April 20, 2006
A little academic back-to-basics
Mortgage securities represent an ownership interest in mortgage loans made by financial institutions (savings and loans, commercial banks or mortgage companies) to finance the borrower’s purchase of a home or other real estate. Mortgage securities are created when these loans are packaged, or “pooled,” by issuers or servicers for sale to investors. As the underlying mortgage loans are paid off by the homeowners, the investors receive payments of interest and principal.
Investors may purchase mortgage securities when they are issued or afterward in the secondary market. Investments in mortgage securities are typically made by large institutions when the securities are issued. These securities may ultimately be redistributed by dealers in the secondary market.
The most basic mortgage securities, known as “pass-throughs,” or participation certificates (PCs), represent a direct ownership interest in a pool of mortgage loans. These mortgage securities may be pooled again to create collateral for a more complex type of mortgage security known as a Collateralized Mortgage Obligation (CMO) or, since 1986, as a Real Estate Mortgage Investment Conduit (REMIC). CMOs and REMICs (terms which are often used interchangeably) are similar types of securities which allow cash flows to be directed so that different classes of securities with different maturities and coupons can be created. They may be collateralized by mortgage loans as well as securitized pools of loans.
