Smart Bond Investing

Individual Bonds


Mortgage-Backed Securities

Bond Fact

Unlike most bonds that pay semiannual coupons, investors in mortgage-backed securities receive monthly payments of interest and principal.

Mortgage-backed securities, called MBSs, are bonds secured by home and other real estate loans. They are created when a number of these loans, usually with similar characteristics, are pooled together. For instance, a bank offering home mortgages might round up $10 million worth of such mortgages. That pool is then sold to a federal government agency like Ginnie Mae or a government-sponsored enterprise (GSE) such as Fannie Mae or Freddie Mac, or to a securities firm to be used as the collateral for the new MBS.

The majority of MBSs are issued or guaranteed by an agency of the U.S. government such as Ginnie Mae, or by government-sponsored enterprises (GSEs), including Fannie Mae and Freddie Mac. Mortgage-backed securities carry the guarantee of the issuing organization to pay interest and principal payments on their mortgage-backed securities. While Ginnie Mae's guarantee is backed by the "full faith and credit" of the U.S. government, those issued by GSEs are not.

A third group of MBSs is issued by private firms. These "private label" mortgage-backed securities are issued by subsidiaries of investment banks, financial institutions and homebuilders whose creditworthiness and rating may be much lower than that of government agencies and GSEs.

The minimum investment amount is generally $1,000 (although it's $25,000 for Ginnie Maes). Secondary trading of mortgage-backed bonds is relatively liquid in normal economic conditions and done over the counter, between dealers. Investors work with brokers, preferably those with specialized expertise in the mortgage bond arena, to buy and sell these bonds.

Because of the general complexity of mortgage-backed securities, and the difficulty that can accompany assessing the creditworthiness of an issuer, use caution when investing. They may not be suitable for many individual investors.

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