments, investors receive interest and principal payments on their MBS investments.
Buying MBSs is different from purchasing individual stocks or bonds because they are not readily available on stock exchanges. Instead, investors can buy them through their brokerage accounts or invest in exchange-traded funds (ETFs) that hold MBSs. But before diving into the details of how to buy MBSs, let’s understand the types of MBSs available.
How Do Investors Buy Mortgage-Backed Securities?
When it comes to buying MBSs, there are several options available. Investors can choose to invest directly in specific MBSs or opt for MBS ETFs. Here are some ways to buy MBSs:
Pass-Through Securities
Pass-through securities are the most common type of MBSs. They represent direct ownership of a pool of mortgages, and investors receive a proportional share of interest and principal payments made by homeowners. These payments are usually distributed on a monthly basis.
One significant advantage of pass-through securities is that they provide a more stable income stream compared to other fixed-income investments. This stability is due to the collateralization of the mortgages, which means that if a homeowner defaults on their mortgage, the MBS investor still receives payments from other homeowners in the pool.
Collateralized Mortgage Obligations (CMOs)
CMOs are another type of MBSs that divide the mortgage pool into tranches or groups with different risk and return profiles. Each tranche represents a specific portion of the mortgage pool’s cash flow, and investors receive payments based on the tranche they invest in.
For example, a CMO may have three tranches: A, B, and C. Tranche A receives the first payments made by homeowners, followed by Tranche B and then Tranche C. As a result, Tranche A has lower risk and lower yields, while Tranche C has higher risk and potentially higher returns.
Government-Sponsored Enterprise (GSE) MBSs
GSE MBSs are issued by government-sponsored enterprises such as Fannie Mae, Freddie Mac, and Ginnie Mae. These institutions purchase mortgages from lenders, pool them together, and then issue securities backed by these mortgage pools.
One significant advantage of investing in GSE MBSs is that they come with government backing for the underlying mortgages. This means that investors have lower credit risk as the government guarantees the repayment of the mortgages.
Private-Label MBSs
Private-label MBSs are issued by non-GSE institutions such as banks, mortgage companies, and real estate investment trusts (REITs). Unlike GSE MBSs, private-label MBSs do not have government backing, making them riskier investments.
However, private-label MBSs typically offer higher yields to compensate for the higher risks involved. These types of MBSs are also more customizable, allowing investors to choose the underlying mortgages and the structure of the securities.
Are Mortgage-Backed Securities a Good Investment Now?
Like any other investment, the performance of MBSs depends on various market factors such as interest rates, economic conditions, and housing market trends. However, historically, MBSs have been a reliable source of income for investors, especially during periods of low-interest rates.
During the 2008 financial crisis, MBSs were at the center of the collapse of the housing market. However, the market has since then recovered, and MBSs have continued to offer stable returns for investors. In 2020, despite the economic downturn caused by the COVID-19 pandemic, MBSs delivered an average return of 7.5%.
However, it’s essential to note that MBSs are still subject to market fluctuations and risks, such as prepayment risk and credit risk. Therefore, it’s crucial to research and understand the current market conditions before making any investment decisions.
Who Typically Buys Mortgage-Backed Securities?
MBSs are popular among a wide range of investors, from individual retail investors to large institutions. Here are some of the key players in the MBS market:
Banks and Financial Institutions
Banks and other financial institutions are among the largest buyers of MBSs. These institutions purchase MBSs to diversify their investment portfolios and generate stable returns.
Pension Funds and Insurance Companies
Pension funds and insurance companies also invest in MBSs to generate income to meet their long-term obligations, such as pension payments and insurance claims.
Individual Investors
Individual investors can buy MBSs through their brokerage accounts or invest in MBS ETFs. MBSs can provide a steady stream of income, making them attractive for retirees looking for a reliable source of passive income.
Hedge Funds and Asset Managers
Hedge funds and asset managers also invest in MBSs, particularly in private-label MBSs, to take advantage of higher yields. These institutions have the resources and expertise to analyze and invest in different types of MBSs.
Can I Buy Mortgage Backed Securities?
Yes, you can buy mortgage-backed securities through your brokerage account or invest in MBS ETFs. However, it’s essential to research and understand the MBS market and the specific type of MBS you want to invest in before making any investment decisions.
Mortgage-Backed Securities Example
To better understand how MBSs work, here’s an example:
Let’s say you have $100,000 to invest and decide to buy an MBS with a 5% interest rate. This MBS has a maturity period of 15 years, and homeowners make monthly payments on their mortgages.
With this MBS, you will receive a monthly payment of $416, representing a portion of the interest and principal payments made by homeowners. Over the next 15 years, you will receive regular payments until the MBS reaches maturity.
Mortgage-Backed Securities ETF
Investing in MBS ETFs is another way to gain exposure to the MBS market. These ETFs hold a basket of MBSs, providing investors with a diversified portfolio of MBS investments. Moreover, investing in ETFs allows for greater liquidity, as they can be easily bought and sold on stock exchanges.
Here are some popular MBS ETFs:
- Vanguard Mortgage-Backed Securities ETF (VMBS)
- iShares MBS ETF (MBB)
- SPDR Portfolio Mortgage Backed Bond ETF (SPMB)
Buying Mortgage-Backed Securities with Fidelity
Fidelity Investments is one of the largest brokerage firms in the United States, offering a wide range of investment options, including MBSs. Here’s how you can buy MBSs with Fidelity:
- Open a brokerage account with Fidelity.
- Research and select the MBS you want to invest in.
- Place an order for the MBS through your brokerage account.
- Monitor your investment’s performance and manage it accordingly.
Mortgage-Backed Securities 2008: Lessons Learned
The 2008 financial crisis was a wake-up call for the MBS market, which played a significant role in the collapse of the housing market. The crisis exposed the flaws in the mortgage lending system and the lack of proper risk management practices by financial institutions. As a result, MBSs became synonymous with high-risk investments, and investors became wary of investing in them.
Since then, regulators have implemented stricter regulations, and financial institutions have become more cautious when issuing MBSs. Consequently, the MBS market has recovered, and investors continue to see stable returns from MBS investments.
Best Mortgage-Backed Securities ETFs of 2021
Here are some of the best-performing MBS ETFs in 2021:
- iShares MBS ETF (MBB): This ETF holds a diverse portfolio of investment-grade MBSs, providing investors with a mix of government-backed and private-label MBSs.
- SPDR Portfolio Mortgage Backed Bond ETF (SPMB): This ETF provides exposure to government-backed MBSs with a focus on liquidity and credit quality.
- Vanguard Mortgage-Backed Securities ETF (VMBS): This ETF tracks the performance of the Bloomberg Barclays US MBS Float Adjusted Index and offers low-cost exposure to MBSs.
Agency MBS vs. Non-Agency MBS
When investing in MBSs, another important distinction is between agency MBS and non-agency MBS. Agency MBSs are issued by government-sponsored enterprises, while non-agency MBSs are issued by private institutions. The primary difference between the two is that agency MBSs have government backing, while non-agency MBSs do not.
Investing in agency MBSs is generally considered less risky than investing in non-agency MBSs. However, non-agency MBSs may offer higher returns to compensate for the higher risks involved.
Mortgage-Backed Securities Interest Rates
Mortgage-backed securities interest rates are closely tied to the overall interest rate environment. When interest rates are low, homeowners are more likely to refinance their mortgages, resulting in lower prepayment rates for MBS investors. On the other hand, when interest rates increase, prepayment rates tend to decrease, resulting in higher returns for MBS investors.
Additionally, the Federal Reserve’s monetary policy and economic conditions also play a significant role in determining MBS interest rates.
Conclusion
Mortgage-backed securities can be a valuable addition to any investor’s portfolio, offering stable income streams and diversification benefits. However, they are not without risks, and it’s crucial to understand the different types of MBSs, market conditions, and investment strategies before purchasing them. As with any investment, it’s always advisable to consult with a financial advisor and conduct thorough research before making any investment decisions.
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